As my series on the beginner's guide to investing nears its end, I focus on a controversial area, but one I think all investors need to understand, namely disruptive technology.
Beginner's guide to investing part 6: Disruptive technology
There is something about disruptive technology that many people don’t appreciate. In some ways, it goes against our intuition. There is no trend to speak of. With disruption, the change can occur incredibly quickly. Those who fail to spot it, can be left nursing heavy losses.
The best word I can think of to describe how disruptive technology works is whoosh. One moment some new technology or business model feels like a no-hoper, the next it is changing the world.
The smartphone is a good example. Apple’s then boss, the late Steve Jobs revealed the iPhone in 2007, in what is my all-time favourite business presentation. Up to that point, the mobile phone market was dominated by Nokia, and if you wanted to use your mobile phone for business, you used a Blackberry. And when the iPhone was announced, there were many cynics, including the then Microsoft boss, Steve Ballmer.
The truth is, if the iPhone had been released a year or so earlier, it would have died a death. Technology wasn’t ready at that point. It was a combination of wireless internet access, commoditisation of components and Moore’s Law that made the wireless smartphone practical. (Moore’s Law is named after Gordon Moore, the co-founder. of Intel, who in 1965 suggested that the number of transistors on an integrated circuit doubles every two years, leading to a doubling of computer power.)
But by the last few years of the last decade, conditions were right for a touchscreen smartphone. Ten years before the iPhone announcement, Apple was struggling for survival. Within a few years of this announcement, it became the biggest company in the world. Nokia, RIM/Blackberry and most famously of all, Kodak each went on to experience existential threats.
There was no notice. An investor who had ploughed money into Nokia, Blackberry/RIM or Kodak would have no doubt been following a very rational and well thought-out investment strategy, but nonetheless, they would have lost most of their money.
There is an important piece of theory that helps explain disruption, called Innovator’s Dilemma. I sometimes think it is the most important business idea of our age.
Innovator’s Dilemma, authored by the late Harvard Professor Clayton Christensen, was published in 1997. Intel co-founder Andy Grove said it was the best book he had read in ten-years. That was the same year that the first Harry Potter book was published, maybe Innovators Dilemma was to books in business what the JK Rowling series was to children’s books.
But in a way, I would say that Innovators Dilemma had more in common with Darwin’s Origin of Species than a scarred wizard. Darwin came along with what was actually a quite simple theory, (although it is remarkable how often it is misunderstood) which transformed our understanding of who we are. Innovator’s Dilemma transformed our idea of what a company must do to survive, long-term.
Because Innovator’s Dilemma presented such a radical view of business, many reacted in dismay — it was not a popular theory.
To explain: Innovators Dilemma is an attempt to model how companies in a market dominant position can lose their position of strength.
At first, Christensen looked at what he called the mudslide hypothesis — companies clinging to their position of strength, against a slippery cliff face. His analysis led him to reject this particular hypothesis, instead Innovator’s Dilemma was born. He took a specific example — the disc drive industry. The industry changed over time from 12-inch for mainframe computers, 8-inch for mini computers, 5.25 inches for desktops, 3.5 inches for laptops.
With each switch in the industry, the market leaders, with the exception of IBM, lost their position of pre-eminence, in many cases going bust.
It seems that the companies in question did all the things business gurus said that they should do. They surveyed the market, listened to customers, considered new technologies and canvassed the views of existing customers on these new technologies.
The trouble is, the customers didn’t know what they would want in a few years time. As Henry Ford is supposed to have said: “If you ask people what they want, they say faster horses.”
Or as Clayton Christensen said: “The popular slogan ‘stay close to your customers’ appears not always to be robust advice.”
In the case of the disc drive market, customers might have taken one look at 5.25 inch drives for desktops and said: “Don’t touch, they are little more than toys.”
Often it was the marketeers who gave this advice, the techies, the engineers often had a much better grasp of where things were going.
Tesla and electric vehicles are classic examples of disruptive technology. Until a few years ago, the sensible, pragmatic business case for either Tesla or electric vehicles was not strong. But advances in battery technology, advancing knowhow in how to manufacture electric vehicles and fears over climate change, combined to change the fundamentals. Add to the mix, advances in AI supporting the evolution of autonomous cars, which work better with electric vehicles, as they can be re-charged automatically, and you can see how the economics of electric vehicles will continue to change.
Tesla has been like a disruptor in the tale of Innovator’s Dilemma, and those who wrote it off, were similar to marketing executives at a 8-inch disc drive dismissing 5.25 drives. Don’t get me wrong, don’t take this as an endorsement of Tesla now, that’s not what this is about. But there is no doubt that Tesla and electric vehicles have confounded the sceptics.
Lesson for business
For companies, there were multiple lessons to Innovator’s Dilemma. Among them, try and anticipate how things might change, embrace startups, work with them to increase your understanding and readiness for change, experiment and make yourself agile, so you can rapidly respond to change.
I think that first of all, investors need to understand how disruption works.
Secondly, building upon this, bear in mind that trend has limited meaning with disruption, a trend can go into reverse very rapidly.
Thirdly, look at companies that are applying the lessons of Innovator’s Dilemma. Look at how willing they are to work with startups, experiment and how flexible they are.
Are you new to investing? This is one part of a series; catch up with the other parts here:
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.