A long time ago when I worked as a management consultant, I did a study for Lafarge which has a huge cement business. The study involved real sleuthing as we were trying to determine the operational capacity of cement plants owned by others and under construction all around Europe. At times I felt like a spy as I was hanging out counting trucks going in and out of facilities and sidling up to engineers who worked there as they were getting coffee before work.

Why all the sleuthing? Well, Lafarge understood well that cement was a capacity industry with boom and bust cycles. They wanted to figure out where the cycle was in order to figure out whether or not they should build more capacity themselves. The cycle in cement looks something like this: construction in a region heats up increasing the demand for cement. Since supply is inelastic the price rises. All of a sudden it becomes very profitable to build a new cement plant. Several players rush in and all build new cement plants. This upswing may continue for some time with all the new plants profitable too and even more coming online. Then construction slows down and voila: an overcapacity of cement factories results in a supply overhang which in turn causes a collapse of cement prices. The collapse is dramatic because the construction cost of the plant is sunk cost.

Venture capital shares some of the characteristics of the cement industry. It is a capacity industry also because it takes a long time to raise a fund, but once you have raised a fund, it has capacity to invest for a long time period (often 4-5 years). When there is a wave of innovation it produces good investment returns which results in many new funds being raised. Again this capacity build up will continue as long as returns are good. Existing funds will raise bigger funds, new funds will be formed and corporations spin up their own venture arms. Inevitably of course the innovation wave will run its course and now you are left with an overcapacity of funds to invest. The equivalent of the price of cement collapsing is the collapse of returns.

The funds that perform worst will be the ones that entered most recently or expanded the most *and* are following the existing playbook in the industry. The ones that will do best are the ones that remain disciplined in size and also are looking actively for the next wave of innovation. The most promising candidates in terms of innovation are blockchains and hard sciences (especially in medicine, but also materials, energy and possibly space). For signs of bust look for more investments like Juicero.

I have been looking for global statistics on the expansion of committed capital for the current cycle but have so far only found regional ones and they show a strong expansion of capacity. Since the Internet innovation cycle has been a global one and since investors have been deploying capital with far fewer geographic restrictions than before it would be interesting to see the global amounts added up.