Read more »

"> Read more »

" />


Technological disruption and financial markets


What is disruption?

Disruption is to displace an existing market, an industry or technology to create something new in a more efficient manner which creates greater value. It is also destructive and creator and few companies are immune.

Company leaders play a very important role. We can take as an example the case of Kodak; in the 2000’s, which was a company that had robust financial information: revenue for $14 billion and net profits for $1,4 billion dollars. Its main business line was the sale of rolls of films, each film allowed for the printing of 24 images approximately. However, in 2012, only 12 years after that, the company declared to be bankrupt due to the greater use of digital cameras. Ironically, digital cameras were invented and patented by Kodak 35 years before, but their leaders, at that moment, decided to keep its old DNA and not to change it; this decision made them lose the company.

When does technological disruption occur?

Tony Seba, a recognized leader, and expert in disruptive technologies, author of the book “Clean Disruption of Energy and Transportation” states that technological disruption occurs when “convergence” takes place.

We all know that Steve Jobs is a great visionary, but history has forgotten to give credit to the role technology played in the creation of the iPhone. Have you ever asked why iPhone was launched in 2007?

If iPhone was real in 2007, this is because each of the technologies necessary for its creation had a possible production cost that allowed to combine and create the first Smartphone. This process is the “convergence” defined by Tony Seba. What were these technologies? Transmission of a bit for dollar, digital image (dollar for pixel) and lithium battery (cost of kilowatt per hour for a dollar).

Are we going through a technological disruption?

One thing is clear the world is not what it was 10 years ago. Technological disruption has reduced companies’ average lifetime that is part of the S&P 500 rate in a substantial manner. In 1964, this was 33 years, in 2016 it was reduced to 24 years and according to an Innosight study, for the year 2027, average life will be of 12 years (see graphic I).

Companies of greater value nowadays are companies that have changed the rules of the game. Domain of digital platforms has changed the business model of many industries such as banking, health, transport, tourism, telecommunication, and real estate, among others.

Digital platforms are powerful as they provide possibilities to expand to new growing markets, regardless of what part of the world they are in, at a speed that has never been seen before.

At the end of 2018, five companies that work with digital platform technology represent a market value of around $3.4 trillion dollars. These companies are: Microsoft, Apple, Amazon, Google, and Facebook (see Table I). Only these companies make up for 32% of the Nasdaq rate, which at closing in March 2019 had a YTD of 15.49%.

Source: Bloomberg

How do company leaders face this reality?

Company leaders and Wall Street coincide in the following: every year the feasibility of a company depends on its ability to innovate.

Under what level they recognize the need to change, defined as “changing core transactions or business model”.

According to a survey made in 2017 by Innosight, leaders are aware of the importance of technological disruption and innovation. Eighty percent stated that their companies need to change, that is, renew their DNA.

However, reality expectation is distant. According to an article published in Harvard Business Review “ManagingYourInnovation Portfolio”, it is shown that efforts of companies to innovate are not well oriented.

All companies have three types of innovative activities:

  • Core activities: changes in existing products
  • Adjacent activities: they allow the company to take advantage of their existing capacities for new uses.
  • Changing activities: they create new offers or change a complete business model for new markets or consumers.

Instead of focusing on changing and adjacent activities, which would generate a greater return on investment, attention of leaders focuses on initiatives related to core activities, they focus on keeping their old DNA as they are doing well. However, focusing on core innovations divides the cake into smaller portions as the only thing they do is to increasingly divide the market and does not help it grow.

                              Graph 1: Innovation activities v. Return

  • Source: “Managing Your Innovation Portfolio. Nadji, B. and Tuff, G. Harvard Business Review. May 2012.

Technological disruption and financial markets

As investors, it is important that disruptive companies with a “transformation” culture” are part of our portfolio. According to Tony Seba, the 2020s will be the most disruptive one, so at K&B, through an exhaustive analysis, we have identified the four sectors that will have a greater economic impact for the year 2025: Internet of Things, Cloud Computing, Artificial Intelligence, and Fintech (see graphic 1), and based on this analysis, we have questioned our house fund, which at the end of March 2019 had a yield of +23.3% YTD.

 

Technology has totally changed the manner in which industries operate their business and technology companies are the ones that have grown the most as they continue innovating. Microsoft, Apple, Amazon, Google, and Facebook have had an annual growth for 10 years of 26.3%. Just to compare, the S&P 500 rate, for this same period, has had an annual growth made of 10.7%.

 

For more information, contact:
Lisamarie De Rinjonneau
Portfolio Analyst
+ (507) 209 2944
[email protected]

Oct 10, 2019