Disruption!

Posted in BusinessWorld on January 24, 2010

            To Joseph Schumpeter, the Austrian economist and author of Capitalism, Socialism, and Democracy, the most prominent feature of capitalism is “creative destruction,” a process by which innovating entrepreneurs drive growth by upending the old order. 

Whereas Marx portrayed capitalism as “exploitative” and characterized by periodic crises, Schumpeter celebrated the dynamism of capitalism.  In other words, in capitalism, disruption is the name of the game.

Who can argue that disruption is around everywhere today?

Newspapers are being disrupted by the internet, film photography is being disrupted by digital photography, postal mail is being disrupted by email and texting, music CDs are being disrupted by file sharing, landlines are being disrupted by mobile phones, voice calling is being disrupted by Skype and other internet based services, and pretty soon, fuel engines will be disrupted by electric vehicles.

While I was in college, all the engineering students had to have slide rules.  Then the slide rules went the way of the dodo bird, replaced by scientific calculators.  Recently, I stumbled on www.wolframalpha.com, a website that has been described as a “computational engine.”  I guess even the engineers are being disrupted.

Nothing much is safe from disruption.  Even doctors are finding this out.  Open heart surgeons are being disrupted by cardiologists doing angioplasty while a new breed of cardiac surgeons are using minimally-invasive robot-assisted heart surgery. 

Disruption and competition can come from anywhere, not just from one’s direct competitors.  Kodak, of course, was and is being disrupted by Canon, Nikon, Pentax and the “usual suspects” in the digital film world.  However, guess who are the biggest sellers of digital cameras to the public?  The mobile phone manufacturers.

I’ve previously written about how the Aboitizes’ shipping business got disrupted by budget airlines in the passenger side and RoRo ships in the cargo side.  Who knew that the Aboitizes would be competing with Alfred Yao and Lance Gokongwei?

I have a few other examples:  Eyeglass manufacturers had only each other as competition.  Then came the contact lens manufacturers.  But could corrective eye surgeons wielding the disruptive technology of laser surgery qualify as competitors?  The technology may not be mass market now, but it could still affect the demand for eyeglasses in the future.

The car manufacturers will face severe competition and disruption in the near future and competition will not come from any existing car company.  This is because of the global push toward  “clean engines” and electric vehicles. 

There’s a huge barrier to entry in the car industry because producing today’s fuel combustion engines with its array of computers intelligently coordinating the engine require huge capital.   Not so with electric vehicles.  The barrier to entry is low.  This is why a battery manufacturer like China’s BYD has been the recipient of a Warren Buffet investment and is seen as an emerging force in the automotive industry. 

The corporate graveyard is littered with corpses of companies disrupted by technology:  Visicalc (spreadsheet software), Wang (wordprocessors), Smith-Corona (typewriters), Kaypro (computers), Polaroid (instant photography), etc.  Disruption in the personal computer storage industry has been fierce:  5.5 inch floppy disks replaced by 3.5  inch floppy drives replaced by CDs and DVDs and flash drives. 

It’s possible for an industry to “reinvent itself” in the face of disruption.  Moviehouses were supposed to die with the advent of the Betamax and the VHS.  It didn’t.  Instead, cinemas got “reinvented” as multiplexes in malls.  The standalone theater died (I remember Avenue, Galaxy, and Lyric in the old days), but was reborn as multiplexes in Powerplant Mall, Megamall, etc. 

What accounts for the accelerated pace of disruption and creative destruction?  Globalization is a factor.  Barriers to entry, usually government imposed, have fallen away in the wake of WTO and free trade rules.  I remember a time when the Board of Investments used to mandate “measured capacity”, which is a way of restricting competition and dampening innovation.

In many more countries, anti-trust is accepted government policy.  An insurgent company with a disruptive technology stands a better chance when monopolies are prevented from exercising predatory behavior. 

But the biggest factor may be that there’s much more capital going around looking to finance the next Google, Apple, or Amazon.    Savings from pension funds are going to venture capitalists who finance disruptive companies.  Amazon.com, for example, disrupted traditional bookselling with its online bookstore. It was financed by Kleiner, Perkins, Caufield, and Byers, a VC firm.  .

Stock markets are also doing their part.  Companies with a potential to disrupt an industry and make lots of money for their investors are getting higher P-E (price earnings) multiples – and therefore cheaper cost of capital) - than tradition bound companies with stable incomes.  Microsoft has a lot lower P-E than Apple although the former makes much more money.

Creative destruction or constant disruption, however, has a downside, apart from the capital values that are destroyed in the disrupted company.  Labor suffers, particularly those whose work involves specialized skills.  What if you were a linotypist in the old printing presses?  Or the machine operator of lathe machines being replaced by CNC (Computer Numerical Controlled) machines?

This is why we must develop innovative social policies involving lifelong education and retraining, portability of pensions, and other types of social insurance.  Furthermore, we must rethink our bankruptcy laws to facilitate a company’s exit from an old industry and its possible reincarnation with new technology.

Unless societies become communist, disruption will be a way of life.  We must learn to live with it.