No one expects a company to live forever, but the rate of attrition of top companies is accelerating. From 1955 to 1975, the roster of the U.S.’ top 500 companies churned an average of 11 per year. From 1976 to 1995, that figure rose to 15 per year; and from 1996 to 2012 it was 21 per year — almost doubling from the heyday of postwar American capitalism.
Of course, there are many reasons for this accelerating attrition rate — mergers, poor management, and spinoffs, for example. Over the last 15 years, though, technologically-driven disruption has become a more prominent cause. As we have frequently commented in this letter, we believe that the economy of the developed world is approaching a technological singularity with big data, cloud computing, artificial intelligence, the internet of things, and digital disintermediation. This means that the rate of incumbents’ attrition will accelerate even further.
The Digital Vortex
We recently read a report from the Global Center for Business Transformation, a joint initiative of the International Institute for Management Development in Lausanne (IMD) and Cisco Systems (NASDAQ: CSCO). The authors set out to survey attitudes of executives in almost a thousand global companies to gauge their fears and plans to counter and embrace new, digitally disruptive competition and technology. They settled on the analogy of a vortex, such as a whirlpool or a cyclone:
“Given the chaos and complexity of digital disruption, it can be difficult to discern patterns or ‘laws of nature’ in this rapidly evolving competitive landscape… The construct of a vortex helps to conceptualize the way digital disruption impacts firms and industries. A vortex exerts a rotational force that draws everything that surrounds it into its center…
“The Digital Vortex is the inevitable movement of industries toward a ‘digital center’ in which business models, offerings, and value chains are digitized to the maximum extent possible. Physical and digital sources are separated by the force of the vortex, creating ‘components’ that can be readily combined to create new disruptions, and blurring the lines between industries.”
Powering the Vortex
What is driving the vortex is simply the value that is delivered to consumers as digital upstarts sidestep many of the costly and burdensome impediments faced by incumbents — incumbents who find themselves highly “encumbered” by capital costs and regulatory requirements. It used to be that having economy of scale was valuable — but one of the critical features of the digital vortex is that it renders scale increasingly cheap and easy to acquire. Consider the infrastructure investment that was required for telecom incumbents to build out their networks for cell phone communication — and compare it with the growth of digital disruptor applications such as WhatsApp, owned by Facebook (NASDAQ: FB), or SnapChat. As we commented last week in our discussion of “wi-fi first” cellphones, telecom incumbents are projected to lose 6 billion in revenue to these upstarts over the next four years. Digital disruptors can grow fast because they don’t need to sink the capital costs of incumbents, and they can sidestep onerous regulation while they deliver superior value, superior experiences, and superior networking power to their customers.
Pulling Businesses Apart and Recombining Them
This points to another characteristic of the disruptors: their capacity to pull apart existing business models, unbundle them, and seize profitable shares of existing businesses without needing to reproduce their whole value chain. The communications disruptors mentioned above are prime examples, as are many digital disruptors in
“fintech” — tech companies operating in various segments of finance. Full-service banks are facing digital lending, savings, payment transfer, and investment disruptors — intent not on taking all of their business, but on taking a piece of it. Companies such as Alibaba (NYSE: BABA) are combining fintech with e-commerce and other disruptive businesses in unexpected ways. Old suites of products and services will be pulled apart and reconfigured.
Just as the nature of digitization is “granular,” the push of digital disruption is towards more and more “granularized” offerings — focusing on individual products and services and on customization. Incumbents increasingly feel that their revenue streams have “sprung leaks” and that they are suffering “death by a thousand cuts.” Looking for the disruptors, therefore, isn’t a matter of spotting a “digital replacement” for a full-service bank or an auto manufacturer. Disruption will mean revenue streams being peeled off incumbents, and perhaps recombined in new ways.
Tesla Motors (NASDAQ: TSLA) is a case in point. It started as a car company. Then CEO Elon Musk announced the project of his “Gigafactory” to dominate energy storage. And recently he unveiled a plan to offer whole-house batteries which can store solar-generated power during peak use, and draw from the grid when power is cheaper. This reconfiguration is typical of the disruptors — industries are no longer water-tight, and incumbents can find themselves being challenged from sudden and unexpected directions. Lo and behold, TSLA is not fundamentally a car company, it’s an energy company — or perhaps more accurately, it’s both and neither.
But This Time Might Not Be Different
While reviewing fintech companies, we came across one called OnDeck (NYSE: ONDK), which serves as an alternative source for loans for small businesses. An analyst commented, “Businesses have flocked to OnDeck because it uses a proprietary method to evaluate creditworthiness that works better than the personal credit check that banks rely on. OnDeck is also faster—loans can be processed within a day. Banks sometimes take weeks to make a decision.”
This reminded us that as much value as digital disruption can give consumers, this time is not necessarily different — and particularly among the fintechs, we think it’s likely that some will show what might be called “big data hubris.” In the end, digitization relies on human models — and when human models prove wrong, they are merciless in pulling down those who have relied on them. Although we are far from another Internet bubble, investors must still examine businesses with a critical eye.
Investment implications: The arrival of the era of “digital disruption” will accelerate the attrition rate of the U.S. and the world’s top companies. Incumbents in every sector will find themselves drawn into the “digital vortex,” where many aspects of their business that can be digitized, will be digitized. In the process, they will face challengers who rise with great speed to siphon off revenue streams — and these competitors will be able to build scale quickly and sidestep a lot of the onerous regulations that constrain incumbents’ day-to-day operations. We continue to favor disruptors in biotechnology (with big data applications in genomics), tech, and cybersecurity.
For more commentary or information on Guild Investment Management, please go to guildinvestment.com.
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