On the contrary, investors should look at innovation and disruption over the long term. Many sectors have been disrupted in the last decades such as everything related to retail, where all moved towards online (E-commerce), the whole media landscape has been also shaken by a disruptive force with the example of NETFLIX moving towards a more flexible model of television not based on advertisement.
In this particular NETFLIX case, the disruption was underestimated at the beginning. Today NETFLIX is the first provider of content and is becoming a key producer in the industry.
It is also relevant to mention that typically innovation and disruption come from small & mid-cap companies. That is why we have a mid-cap bias in most of our strategies. These companies often are not established yet, therefore they are more inclined to innovate and take this risk, in order to find and settle its place in the market.
Innovation mindset – long term success factor
At the beginning, any innovation is expensive because there is not scale in it. Once that you increase your scale, costs go down. Again, the key factor is the long term perspective.
Other important factor is that innovative and disruptive companies typically trade at higher valuations, while disrupted companies typically trade at low valuations. A human reflex would say: “the first group is expensive and the second group is cheap, so let’s sell the first and buy the second”. It also goes the other way around though. In many cases, when companies are getting disrupted people tend to underestimate that disruption, and to buy these companies does not work many times.
Efficiency of the R&D of the company
As shareholder, you need to check how focused companies are on innovation. The first question we need to answer: Is R&D investment well managed or the money is spend around with no clear innovation plan? Firstly, we must look at metrics and qualitative assessment: is the commercial potential good enough? Is the market big enough or this disruption? Secondly, leadership management’s view on innovation is key (Microsoft case – anchoring to its dominant position (Steve Ballmer’s view) versus investing in innovation (Satya Nadella’s view). In this example of, Ballmer tried to defend the fort and defended their monopoly position at all cost. Also, they were not present in the new way of computing so he bought Nokia’s smartphone business (a very mad move in hindsight). Nadella is much more of a true visionary and very importantly, he opened his company for self-disruption. For instance, office applications like word, powerpoint are now available for all operating systems instead of only on Windows and made them all available through the cloud.
It is also of upmost importance when people talk about innovation, to check as well that the management of the company is not building castles in the air. Returns and Capex must never be overlooked.
Another element is that once that the disruption has been identified, we need to follow this disruption. Adoption is key in the kick starting of the S-Curve. We need to check to which extent the adoption of the disruption or innovation is feasible. Maybe it is the best technology but is it possible to be adopted? Not all innovations follow the S-Curve due to the fact that the best solution is not always the one to be adopted.
Another key element is the price. In many cases pricing is high but is not always determinant. It will depend on the advantages offered by the disruption. The important thing is the direction.
Innovation and Sustainability
Within this context, we are looking more and more at capitalizing on ESG opportunities, especially through the SDGs integration. Companies are getting higher market share based on innovation. The key element if you want to assess the commercial potential of the innovation, is to focus on quantitative and qualitative metrics. For us, as fundamental driven investors, the most important is the qualitative part such as engagement.
ESG is about addressing challenges beyond risk mitigation. ESG-conscious companies often show operational excellence (smart use of resources) by changing behaviors, but also by innovating on products and services that enable lesser E impact or replacing harmful products (ESG opportunities). Innovation cycle is lengthy and not all companies have this long term focus while seeing ESG challenges as something they need to tackle. Therefore, it is important to engage with companies on these matters.
One key way of addressing challenges (E impact) is energy usage efficiency. Improvements in energy efficiency are generally achieved by adopting a more efficient technology or production process. A good example in terms of energy efficiency or sustainable energy solutions within the whole value chain is NIBE, the world leader in heat pumps and provider of climate solutions. This Swedish mid-cap company is not very known, but it has a quite significant potential and represent the best example within this framework.
