Innovation, Disruption, and Perseverance
As of September 21, 2020
Brian Collins, CIO, Harbor Capital Advisors, Inc.
Back to school, physically and from our homes
Back to school season is different this year. For many students, this ritual typically means shopping for things like new shoes, school supplies, and a new backpack. It is a time to say goodbye to carefree summer days and look forward excitedly, or begrudgingly, to school bus rides and cafeteria lunches. The best part for many students is reconnecting with classmates who may have been away at summer camp or on family trips. Similarly, for teachers back to school usually means setting up classrooms, posting inspirational messages on bulletin boards, and assigning desks to keep the troublemakers apart. They look forward to seeing familiar faces as well as meeting new ones who will be with them for the next nine months. In a normal year, the start of the school year signals a new beginning and a greater sense of familiarity and routine.
Classroom prep…charging devices
But 2020 is in no way a normal year. Added to the typical school supply shopping list now are computers, webcams, and headsets to facilitate e-learning along with gallons of hand sanitizer and many facemasks for those fortunate enough to have some in-person learning this fall. For teachers, the changes are even more significant as they figure out how to teach in all the hybrid modes. And if that were not enough, they also need to become experts in solving technical issues with Zoom, TEAMS, Google meetings, and WIFI connections – all while trying to juggle their own families’ situations.
Both teachers and students are being forced to adapt to a new environment with new ways of teaching and learning. While there are many questions about how effective these arrangements will be and whether students will progress at the same rate as in past, one thing is clear – if not for new technologies and capabilities, none of this remote learning would be possible.
A new view of benefitting during the pandemic
Much has been written in the past few months about many companies that have benefitted from the impact of the pandemic. Early on, we saw grocers with bare shelves ramping up online ordering and home delivery along with significant upticks in video streaming service subscriptions. Many existing business types were well positioned in advance of the pandemic. Other businesses were fortunate to have been on the cusp of new growth that has accelerated faster than ever anticipated due to the demands of the pandemic. Zoom is one of the obvious examples, along with many pharma and biotech companies that ramped up research and product delivery of testing kits and potential vaccines.
The market impact of the pandemic has brought innovation and disruption to the forefront of many investors’ minds. Companies that are seen as innovation leaders or disrupting the status quo of their industries are, in many cases, driving equity markets to new highs. We think that some of these companies were already leaders in their markets while others were the hard-charging upstarts that were threatening the leaders. What makes a company innovative or disruptive? Additionally, are these companies only found in the technology or healthcare sectors?
Harbor’s definition of innovation and disruption
We believe innovative and disruptive companies are those that identify opportunities to substantially change the dynamics of their industry. They do this either on the demand side by changing buyer behavior or on the supply side by creating a new product or new use. Some of the most innovative or disruptive products or services create demand from users who did not even know they would need the new offering. Think about the first iPhone which came out well before the world knew about App Stores or TikTok. Cellular phones had existed for years, so a new type of phone was nothing too novel. But pairing a phone with the capabilities of an iPod and a digital camera, both of which had already disrupted established market segments, along with access to the internet created an entirely new use case for a personal device. Did everyone need to have all of this access at their fingertips? Naysayers were skeptical but as Apple and others continuously innovated the product, they dramatically disrupted entire product groups. Sales and subsequent profits of personal planners, traditional cameras, and other single-purpose items declined sharply in the iPhone’s wake. Fast forward to 2020, and it is hard not to see how these innovations have enabled so many students and workers to adapt to the new normal of the pandemic life.
So, are innovative and disruptive companies limited to the technology and healthcare industries? We feel the answer is no. Innovation and disruption as defined above occur across all industries and have been happening for centuries, with periods of heightened rates of innovation and disruption following significant “technological” achievements. Technology, defined very broadly, is often behind much of the innovation and disruption, but it is frequently the result of one or more individuals who have the foresight to see both the unknown and unmet needs of the buyers and the potential solution to this new demand challenge.
Many look to Henry Ford’s use of the assembly line to mass-produce automobiles in greater volumes and more consistently than his peers as his biggest innovation. This is true, but he also had the foresight to see the potential to create significantly more demand for personal transportation that would be met by his mass-produced autos. Is Elon Musk the next Henry Ford? For some, the jury may still be out, but we think he has disrupted a mature industry through not only product innovation but also through creating a new type of demand.
Another example is the success of Domino’s Pizza which embraced the use of mobile ordering on smartphone apps to make the simple act of ordering a pizza even easier. Add the ability to track the pizza from prep, to cook, to delivery and customer activity grew significantly in a mature industry. Older pizzerias are challenged to compete against this innovative market leader.
As investors, one of the biggest challenges is being able to identify which companies are truly innovative and are capable of significantly disrupting an existing industry or market segment such that others are left in their wake. Not every growth company is disruptive or innovative. A company may have a strong competitive advantage or a near monopoly-like position within their industry that is driving year on year growth, but if that company fails to continue to innovate and improve their offering, a disruptive market entrant or competitor will likely capture the growth opportunities of the future. Consider Nokia and Motorola in the cellphone space in the 1990s and early 2000s, and how harshly these companies were overrun by Apple, Samsung, and other competitors who created greater demand in an already growing market segment.
Harbor believes the potential benefits outweigh some of the bumps along the way
We have observed that many of our subadvisers have shown great skill in being able to identify innovators and disruptors early in their ascent. They will be the first to tell clients that they do not always get it right, or they miss many for various reasons. But over time, many subadvisers, not only our growth-oriented managers, have generated positive returns through a combination of assessing the potential for companies to create greater demand growth and their ability to meet that demand with innovative products or services. The most skilled investors can identify innovators and disruptors early and before the inflection points in their growth start to attract other investors and valuations rise quickly. Through a disciplined research process, a keen eye for talented, visionary leadership, and some good fortune, these subadvisers have added value for many of our shareholders over extended periods.
With back to school season, in whatever form it takes, think about how innovative and disruptive businesses and products are allowing us to move forward during this pandemic. We are all benefitting in some way from the foresight that many companies had well in advance to push forward with ideas and concepts that have now become essential to our daily lives. Finally, while social media certainly has been a disruptive new technology, please consider our teachers before posting a potentially negative comment about how e-learning is not working well. Take a breath and remember that the school and faculty are all doing their best in an entirely unprecedented new learning world.
Past performance is no guarantee of future results.
The information shown relates to the past. Past performance is not a guide to the future. The value of an investment can go down as well as up. Investing involves risks including loss of principal.
The views expressed herein are those of Harbor Capital Advisors, Inc. investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice.