Investors love to speculate about finding the next Uber or Airbnb, but the custodians of capital at Australian superannuation funds should be more focused on how these “disruptor” businesses affect the outlook for today’s blue-chip stocks.
After all, that is where they are heavily invested today and, thereby, stand to lose. And while it is extremely difficult to pick the new crop of winners, it is perhaps easier to spot the incumbents that risk going the way of the dinosaurs.
That was the warning issued by Goldman Sachs executive director and equity research analyst Gabriel Wilson-Otto, who said the negative impact of technological disruption on incumbent market leaders was too often “glossed over” in conversations about how innovation is changing the investment landscape for local super funds.
Speaking at the Responsible Investment Association of Australasia’s annual conference, held in Sydney, November 15-16, 2017, Wilson-Otto shared findings from recent research by the US investment bank to evaluate and quantify the risk of disruption to incumbents.
Goldman Sachs researchers found that the Australian economy has unique characteristics, such as population size and density, that make certain sectors of its business landscape particularly prone to disruption.
“Australia typically has much more consolidated industries than offshore,” Wilson-Otto said. “We also typically have a higher infrastructure cost to serve each customer. When you combine that with relatively high wages and high rent, it means that you can’t afford to fragment an industry as much as you can within the US, or Europe, or other areas.”
These factors lead to business models with a lot of asset intensity and higher prices to get the same overall returned compared with international developed market peers. Historically, if a company wanted to enter the market and compete in this environment, it would need to replicate the required infrastructure.
In the new digital economy, barriers to entry are lower and the infrastructure burden is no longer a competitive advantage.
“The disruptors now have a huge opportunity to come in – facing structurally lower costs and high prices that they can easily undercut – and offer a superior or more tailored service,” Wilson-Otto said.
When an industry is disrupted, it poses thorny problems for investors who want to see incumbents respond in a way that will ensure the business survives and thrives long term.
What is often required is self-disruption: a complete repositioning of the business.
“The problem is that for every dollar a department store shifts online, they typically lose about 30 cents in the dollar,” Wilson-Otto said. CEOs who want to defend against new entrants to their market must reinvest in capital, lower earnings forecasts and “accept that a lot of the stores you’ve opened over the last five or 10 years, or the infrastructure investment that you’ve made, was probably the wrong decision.”
That’s not an appealing option for a company incentivised via total shareholder returns.
“They’re not going to hit their targets, they’re not going to get paid, and the board will have to do a mea culpa and accept that they should have seen this coming, but didn’t,” Otto-Wilson said. As a result, the type of dynamic response needed in order to deal with these issues is often constrained.
The solution to much of this lies with corporate governance: remuneration culture, the strength of the board, and the level of incentive towards innovation. “Are you attracting people within an organisation that are going to be able to deal with these issues?” Wilson-Otto asked. “Or do you have [a] culture [where] no one innovative wants to work for you because you’re the dinosaur who’ll never change?”
While it’s important that companies have a strategy in place to deal with disruption, it’s equally important to communicate that strategy to investors, said Macquarie Group’s head of ESG research in Australia Phineas Glover.
Companies “can be hit quite hard if they’re effectively an income stock, [in which] their shareholders are just looking forward to their dividend, and suddenly the company announces its going to spend $150 million developing a digital marketplace,” Glover said. “It really is important that they take investors on a journey and give strong milestones in terms of what it is they’re actually trying to do to.”