You may have heard the word “disruption” being used more commonly in the investment world―but what does it actually mean and how is it relevant to investors?
The term “disruptive innovation” was coined to describe a process where a company, usually small and with few resources initially, targets a particular market niche. Eventually, this company displaces the previously dominant competitors―with its offering taken up by the primary market.
The colloquial usage of “disruption” or “disruptive innovation” tends to be broader―describing the role innovation plays in significantly transforming markets, industries, and companies. At its core is the idea of challenging traditional thinking. Much like Steve Jobs did in the phone market with the introduction of the iPhone.
Disruption has become increasingly prevalent over recent years, driven by advancements in technology such as fixed line broadband, developments in mobile network speeds and capacity, smartphones, cloud technology, and the internet.
Now, innovative technologies that initially disrupted traditional thinking―such as driverless cars, 3D printing, social media, genomics, renewable energies, and artificial intelligence―are having a greater impact on our lives.
Disruption and business
To illustrate the power of disruption, let’s examine Amazon―one of the big modern-day disruptors. Amazon began its journey in 1994 selling books. It continued to innovate and grow, going on to disrupt the retail sector by expanding its product and service offering through an online business model built around third-party vendor transactions, storage, and delivery.
And what can we see now?
It was reported in 2017 that in the United States, Amazon rather staggeringly accounted for 50 cents in every dollar spent online.1 And according to a survey finding, more than half of online consumers in the US begin their shopping searches with Amazon.2 Amazon’s success story to date is such that when it announced its launch into the Australian market, forecasts suggested the move could cost local retailers up to $12 billion within the next decade.3 For many businesses in Australia, this has the potential to be very disruptive.
Looking more broadly, tech disruption is making its mark on just about every industry and remains on a clear trajectory. This requires businesses to not only become more adaptable, but to think ahead. We can see this in action every day, from streaming platforms (such as Netflix) driven by the population’s change to “on-demand” entertainment consumption habits, to the use of big data to innovate primary industry and agriculture. Now, we have GPS tracking integrating with climate data, which could have huge consequences for global food production.
There are two clear sides to what disruption can offer―there is a winner and a loser―and it impacts both businesses and the way we, as consumers, live our lives. Regardless of what we may think about the change that comes with disruption, we need to accept that it is now part of our world. Even some of the original disruptors such as Facebook, Amazon, Netflix and Google (collectively known as the FANG stocks) are now being disrupted themselves.
Only last year it was reported that Disney, which is currently streamed on Stan (as well as other platforms), announced it was planning to create its own streaming platform―a move that will compete with Netflix. It may sound like a bold move, however, given the extensive amount of content Disney has across film and television, analysts believe it could pose a legitimate threat to Netflix. Here, the disrupter is being disrupted.
Considerations for investing in disruptive businesses
Developing technologies have the ability to disrupt established business models and this can cause risks in a portfolio. This is why diversification is so important. It can create a hedge against certain companies and industries that are facing severe disruption.
For example, an overweight exposure to banking could see a portfolio significantly more affected if the rise of “fintech” (using technology to innovate banking―for example, using smartphones for banking) continues. To address this risk, an investor may look to hold some exposure to the companies doing the disrupting. Then, if the disrupting companies are successful in their fintech endeavours, the portfolio can benefit while the banking exposure might be suffering.
We know there are established industry players being disrupted by new entrants. However, much technological change is still in its infancy. While rapid tech advancement has the ability to result in widespread economic transformation, existing markets are not likely to disappear overnight and there is still an array of solid traditional opportunities.
Real assets are typically less susceptible to the disruption phenomenon. We still need houses to live in, places to conduct business and infrastructure to transport essential services. For this and other reasons, Dixon Advisory generally continues to suggest investors retain a portion of their portfolios in select real assets.
Investors should also consider that specialist industry research is key to identifying where there are disruptive opportunities in the equity market and which sectors and companies may be more vulnerable to its effect.
This comprehensive level of analysis should be an integral part of your decision-making before investing and is something you can discuss with your adviser.
- L Fickenscher, The cutthroat jobs strategy Amazon uses to conquer retail, New York Post, 25 April 2017. Accessed April 2019
- BloomReach, State of Amazon 2016, September 2016. Accessed April 2019
- Morgan Stanley Report cited in S Letts Amazon’s $12b raid on Australia’s retail: Who’ll feel the pain and why consumers won’t gain (too much), ABC News, 2 June 2017, Accessed April 2019