Yesterday we took a brief look at how visionary empire builders like Carnegie and Rockefeller created fantastic conglomerates that made huge fortunes for investors. And we also saw how these businesses were ultimately subject to what economic historian Jo Schumpeter terms "creative destruction". This is the idea that competitors who find innovative new ideas will ultimately destroy those that dominated an industry in the past.
Creative destruction works for economies too. And boy, are we seeing destruction in the economy today.
Today I want to look at the three most important things you need to tough it out in this destructive world. Let’s start with a great example of creative destruction – the internet.
What we’re up against
Last week, book publishers Penguin and Random House announced plans to get together. And the reason is pretty clear. They need to take tough action against the increasing power of the likes of online retailer Amazon.
They’ve seen the way the music industry has been taken apart over the last ten or 15 years. They want to wrest control of pricing back into their own hands by allying forces. Will it work? I doubt it. The industry needs to develop and evolve to survive. But innovation nearly always comes from small companies, or start-ups. If it is to come out of the incumbents, it’s usually a business insider that breaks out on his own.
I’ve seen the internet shake up my own business. Having established a new brand and brought it to market (largely online), sales went very well for a few years. But of course, as the thing started to grow, competitors ultimately came in and copied our products. We had to adapt. How? Well, I bit the bullet by moving into wholesaling products to the competition.
Though the internet is a significant force for destruction (and reconstruction) of industry, it’s not all we need to worry about. Globalisation has brought on fantastic changes too. Some firms are loving it. Others aren’t coping.
We need to adapt too. I’d urge you to take a hard look at your investments and decide which ones looking vulnerable. Here are the three qualities that you need in your portfolio right now…
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Three crucial things to look for when you invest
Factor 1: Flexibility. We’re looking for companies that are malleable and ready to move. That may mean physical mobility – like the ability to move production to wherever it’s most cost effective. It could be wages, taxes, or a whole host of factors at play.
Take oil majors. Wasn’t it interesting to see that George Osborne has finally renounced (to some degree at least) previous tax hikes on North Sea oil production? Did he do that out of the kindness of his own heart? No, of course not. It was because the oil majors had cut North Sea production and decided to drill in lower tax jurisdictions.
Now imagine if companies like BP, or Centrica didn’t have mobility and alternatives on their side? I strongly suspect our chancellor wouldn’t have been quite so generous. Love them or hate them, large multi nationals have flexibility.
Factor 2: Emerging-market focus. I’m always keen to bang the drum for the emerging markets. In terms of creative destruction, we have a lot to be thankful for and worried about. The businesses most likely to cope with the brave new world are ones that can benefit from the emerging markets story. Now this can most certainly include UK companies. I mean just look at Jaguar Land Rover. It’s fantastic to see the renaissance of this company. It’s growing strongly in the emerging markets and though it has an emerging market owner too, the important thing is that its bringing jobs here... right to our industrial heartland.
This is a great example of a business that’s benefitting from the emerging markets story. There are plenty of others. Multi-nationals like Diageo and our giant pharma businesses are making hay while the sun shines over the whole globe.
But it’s not all about size...
Factor 3: Small is beautiful. The problem with the first two factors I’ve identified is that they’re generally associated with large companies. The ability to enter new markets abroad and the flexibility offered to the multi-nationals point the finger toward the biggies. But, when it comes to innovation, we know that the big boys are often stymied.
So is what we’re looking for unachievable?
No, of course not. It just means we need to look a little harder.
Take Agriterra, the African food producer I talked about yesterday. Now there’s a company quoted in London, it’s building a flexible production platform across Africa and yet it’s still very much a small cap. That makes them very nimble. Consider this: Last year, as cocoa prices hit $2,400, (and the average cost of production about $800), these guys said to themselves “We want a piece of that!” Within months they were on the case.
The smaller the business, the quicker it is off the mark, and the more likely it is to be innovative.
So that’s the three things I look for in an investment to survive the constant threat of creative destruction. Of course these aren’t the only things we look for in an investment, and given time, the factors will likely change. After all, that’s the nature of the beast.
But stay with me, as over the months and years, I’ll dig out the best ideas I can to make the most of these turbulent times.
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