Last week we opened this series by looking at
why, in the middle of these unprecedented times, there is a need for us as investors
to be aware of the concept of disruptive innovation. In times of crisis, the
process of disruptive innovation within businesses and industries accelerates; the
COVID-19 pandemic is proving to be yet another of these inflection points.
The reality is however, that disruptive innovation is not a new phenomenon. As a popularised concept it has been around for over 20 years’ – in practise, it has been part of the natural order of development for many industries since before the industrial revolution.
However, we believe that we have reached an inflection point in time, in which disruptive innovation is not only becoming more impactful, but it also accelerating. The pandemic might have thrown the spotlight on this, but the momentum was already there. With that in mind, what we need to do now is seek a more in depth understanding of disruptive innovation and why it should matter to us.
A dictionary definition of disruptive innovation
Disruptive innovation is a phrase that was first coined by Clayton Christensen, a professor at Harvard Business School, in 1997. It describes the process by which a product or service is introduced to the market and then relentlessly moves upmarket, eventually displacing established competitor products and in some cases, upending entire business models.
Disruptive innovations are not necessarily breakthrough technologies, but rather they can often be innovations that enhance the accessibility and affordability of existing products and services, thereby making them available to a larger proportion of the population. Despite the phrase only being popularised in the late 90’s, the evolutionary trend of disruptive innovation has actually been around for centuries. Think about the invention of the steamboat in 1807, the transistor radio in 1947, or the digital camera and personal computer in 1975, as hallmark examples.
Underestimate it at your peril
For a well-trodden and yet continually fitting example of how impactful disruptive innovation can be, we can look to Kodak, the American consumer electronics company whose name was synonymous with photography. For the best part of a century the company dominated its core market – at one point in the 1980’s it commanded an 85% share of all film cameras and 90% of all film sold in the United States. It even invented the digital camera. At its peak, Kodak was a corporate behemoth with a $31 billion market capitalisation, generating more than $16 billion in revenue and $2.5 billion in net profit annually.
The average tenure of a company on the S&P 500 has never been shorter than it is currently. In 1965, the average length of time a company on the S&P 500 was 33 years. By 2016, this had fallen to 24 years.
Not only that, but since 1990, the number of photos taken by individuals has risen exponentially from 80 billion per year to 2.5 trillion per year today. With such a strong foothold in their core markets and robust underlying financials, it appeared that Kodak could only continue to dominate and prosper from the strong growth in the digital photography market.
What followed was a catastrophic failure on the part of Kodak’s management to pursue technological development, ultimately at the expense of the company, employees and shareholders. The shift from analogue into digital photography brought with it a new wave of innovative competitors, to which Kodak rapidly lost ground.
Kodak filed for bankruptcy in 2012. In that same year, Instagram, the smartphone based photography-sharing app with no revenue, 30 million users and just 13 employees was acquired by Facebook for $1 billion.
Disruptive innovation is picking up the pace
As we said earlier, although the concept of disruptive innovation has been around for so long, we are now seeing it become more impactful and faster accelerating, driven by rapid technological advancements.
This has led to an increasing number of these “Kodak moments” in recent years; Staples, Blockbuster and Blackberry are just a few more examples of large multi-national corporations that have lost considerable market value or indeed declared bankruptcy over the last decade due to disruptive innovation within their markets.
The average tenure of a company on the S&P 500 has never been shorter than it is currently. In 1965, the average length of time a company on the S&P 500 was 33 years. By 2016, this had fallen to 24 years. It’s estimated that this could shrink even further, to just 12 years by 2027. That means that approximately half of the current S&P 500 constituents will be removed from the index over the next decade.
What will all this bring next?
For us as responsible and sustainable investors, disruptive innovation creates an expansive opportunity set of investable businesses. At EdenTree, we seek to invest in those companies providing a long-term solution to a pressing socio-economic challenge, and therefore innovation is often inherent within our holdings.
Equally, disruptive innovation presents a number of risks for investors. As Kodak proved, a dominant market position for an industry incumbent counts for nothing if that market is facing structural challenges. Consequently, for investors, assessing a company’s commitment to constantly improve and evolve forms a key part of the fundamental investment process. Heraclitus, a philosopher of flux who lived 2,600 years ago, wrote, “Nothing endures but change.” We underestimate its pace at our own peril.
The next instalment of Tom’s Disruptive Innovation series will be published next week, looking at some of the driving forces behind the acceleration of disruptive innovation. Check back on our Insights Hub to continue reading, or follow us on Twitter at @EdenTreeIM or search for us on LinkedIn so that you can get updates on new posts.