Innovation, disruption and the impact of Amazon
Disruption is the word. Disruptors are winners, apparently, with profitability a secondary concern to stratospheric multiples, and the disrupted are the losers. In Australia, the search for the loser to Amazon as it enters the Australian market has become a corporate equivalent to “Where’s Wally”...
Disruption in Retail
Disruption is the word. Disruptors are winners, apparently, with profitability a secondary concern to stratospheric multiples, and the disrupted are the losers. In Australia, the search for the loser to Amazon as it enters the Australian market has become a corporate equivalent to “Where’s Wally”, and we suspect that whilst the risk to some early nominees may have been overstated, the ultimate disruption to others, whilst less immediately obvious, is yet to be identified. Disruption is a noble goal, and indeed the battle between the disruptor and the disruptee has been the basis for much of commerce for centuries. Your profit, is my opportunity. It applies, however, in many forms, not just through the prism of technology, as the battle in retail, featuring Amazon in the blue corner, is often depicted.
The implications of Amazon on the Australian equity market will be material, but maybe not in the ways anticipated. Amazon’s share in retail in the US by category gives some insight as to where its impact may most be felt in retail; whilst it has 5% of non-food retail spend in total, and 8% of apparel spend, it has only 1% in each of consumer electronics and grocery. JB Hi-Fi, Harvey Norman, Woolworths and Coles may all be affected, but in the main their prices are already competitive and combined, pre- tax profit in the Australian market for consumer electronics and furnishing is not large. The bigger commercial vulnerability may rest with those with a business model reliant upon apparel, and with long dated, expensive leases; the candidates are obvious.
The largest disruption from Amazon in Australia, however, may come in the media space. In recent months Amazon has purchased sports streaming rights in rugby, golf and tennis. Further, globally, sports audiences for broadcasters are in decline; NFL and EPL viewership was each down approximately 10% last year. Given sports has been the magic pudding for Australian broadcasters for decades, a reversal in viewership trends here (is this year an early warning signal?) may turn the business model on its head, especially if digital streaming rights are subject to bid by new entities such as Amazon and Twitter. Finally, Amazon also has the potential to monetize its data analytics on its audience, especially for Amazon Prime, and deliver targeted audiences to advertisers in a way broadcasters cannot hope to achieve. Google and Facebook are already dominating advertising spend in Australia, and the assumption of a residence by Amazon in the Australian market may compound that migration from traditional to new media channels.
In short, it is good for competition for the major supermarket chains in Australia to be alert to the threat posed by Amazon and to adjust their business models (especially relating to delivery) accordingly, however the greater commercial threat may ultimately be posed to industries outside of grocery retailing.
Disruption in Banking
In the banking sector, ANZ is looking to portray itself as a disruptor, through unveiling “the ANZ Way”. ANZ spoke to two pillars of focus in this new way, one being a more granular pricing of risk and hence more individual pricing of retail banking products, and secondly using Agile work practices to materially improve productivity. That improvement was speculated in the potential halving of the 40,000 workforce through the medium term. Much of this is no doubt due to portfolio adjustment as businesses such as wealth and Asian retail are sold, and examples of other major banks globally that have adopted Agile has seen work forces drop materially. With these ambitions, it is not possible to look at ANZ as anything other than attempting to be a disruptor from within, which is a noble goal but one fraught with executional risk. Since becoming group CEO two years ago, Shayne Elliott has hired senior executives from Google and McDonalds in an attempt to imbue a leadership capability to enable aggressive change, and the time for execution has arrived. Various parts of financial services are already in the nascent stage of disruption in Australia – payments and platforms especially – and ANZ clearly want to get ahead of the curve with respect to products that generate the vast bulk of existing group product. The competitor response will be fascinating, especially as some may be more timid than ANZ given some of their operational risk difficulties in recent times.
Disruption in Minerals and Mining
James Hardie has been disrupting the US building materials industry for more than a decade. Revenue has almost doubled through the past decade, just as it had doubled in the five years prior. All the while, ebit margins have grown and then kept in a range of between 20% and 25%, whilst cashflows have usually mapped to the profit and loss account well. None of these financial indicators are reflective of the industry – most building materials companies operate with sales growth at or about gdp growth and margins a mere fraction of those James Hardie enjoy. With a 90%+ market share in US fibre cement, and competitors which have mostly struggled to generate a consistent economic return, James Hardie also has established and maintained a market position the envy of many “disruptors”. In many respects – production methods, range, distribution strategy and pricing – James Hardie has had to forge its own path, to innovate. Unfortunately the senior management team has also been subject to significant disruption in recent years and stabilising this whilst the group returns to a stable operating platform would help the group to start relatively outperforming again.
One sector which hitherto has been seen as largely immune from disruption (and indeed innovation) has been Mining. This is changing, to some extent. As in many industries, innovation is spurned by newcomers. Fortescue has turned a desert into the operating base for a $20b company in less than two decades, by building infrastructure and operating mines at levels of efficiency which is both unprecedented in the industry and has consistently been dismissed as unsustainable. We have not owned equity in Fortescue, and are not corporate cheerleaders, but it is fair to say they have introduced more disruption and innovation to industry practices than their competitors, combined, through the past cycle. For BHP to respond to this and other public criticism of operating performance with an ad campaign labelled “Think Big”, is surprising. Fortescue innovated by thinking good, not big. ANZ is trying to prove the two are not incompatible.
Innovation is required by every company to continue to compete for capital. It is not just the preserve of the disruptors, although creative destruction is clearly easier when profits aren’t yet present to be disrupted. As July’s market performance on the ASX showed, disruption is interesting but not a panacea for performance – the best performing sector, Materials, hosts some pockets of disruptors such as James Hardie and select miners, but it would be a stretch to suggest it hosts more innovation than that seen in Healthcare, the worst performing sector for the month. In a world awash with expensive assets, there is no pretending that equities listed on the ASX are any different. Within that context, though, we continue to believe better relative value can be found among major miners and those with offshore earnings streams, and our portfolios are positioned accordingly.
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