Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards

Portfolio > Portfolio Construction

What Tech Will Disrupt Next: Your Portfolio

Your article was successfully shared with the contacts you provided.

Since the start of the new millennium, we have witnessed a large number of industries being severely disrupted by the effects of the technology revolution that took place in the final two decades of the 20th century. During that period, an unprecedented number of new global brands emerged, to the extent that none of the world’s three most valuable ones — Apple, Microsoft and Google — even existed before the mid-1970s.

More to the point, established companies with global brands operating in cozy, old-style industries and stable markets saw their market shares decimated by new arrivals. The ease with which new companies have been able to enter previously well-protected markets in this new environment, and to fell old stalwarts that used to dominate those markets, suggests not only intensifying turmoil in world markets going forward but — perhaps surprisingly, given the spectacular corporate profits growth both in dollar terms and as a share of GDP seen in recent decades — relentless long-term pressure on profit margins.

Work Disruption

Creative destruction, the great Austrian-American economist Joseph Schumpeter wrote in 1942, is the essential fact about the workings of capitalism. Earlier (in 1911, to be exact) he also wrote that innovation is not limited to inventing new technology or new ways of producing goods and services, but it requires bringing those inventions to the market.

Americans have always been good at generating new ideas, and U.S. universities, research hospitals and corporate departments involved in R&D were responsible for the lion’s share of patents issued in the post-World War II period. But innovation in Schumpeter’s sense of the word only really began to happen in the United States with the development of the financial infrastructure for capitalizing on those ideas. Since the 1990s, successful commercialization of ideas, which gave rise to a crop of tech millionaires and billionaires, in turn bolstered the ideas factory, creating a formidable innovation establishment.

Innovation has even made changes in the efficient markets theory, which is based on the often disputed assumption that whenever investors make stock purchasing decisions they are in possession of all available information that impacts the price of shares. Some economists have modified the efficient markets theory by suggested that broad long-term market movements occur in response to the invention of new technologies.

One undisputed result of innovation has been creative destruction accomplished on a massive scale. The list of markets and industries that have been disrupted over the past two decades is long and constantly growing. The music industry was hit early on by the spread of file-sharing software and is yet to recover fully: Even world-famous musicians can no longer make a living by selling their recordings, while venerable recording labels of the past have either disappeared or are moribund. The economic model that has sustained the free press, a key component of a functioning democracy, is in tatters. Thousands of members of the fourth estate find themselves permanently out of work or working for a fraction of their former salaries.

Major disruptions have occurred in the retail industry with the advent of Amazon, in antiques trade and collecting with the emergence of eBay, in television and cinema with the spread of Netflix and other streaming services, in taxi and limousine services as a result of the creation of Uber and its competitors, and in travel and hospitality thanks to Expedia and Airbnb.

The most recent and perhaps most dramatic example of market disruption was seen in mid-2014, when oil prices suddenly plummeted under the combined assault of new energy-saving technologies, alternative energy technologies and new oil exploration and production technologies that both boosted production in conventional wells and allowed the exploitation of shale and deepwater fields.

Watch Out, Detroit

One factor in bringing down oil prices has been the development of hybrid and fully electric cars, and, even more important, a steady increase in gas mileage. This is why U.S. oil consumption is now down to mid-1990s levels even though the number of vehicles on U.S. roads has increased by around 25%. Moreover, the average age of light vehicles is now a record 11.4 years, and as motorists replace them with newer vehicles, energy efficiency will rocket.

Along the way, advances by Tesla, Nissan and other carmakers in lithium-ion battery technology, in combination with the spread of solar panels used in private homes, may change the way electric utilities provide power to residential customers.

An even greater disruption may be in the making, impacting all aspects of the auto industry, the most important manufacturing industry in the U.S. and one of the core industries in the world economy. It promises to change not only how cars are fueled, but how they are made, sold, owned and driven.

