Chapter 3
Disruptors or Just Progress
Disruption is part of life; little to no innovation or economic progress happens without it. In this century much of the economic innovation has come from digitally driven computing technology. This has been utilized to make new products and revolutionize various processes and services.
It is difficult to predict and track all of the various disruptions that have been occurring in the economy in recent decades. Most of these developments help make the overall economy more efficient and more flexible. This should allow for longer periods of expansion. However, it will also lead to more distress and distortions within selected regions, industries, and corporations.
One of the reasons for the dramatic impact from these innovations and why they are having a different effect at the macro, medi,8 and microlevels of the economy is because of how quickly they are being adopted compared to the past. Electricity took thirty-five years to reach 10% of the United States population, the telephone took twenty-five years, but it took computer tablets just five years to reach the same level. The cell phone took only five years to reach 50% of households.9 This rapid adoption creates constant gains in economic efficiency while potentially enhancing job creation and consumption for the macroeconomy. However, it also represents rapid and sudden competition to incumbent businesses giving them little time to react.
One of the problems with economic data is that it is always from the past. The faster changes happen in the economy, the more rapidly historical data depreciates in value as an analytical tool. Therefore, understanding where and what kind of disruption is occurring, what the multiple layers of potential consequences are, and how current conditions differ from the past are all necessary if you use any kind of economic data to make investment decisions.
In the 2010s every time there is an innovative change to a business it is referred to as a “disruptor.” Disruption has been around a long time. Pants apparently came on the scene about 1000 to 1300 B.C. in China. It was a major change for horseback riders. Pants improved riders’ comfort and their stamina to stay on horseback.10 While you can not prove it, it is probably safe to assume that the media at the time had stories about how the pant innovation would wear down horses and create a horse shortage, and would reduce the need for riders and give pants-wearers an unfair advantage over other riders. This did not even begin to touch on what pants might do to the incumbent loincloth manufacturing industry. Clearly, disruption has been around for some time and innovation has economic ramifications. Also note that there is no evidence that the inventor of pants created a great company based on the invention of pants. This is a good reminder that sometimes a good innovative idea survives even if the companies that created them do not.
Innovation that seems ground breaking at first may often evolve into being common place. However, sometimes an invention that seems relatively mundane can shake the global economy up as much as a break through like the smart-phone. Sometimes the ideas even come from Newark, New Jersey.
Malcolm McLean was not tech savvy; he did not even like to do business over the phone. However, Mr. McLean developed one of the most impactful disruptors in the world as he sat in a truck waiting to load cargo onto a boat. He watched as each item was unpacked from the trucks, reloaded on the boat, and then repacked. He came up with the idea to put all the goods into one container, load the container on to the boat, and then unload the container at its destination. If planned right the container could be taken right off the boat and put onto a truck for delivery to its destination. This innovation was the intermodal transport container. From this innovation Mr. McLean grew his company Sea-Land into a transportation logistics giant. His first container shipment went out in 1956 from Port Newark in New Jersey. Forty years later it was estimated that 90% of world trade moved by container.11 This massively disrupted the role of the longshoremen that loaded and unloaded ships but reduced shipping time and costs and was a major step in the development of global supply chains. The improvements and use of technology in logistics have been a huge part in making economies more flexible. This was a major innovation, it could be argued that it was as simple as deciding to put things in a box.
Relatively simple developments in efficiency and process can vastly impact economies, especially if they are in segments that are very far reaching and touch all aspects of people’s lives. Logistics is one of those subtle industries and so is energy. They are both so ubiquitous it is easy to not think about them. Recent technological innovations in the oil and gas industry has reshaped global supply
The evolution of fracking has appeared to change the global dynamics in energy more than any development in sustainable energy so far. Fracking is not a slick, clean, or green business, it has almost nothing to do with Silicon Valley but it has been a disruptor. Large scale use of fracking is a relatively new way of extracting oil and gas from subterranean deposits. It uses modern technology that applies high pressure to force water, sand, and other chemicals into underground rock formations to open fissures (or “fractures”) to gain access to more oil and gas in shale structures. While the process can be controversial, it has changed the energy business. From 2008 to 2018 it is estimated that shale oil production went from 450,000 barrels of oil a day to 5 million.12 These wells can be used to increase the rate of extraction of oil and gas more quickly than traditional drilling. This extraction from shale structures lends itself to a more “manufacturing lite” process that is able to be toggled “on and off” more easily than conventional wells, making it more responsive to market prices for oil and gas. This technology has changed the balance of power in global oil supply and impacted prices for energy around the world. In addition, the technology is not standing still, there have been continual improvements in drilling wells and extraction. It is not as cool looking as a new iPhone, but it has been a global disruptor of epic proportion.
The increased United States oil and gas production has also changed several dynamics in economic data. It makes extrapolation of historical oil imports and exports somewhat meaningless. It means inflation models for the United States that may have been heavily dependent on the price of oil shipped from the Middle East or the North Sea now must factor in the price of domestic oil. It can impact the cost of shipping and employment.
Anytime there are disruptions there are also typically derivative “disruptions.” Amazon disrupted the retail environment, which hurt brick and mortar retails stores like Toys ‘R’ Us. A derivative disruption occurred in the real estate market because values for shopping malls suffered as stores struggled to compete with the internet. This could then put pressure on some banks with loans to shopping mall owners. On the flip side, the internet retailers have increased the demand for delivery services and packaging. Fracking has spurred demand for new equipment manufacturing, however, if it keeps oil and gas prices down it could hurt the development of alternative energy sources. To try to invest properly in disruption you must look at multiple layers of analysis.
Great ideas can be very disruptive but they do not always create great businesses. While the idea may live on, the business may fail. When thinking about disruption it can be helpful to try to categorize the type of innovation you are looking at, the opportunities and challenges. Figure 3.1 shows a simple way of laying out some of these issues. Do not just be a believer, be a cynic too.
The bottom box in the figure can often be the most impactful on your investment decisions; the derivative impact of true innovation is very far reaching. In the great book Economics in One Lesson by Henry Hazlitt, the author outlines that economics consists of understanding not just the immediate but the long-term impact of economic policy and then tracing the impact of it not just on one group but on all.14 Mr. Hazlitt’s emphasis was on public policy, however, the same concept can, and should, be applied to economic developments in the private sector. This is especially true when there is disruption afoot.
Following the multiple trails of what a truly disruptive innovation will do, and keeping in mind how it changes historical data may lead you to successful shifts in investment strategy.