What is the difference between a technology investment and a disruptive one?
Investors always assume that disruptive businesses are technology businesses. Amazon started as a constituent of the technology sector, but is now part of S&P consumer discretionary, along with Toyota, Home Depot, McDonalds and Disney.
But a rose is rose, right? Yes, well, sort of. Investment management isn’t just about picking winners – though it mostly should be. Done badly, it’s increasingly about pretending to invest in good companies but buying indexes instead, under the guise of managing risk.
Managing risk isn’t a bad thing. It’s just a matter of whether you hide behind it. To explain, your investment manager’s PDS may well include exposure to the aforementioned consumer discretionary index. But having too much Amazon (at the expense of Toyota and McDonalds) will represent “unacceptable” index risk – even though it may be the right thing to do.
The following is very important. There is no incentive on the part of big managers to take risk outside the index. Performing in line with the index is acceptable, irrespective of how bad the returns. But investment outside the index, and getting it wrong, is a business-ending event. So investment management is now mostly a game of sticking close to an index while pretending you are doing something different.
In this world, and in the world of the investor then, names and classifications really, really matter.
The takeover last week of Dollar Shave Club for US$1b by Unilever is a beautiful illustration of why. DSC is a disruptive company using technology, but not a technology disruptor. It will ultimately live not in a technology index but somewhere in consumer goods.
As an investor, it is an example of why it is so important to properly classify your bets. Failing to do so can mean very bad consequences for your retirement (you could wind up holding Toyota, when you should be holding Amazon). After all, they are in the same index.
A little relevant history on Dollar Shave Club. The company started life just 5 years ago in Los Angeles, by Mike Dubin and Mark Levine. They took a long hard look at the $30 cost of four premium cartridges, and correctly perceived that around $20 of that price was television advertising commercials – in sports programming, for example, with a bit at the Formula 1 track and all the other blokey places we see shaving commercials thrown in.
DSC correctly worked out it could sell the razors very profitably at $10 a month for four (so each shave is well less than $1) – as long as they could find a way to tell enough people they were doing it. Enter technology, in the form of viral video and clever email marketing.
Dubin is good TV talent, and does a fine line in sardonic humour, so his to-camera promotional pieces went down well, with the added benefit that the razor is really good (I use them) and much cheaper. It was a masterstroke.
Fast forward 5 years, and he sells out for US$1b to Unilever (which is just a peach fuzz kid relative to Procter and Gamble’s hirsute, but doubtless fine smelling, Goliath, which did i mention is the owner of Gillette). That price is just over 6x forward sales (not profit).
Is this cheap? I am not privy to the numbers, but I will guarantee that the business model could be vastly profitable as a new-fashion on-line distributor, which could expand into a string of other products and verticals – shampoos, feminine hygiene products etc. In fact, in anything where most of the product cost is mainstream media advertising.
The implications of this are huge. First, it breaks the fmcg (fast moving consumer goods) model by providing the product for a fraction of the price without using the traditional expensive tv selling tools. It also seriously damages the recipient of the majority of P&G marketing dollars: I mean TV. If you think you have seen a lot of profit downgrades in this area, please stand by, as they say.
But back to the point. Dollar Shave is not a disruptive technology company – don’t look for it in the NASDAQ. Its product is a razor blade. Its viral marketing message is disruptive, but the technology on which it is conducted has been around for a long time and can no longer be considered so. DSC has not disrupted technologically, but by better understanding the economics of the thing it is selling. Procter and Gamble has access to every business and technology tool that DSC has. They just don’t use them as well.
From the investor perspective, looking for the best business models only in technology is not going to work. And if you look only there, you are likely to miss a very fine disruptor in consumer discretionary. So if you choose an investment manager who manages according to the index (and most do) you will wind up holding an index of companies that used to be important, and miss the new disruptors.
DSC also proves that disruption has a long way to go from an investment perspective. Meaning that it is now the physical world that is being disrupted – razors at your door for a fraction of the cost, a better taxi service in the form of Uber, spectacles through Bailey and Nelson, etc.