New World.

Move with the times

Even if they do everything right, Professor Christensen argued, big companies can find it hard to move with the times. Their day-to-day efforts are naturally focused on refining their businesses and responding to customer demand. Why should they spend time and resources experimenting with niche products and markets posing no visible threat?

Meanwhile, earlier stage companies are often much freer to pioneer new technologies and experiment with new business models. Undistracted, they can develop entirely new approaches, to provide the products and services that will serve the needs of tomorrow’s customers. By testing these offerings in a small target market, and by envisioning their wider appeal, the likes of Airbnb, Spotify, Amazon and Skype made deep inroads into long-established, profitable industries as diverse as hospitality, music, book publishing and telecoms. The new world they created came about when dominant companies were slow to spot how new products could please consumers. By the time they did, the disruptors’ technology or competitive position were too far ahead.

Actual investors understand how disruption speeds up as human ingenuity is boosted by computer processing power and improved artificial intelligence. An accelerated wave of change is hitting new areas of everyday life: from consumer products to public services such as healthcare and education. In this new world, seemingly unassailable companies become vulnerable.

Even long-established and seemingly impregnable strongholds can crumble if they underinvest in their own future in response to the insatiable short-termism of the stock market. The pressure on companies to maintain payouts to shareholders via dividends or buying back stock – sometimes even borrowing to do so – can be intense. Reinvesting current cashflow to generate far-distant revenues, even where there is plainly a good opportunity, all too often results in a share price fall. And those far-distant revenues aren’t always so far off: academic evidence shows that company management often forego projects that have payback periods of as little as three years.

At Baillie Gifford, we actively seek out companies that can reinvest cashflows at high rates of expected return, so capturing the phenomenal power of compound growth. Increasingly, we provide primary capital to early stage companies as they build their business, sometimes before they are even profitable.

Companies that pay today’s investors out of yesterday’s business are of little interest to Actual, long-term investors. However well-crafted or well-marketed their offering, if they’re merely shoring up the old world, it’s hard to see them surviving into the long term, let alone outperforming over Baillie Gifford’s preferred long time-horizons.

In sectors as diverse as oil and gas, car manufacturing, retail and pharmaceuticals, some companies are simply not capable of adapting to the new world, so great is their reliance on legacy technologies. For Actual investors, it’s the new, unencumbered players that are more likely to achieve long-term growth – and to change the world.

Our job is to seek out the businesses shaping this new world. We find them more often among disruptive new entrants than among past champions attempting to reinvent themselves. There are exceptions: Netflix, for example was a video hire business that killed its own business model by developing on-demand streaming, achieving extraordinary success. But the big businesses capable of reinvention are more likely to be those with disruption in their DNA. Perhaps the best known example is Amazon. Not content with upending consumer behaviour, it saw an opportunity to become a leader in the adjacent area of cloud computing services. Amazon Web Services (AWS) is now its most profitable division.

Investing in new world companies takes curiosity, knowledge, imagination and a long-term perspective. Actual investors build relationships, and encourage the companies we invest in to take risks, invest in their future, and create businesses built to beat the competitors of tomorrow, not today.