A number of companies that are no strangers to the disruption of other markets and industries — most notably Google, Apple and Uber — have joined the race to develop autonomous vehicle technology. Google’s self-driving car project recently got its own CEO. Google plans a major reorganization, in which the auto effort may be separated into a stand-alone company. Google is considered to be one of the most advanced developers of self-driving technology. Its prototype has already logged over 1 million miles in California and Texas. Some estimates suggest that driverless cars will be used commercially by the end of 2020.

This new technology, when fully operational, is likely to disrupt the long haul industry first, impacting some 3 million trucking jobs in the United States alone, and it will start eliminating driving as a form of gainful employment everywhere, eventually affecting another million U.S. bus and taxi drivers. Google, Apple and Uber are planning to build robo-cabs — driverless taxis to be used by young, urban residents who don’t want the headache of owning a car of their own, especially if they live in overcrowded cities.

Upset Applecart

The race for the development of a driverless car is heating up and Google may be left behind by China’s Baidu and German automaker BMW, who allegedly plan to introduce their fully autonomous car later this year. None of the competitors, however, is planning to produce its vehicles independently, and non-car companies are also looking for an association with an established manufacturer. This is why Apple’s Project Titan may be particularly interesting.

Apple’s move into car manufacturing is in itself the result of rapid changes in its markets. Apple remains highly profitable, and its business model has been phenomenally successful, making its brand the most valuable in the world by a wide margin. However, it is increasingly dependent on its iPhone as some of its highly innovative products have been swapped by imitators.

Apple has been typically secretive about its car, but the self-driving and electric aspects of the future vehicle are probably less important than the fact that the company is planning to produce it independently. Since its revival in the late 1990s under Steven Jobs’ leadership, Apple took on a number of formidable competitors in the mobile telephony, computer, software and music industries, and its foray into the auto industry, first announced less than a year ago, may alter the way cars are made and marketed.

In any case, the auto industry may be ripe for a fundamentally new model. On the one hand, it has been going through considerable turmoil for a decade, with bankruptcies, recalls, safety problems and various scandals. At the same time, its customer base is changing, with fewer young people in rich countries getting drivers licenses and owning cars. Cars are considered to be a financial burden rather than a status symbol by the new generation.

Most important, cars are becoming electronic gadgets the way smartphones were when Apple first introduced the iPhone nearly a decade ago. A new generation of motorists demands full connectivity to the Internet, but this is only part of the story. With self-driving technology and the “Internet of things,” numerous vehicle features will be controlled electronically. Cars will become large multifunctional smartphones. Apple has great skills designing and marketing electronic gadgets, and it has been profitably outsourcing their manufacture.

The only problem for manufacturers is that this business model entails much larger profits for Apple than for the manufacturer, whose margins are quite slim. Worse, Apple will be entering an industry that has already been plagued by very low margins and overcapacity.

Airline Test

The technology revolution has been moving in stages. Its effects took a while to be seen, and those effects have so far been favorable to profits, allowing companies to cut their costs, including labor costs. At the same time, easy monetary policies pursued by the world’s major central banks — and especially since the 2008 global financial crisis — helped companies invest in cost-saving technologies while reducing downward pressure on their prices, not forcing them to pass their costs savings fully to their customers.

The next stage, however, may lead to intensified competition and pressure on profit margins as new technologies make it easier to enter pretty much every market and industry. The airline industry may provide a test of how this works. After years of flapping along the bottom, major airlines have been remarkably successful over the past three years. The S&P 500 index of the airline industry rose threefold during this time period, while Delta Airlines’ shares rocketed by a factor of five, from around $10 per share to over $50.

I wrote about the airline industry in this column back in April 2014, identifying certain factors boosting profits: new energy-efficient planes and sophisticated logistics systems allowing companies to fill pretty much every seat. Since then, the unexpected drop in fuel prices further favored the industry. But the broad industry index has already started to sputter.

Remember Warren Buffett’s warning about airlines. The famed investor has been stubborn in his skepticism of that industry as a whole, pointing out that barriers to entry are low and low-cost competitors can be set up to attack the most popular routes, decimating profits. The same technology that has favored the few players who survived a spate of airline bankruptcies after September 11 can now aid their newly emerging competitors.


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.