Keeping an eye on the left field
We spend a lot of time thinking about how defendable the competitive advantage is of the companies we invest in. For us this means understanding the breadth and sustainability of the protective moat around the business which underpins profitability and growth. A broad moat tends to be multifaceted incorporating persistent innovation, deep customer relationships and technological expertise. We view this as a key signpost for a company with the ability to deliver long term value.
However, focusing exclusively on the playing fields where a company already competes can leave investors (and CEOs) blinkered to events ‘out of left field’. Disruptive technology can shift the goal posts, and even the field of play. Further, the ‘winner takes all’ nature of new technology means the viability of incumbent business models can potentially be challenged. Given the size of the downside risk we try to incorporate a regular re-assessment of innovative threats to our invested businesses.
This is often easier said than done, however. Technologies which ultimately become disruptive tend to manifest in unpredictable ways and can work against the grain of the prevailing cultural inertia. Technology which is ubiquitous today often languished beneath the collective conscious radar until a critical mass was reached and adoption exploded. The speed of this adoption is often driven by recommendation and thus the advent of social media has vastly accelerated the pace of disruption.
An oft cited example is Netflix vs. Blockbuster. In 2000 Netflix, then a small start-up, proposed a commercial tie up to Blockbuster, and was summarily rejected. Retrospectively we can see this as a clear strategic misstep: in 2002 Netflix had a market cap of $300m versus Blockbuster’s $1.6bn. By 2010 Blockbuster had filed for bankruptcy and Netflix is now worth $68bn. However, at the time Blockbuster dominated the market through a vast retail presence and massive marketing budgets. It was the de facto market leader. Management, rooted in the established model, failed to perceive the value consumers would come to place on a subscription based model which avoided late fees (a core earner for Blockbuster). Once streaming was introduced the barriers to adoption dropped and the feedback loops via social networks created a swift virtuous circle. The market was equally slow to see the potential. Using a log scale shows the percentage moves in Netflix, removing the distortion of the size of the current price. We can see that the market only started to come alive to the investment opportunity in the run up to the Blockbuster bankruptcy.
We are cognizant of this hindsight bias and our limitations in accurately predicting the pathways of technological change. We try however to identify vulnerabilities to overarching trends and move rapidly when those trends achieve critical mass. For example we monitor closely nascent applications of blockchain and machine learning where the scale of the disruptive potential is still unknown. Multiyear consumer trends have the potential to be even more destructive. For example stuffocation, the trend towards experientialism and away from materialism as coined by James Wallman, is an existential threat to many traditional industries.