Fruits of Creative Destruction
Contributed by Lewis J. Walker, CFP®
In his 2001 Chairman's letter during the "tech wreck" market downturn, Warren Buffett observed, "Only when the tide goes out do you discover who's been swimming naked." To extend the swimming analogy, if a business leader or company gets caught in a rip current of change, some will just go with the flow, some will flounder and drown, while others, facing threats and challenge, will swim free, learn from experience, and grow and prosper as change agents. As the legendary football player and coach Knute Rockne stated, "When the going gets tough, the tough get going."
The cycle of creative destruction is a constant. Companies grow complacent, success turns into atrophy, some disappear, some are gobbled up as "fixer uppers" in an opportunistic play. Upstarts appear and thrive, former leaders fall behind. In the "wild west" of finance the top gun is constantly in the street defending turf and reputation against the latest gunslinger to ride into town.
We see that on Wall Street. About half of the companies in the S&P 500 Index that were listed in 1999 are not there now. Per David Blitzer, Chairman of the Index Committee at Standard & Poor's, "In most years 25 to 30 stocks in the S&P 500 are replaced."
Warren Buffett loves market downturns. If you have a "long ball horizon," tough times allow money managers to pick up bargains, good companies at attractive valuations. Stress, mistakes, intensive competition, and other forces of change, viewed positively, lead to innovation. But if you have a "we've always done it that way" management hierarchy, creative ideas are stifled.
In a June 2016 posting, Ramón Salinas, an innovation expert at the consulting firm Imaginatik, PLC, "Why Real Mistakes Lead to Bigger Innovations," noted, "Executive decision-making often makes or breaks innovation success." True innovators are willing to "'fail fast, fail often' with a bias toward quick experimentation and action." Says Salinas, "Most senior managers must follow a more rigid, risk-averse decision making rubric."
IBM did not see Apple coming. Kodak invented digital photography and did nothing with it. Examples of creative destruction are legion. Leadership constantly shifts. Per data in the Wellington Letter, May 1, 2017, the Top 5 tech stocks in 2000 were Cisco, Oracle, Microsoft, Intel, and IBM. Now the "big 5" are Amazon, Facebook, Microsoft, Google, and Apple. Only Microsoft remains on the list. Money managers continually search for progressive management and emerging ideas, many of which show up in the small- to mid-cap sectors at times, as "upstarts" lead the way.
Writing in The Wall Street Journal, 5/10/17, financier John Michaelson, whose firm provides customized growth financing to entrepreneur-led technology companies, noted that a financial crisis, such as experienced in 2007-2008, leads to new forms of growth. Citing factors since the Great Recession that inhibited growth, government interference in the economy, regulations, and other factors that "preserved the status quo," Michaelson laid out a case for a coming "supercycle of innovation." He notes that many of today's IT systems "are built on platforms from the 1970s to the 1990s." Many legacy systems in private enterprise and government entities, even the military, are ripe for innovation, upgrades, and replacement.
In the defense sector, many weapons systems need to be upgraded. New threats, such as potential ICBM attacks from rogue nations, need to be countered. Space-based weapons systems and countermeasures are a new frontier. Often civilian applications come out of increased research and spending in the military-industrial complex. Says Michaelson, "Crashes are usually followed by massive economic reorganization, spectacular outbursts of innovation, the creation of new industries, increased productivity, and decades of high growth."
In other words, a burst of innovation and reinvention may be coming, creating winners and losers. This opens the door to private equity financing opportunities. Money managers have to anticipate who loses or who triumphs as leadership shifts. Such cycles can be hard on workers who let skills stagnate, while opening doors for those with the right skills and training for the jobs and roles of the future. This is why progressive cities like Peachtree Corners, GA, have opened entrepreneurial incubation centers to spur growth and innovation. Community leaders work with schools to foster the skills and knowledge that will be needed in a fast changing global economy.
"A new supercycle of innovation..." Exciting times for those who thrive on change and challenge!
Lewis Walker is a financial planning and investment strategist at Capital Insight Group; 770-441-2603. Securities and advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative and investment adviser representative of SFA which is otherwise unaffiliated with Capital Insight Group. Past performance is not a guarantee of future financial results.