Change is inevitable and so is its rapidly increasing pace! The pace of change has increased multifold—much faster than envisaged by Moorse’s law. As a result, markets are trumping ‘terminal value’ over the current earnings driver to value a company.
No wonder, the companies with questionable business models or those witnessing disruption are underperforming while the under-ownership is consistently rising. So, what really is in-vogue currently?
The answer to this is - companies which demonstrate agility, nimbleness to adept change and the grasp for innovation to counter ‘Digital Darwinism’. These companies are rewarded well by the markets and sometimes enjoy a stratospheric valuation as compared to the conventional players.
The classic example would be some of the companies in electric vehicles and artificial intelligence space. Their valuations are reaching billions of dollars although their products are still very far away from commercial production. The reason–an idea hungry post pandemic world, where the importance of innovation is more than it ever was.
The companies have recognized that even though their business may struggle with some aspect of innovation in the medium term, they need to embed a culture that encourages innovation to stay relevant.
Disruption does not just mean a ‘slow-to-adapt’ incumbent being thrown out of business by a radical new-comer, it instead is about the reinvention of the wheel by using the modern techniques to remain afloat.
For instance, a train engine-maker firm started with the steam locomotive business in pre-1960 changed to diesel locomotive with 100 kmph speed in 1960, it then turned to electric traction in 1970 with an output of 140 kmph, then came the transition to AC powered locomotive with a speed of 150 kmph in 1995 and finally the semi-high-speed train like Vande Bharat with a speed of 180 kmph.
Disruption is all about the way a company makes their business model sustainable, both at the micro and macro level. It is about evolving and reprioritizing the resources for future growth.
There are typically three types of innovation, the first being the radical innovation, where one replaces an existing product with a brand new one, for example a reel-camera now being switched with a smartphone camera.
The second is the disruption innovation, where the new affordable product and services cater to a large customer base, like washing machines or refrigerators; and lastly, the incremental innovation, where a customer upgrades by replacing the existing products, like switching from an old TV to an LCD TV and thereon to an LED TV. Interestingly, innovation has been accelerating since the last century, and the pace of it is just accelerating further.
For instance, stove, steamship and telephone took more than 60 years to penetrate into 50% of the US, however, the smartphones just took seven years to reach those levels. Therefore, the companies with faster innovations are surviving and outperforming their non-innovating peers. The median age of the S&P 500 top 10 in 2000 was 85 years, it dropped to 33 years in 2018 and is slated to reach 12 years by 2027.
It must be noted that innovation can be found across sectors. It could be technology led innovation or it could be process oriented. The example of process innovation is the Indian low-cost airlines. With no extra frills and improved punctuality, low-cost airlines saw a jump in market share, moving to 55% in 2022 from a mere 2% in 2007.
In order to harvest the benefit of innovation measures undertaken by companies in the listed universe, ICICI Prudential has launched an offering based on the innovation theme. This fund is designed to take a bottom-up approach to invest in companies across sectors, market capitalization, demonstrating innovation traits—a mix of both, quality and growth. The fund will also have overseas equities in the portfolio as a means to capture themes like cloud computing, entertainment and driverless cars.
Moreover, the undercurrent of favouring innovation theme is quite encouraging in the present context, as during the pandemic, the supply chain diversification was best realised leading to a good scope for innovation.
Even in a high inflation environment, the demand for domestically manufactured products would drive more innovation, leading to lower costs benefitting the scheme. At a time when the global central banks’ may resort to pausing the interest rates, such a type of offering which has a growth bias could do well in a normalising interest rate environment.
Harshvardhan Roongta, Chief Executive Officer at Roongta Securities