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Liontrust Insights: Why innovation is important to income investors

Storm Uru, fund manager at Liontrust, shares his views in a short article below.


In 2011, Marc Andreesen famously penned “Why Software Is Eating the World” in the Wall Street Journal. Today, the idea that “every company needs to become a software company” is almost considered a cliché.

No matter your industry, you’re expected to be re-imagining your business model to make sure you’re not the next local taxi company or hotel chain caught completely off guard by your equivalent of Uber or Airbnb.

The playbook used to be simple – size and market power mattered – and the strategy was to create value by controlling the value chain and re-deploying capital to grow your competitive position. From retail to manufacturing, this concept is now broken, and more companies than ever are required to pivot and innovate in a digital world to keep pace with a new generation of software companies.

Business model innovation is not a new concept (just ask Clayton Christensen). It has occurred frequently, reshaping entire industries and redistributing billions of dollars of value. Retail discounters such as Wal-Mart and Target entered the market with pioneering business models and quickly grabbed powerful market positions in the retail sector only to bow to a new dominant player, Amazon.

Even with a backdrop of business model innovation, one theme has remained consistent, spanning across sectors from retail to manufacturing to healthcare: the benefits of economies of scale. It is often used by companies in strong competitive positions to capture the economic profit in a value chain and exploited by linear growth. Importantly, these companies tend to use size and market power to exploit suppliers, essentially meaning the firm with the biggest cheque book and strongest market position won.

During this time, industry dynamics tended to change at a rate that incumbents could respond to − but not anymore. Enter a new cohort of a well-funded, highly motivated group of software focused entrepreneurs intent on disrupting every industry, armed with new business models that tend to have a near-zero marginal cost of manufacturing and therefore near-zero marginal cost of distribution.

The velocity and breadth of innovation has caught many incumbents by surprise and has resulted in many lowering expectations for future growth. For evidence, you only need to look at a company’s proxy statements to see how management’s incentivised growth targets have collapsed over the last decade. In response, management teams are now aggressively reallocating capital to digital transformation, and, in some cases, missing the structural change by continuing to pursue old strategies from tried and tested playbooks.

One of the key themes starting to emerge is that digital transformation just isn’t that easy. In fact, McKinsey recently published a report highlighting that most companies fail to achieve a return on investment in digital transformation initiatives greater than the cost of capital.

Some compelling research conducted by the OECD adds some weight to these findings by showing that digital transformation is leading to a confounding outcome. Those with leading digital capabilities are simply extending their lead while laggards show no sign of convergence, historically a key characteristic in key technological shifts, such as lean manufacturing.

This “productivity paradox” is creating a backdrop where it’s becoming increasingly risky to rely on reversion to the mean or investing in strategies that have historically withheld the test of time. This is why it is important to invest in Global Leaders who do not just rely on size and market power, but also have a culture of innovation and are able to extend their market leadership position and increase dividends long into the future.

Liontrust Key risks and Disclaimers

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Issued by Liontrust Fund Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518165) to undertake regulated investment business. This document should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.  

MeDirect Disclaimers:

This information has been accurately reproduced, as received from Liontrust Fund Partners LLP. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

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