Adapt or Fail: Watch Out for Disruptive Technologies

Today's value investors need to be more alert

Author's Avatar
May 17, 2016
Article's Main Image

"(Amazon [AMZN]) is a big force, which has already disrupted plenty of people and it will disrupt more. When we saw what was happening on the Internet, we jumped in with both feet. We’re mobile, but the nature of capitalism is that if you’ve got a good business, somebody’s always trying to figure out how to take it away from you and improve on it." – Warren Buffett (Trades, Portfolio)

For a long time, I rarely read the FANG’s annual reports. I regarded them as totally unpredictable and out of circle of competency. However, their names kept coming up as I researched other companies. You just couldn’t help but notice Amazon’s name popping up if you were researching Barnes & Noble (BKS, Financial) or IBM (IBM, Financial). If you research media companies, Netflix (NFLX, Financial) will make its appearance sooner or later. If you dig further, you’ll inevitably find Alphabet (GOOGL, Financial) and Facebook (FB, Financial) popping up once in awhile in the advertising-related side of the business. They are almost ubiquitous.

This was intriguing. I remember when Buffett first bought IBM, he said he had been reading IBM’s annual reports for the past 50 years and my first reaction was why? So I started reading the FANG’s annual reports (I’ve read some of Amazon’s annual reports in the past).

Somehow part of the answer came to me when I was reading Amazon’s 2006 annual report. Maybe Buffett reads to alert himself to any disruptions.

Here is what Jeff Bezos wrote back then:

"I often get asked, 'When are you going to open physical stores?' That’s an expansion opportunity we’ve resisted. It fails all but one of the tests outlined above. The potential size of a network of physical stores is exciting. However, we don’t know how to do it with low capital and high returns; physical-world retailing is a cagey and ancient business that’s already well served; and we don’t have any ideas for how to build a physical world store experience that’s meaningfully differentiated for customers.

"When you do see us enter new businesses, it’s because we believe the above tests have been passed. Our acquisition of Joyo.com is a first step in serving the most populous country in the world. Ecommerce in China is still in its early days, and we believe it’s an excellent business opportunity. Shoes, apparel, groceries: these are big segments where we have the right skills to invent and grow large-scale, high-return businesses that genuinely improve customer experience.

"Fulfillment by Amazon is a set of web services APIs that turns our 12 million square foot fulfillment center network into a gigantic and sophisticated computer peripheral. Pay us 45 cents per month per cubic foot of fulfillment center space, and you can stow your products in our network. You make web services calls to alert us to expect inventory to arrive, to tell us to pick and pack one or more items and to tell us where to ship those items. You never have to talk to us. It’s differentiated, can be large and passes our returns bar.

"Amazon Web Services is another example. With AWS, we’re building a new business focused on a new customer set … software developers. We currently offer 10 different web services and have built a community of over 240,000 registered developers. We’re targeting broad needs universally faced by developers, such as storage and compute capacity — areas in which developers have asked for help and in which we have deep expertise from scaling Amazon.com over the last 12 years. We’re well positioned to do it, it’s highly differentiated, and it can be a significant, financially attractive business over time.

"In some large companies, it might be difficult to grow new businesses from tiny seeds because of the patience and nurturing required. In my view, Amazon’s culture is unusually supportive of small businesses with big potential, and I believe that’s a source of competitive advantage."

Notice the bolded words – of course they are intentional. Imagine you read this in 2006; what would you make of it?

Well, back then I didn’t even know what the hell an annual report was, so I’d probably tell you to bugger off.

But I wasn’t a shareholder of any retailers, or technology companies, or third-party transportation logistic companies in 2006. If you were, however, you’d probably be in big trouble if you didn’t notice these early signs of disruptions by Amazon. Look at what happened to RadioShack and more recently, Macy’s (M, Financial), Nordstrom (JWN, Financial) and the like. Look at what happened to IBM when it realized “oops, we need to play a little catch up on cloud.” Although Amazon hasn’t made any significant strides yet, I’d be watching Amazon closely if I hold any shares in UPS (UPS, Financial) or FedEx (FDX, Financial).

What’s different now? Well, technology has made disruptions more powerful and more frequent. This means every value investor needs to accept the new reality, and we need to pay more attention to these disruptive forces. Some disruptions are easier to understand and some require extensive efforts. For instance, P2P lending companies such as Lending Club (LC, Financial) benefit borrowers and private lenders but could disrupt credit card companies and commercial banks. This is easier to understand. On the other hand, genomic sequencing is revolutionizing the way biological information is collected, processed and applied and is disruptive to many health care, agriculture and pharmaceuticals companies. The consequences from genomic sequencing is much harder to grasp.

What about IoTs (Internet of Things), blockchains, bitcoins and the recent hype of the Hyperloop? Who’s going to benefit and who’s going to get hurt badly? Investors need to ask those questions and try to find the answers.

Charlie Munger (Trades, Portfolio) said the following about the DJCO meeting this year: “What’s interesting about this company is it’s a newspaper historically that relied on a combination of public service notices and ads which gave it a monopoly to raise subscription fees every year. Like with others, technology changed, and classifieds went to hell, and lawyers no longer needed to get the info in print. As we sit here it makes about $1 million per year pretax. The newspaper was a fine business. It was foolproof. Of course the world changed. Whether it’ll keep going down a little or hold flat, I don’t know. Any of you holding it [DJCO shares] hoping the newspaper comes back, change your rationale.”

Asia’s most respected business person Li Kashing has a technology fund that invested in technology firms including Facebook, Spotify, Skype and Slack.

If octogenarians and nonagenarians such as Buffett, Munger and Li Kashing still keep up with disruptive technologies, there’s no reason why the younger generation of investors can’t.

Start a free seven-day trial of Premium Membership to GuruFocus.