Disruptive’s influence – Is ‘disruption’ really powerful enough to justify such high valuations?
Here on The Value Perspective, we would never usually set out to write anything awful intentionally but today we are going to make an exception in order to illustrate how the English language is in a constant state of flux. For the original meaning of ‘awful’ was not ‘really bad’ but ‘awe-inspiring’ – and, yes, we appreciate we have now set ourselves quite the challenge.
While it may have taken ‘awful’ centuries to arrive at its current meaning, the journey time for the word that is our principal focus today has been a whole lot shorter. Even 20 years ago, if anyone used the word ‘disruptive’, the chances are they were talking about a person – and probably that kid at the back of the class.
These days, however, the word is far more likely to be used in phrases such as ‘disruptive innovation’ or ‘disruptive technology and is now so ubiquitous in a business context it is dangerously close to becoming a cliché. If you need further convincing, just look at the following graph, which shows how the use of the word ‘disruptive’ in business-related articles has rocketed in recent years.
Source: Factiva. December 2015
Where exactly did the current incarnation of the word originate and, more importantly, why is it now such a big thing? ‘Disruptive’ is effectively the fuel powering today’s vertiginous valuations of growth businesses – particularly among the so-called ‘unicorns’ we have met in articles such as Hit and myth. In Square’s recent IPO prospectus, for example, the first mention of the word came as early as page 4.
The first person to use ‘disruption’ effectively as a synonym for ‘progress’ was Harvard Business School professor Clayton Christensen. In his 1997 book The Innovator’s Dilemma, he argued very successful companies could focus so much on , say, the quality of their products or services that they would price out the mass-market, thus leaving a vacuum that could be filled by low-cost innovators.
To illustrate this business model disruption, Christensen used some curious examples from the worlds of hard-disk drives and mechanical excavation, which may or may not help to explain why, as the above graph also shows, it took around a decade for his idea to take hold. No sooner had it done so, however, and – in a cruel irony – the rise of disruptive innovation was itself essentially disrupted.
Among those leading the charge was Jill Lepore – once also an employee at Harvard Business School – who argued in this pretty damning article for The New Yorker that Christensen’s ideas on disruption had never really been put under the microscope. Once they were, she suggested, his sources, his data and, yes, his examples did not really hold up.
Indeed, with the benefit of hindsight, it is now possible to see that, in the various sectors Christensen highlighted as examples of disruption, the disruptors tended not to do very well while the businesses they supposedly disrupted often survived to thrive again. Here on The Value Perspective, we find that interesting as we would instinctively lean more towards the disrupted than the disruptors.
“Disruptive innovation is a theory about why businesses fail,” Lepore concluded. “It’s not more than that. It doesn’t explain change. It’s not a law of nature. It’s an artefact of history, an idea, forged in time; it’s the manufacture of a moment of upsetting and edgy uncertainty. Transfixed by change, it’s blind to continuity. It makes a very poor prophet.” Ouch.
As you might imagine, Christensen has since sought to answer his critics and reclaim the idea of disruption, arguing in this article in the Harvard Business Review that the word is both overused and misused. He does not believe, for example, that supposed flagbearers for disruption such as Tesla and Uber are disruptive businesses.
Christensen has also evolved his own definition of disruption slightly to mean “a process whereby a smaller company with fewer resources is able to successfully challenge an established, incumbent business”. That at least brings some rather more accessible examples into the fold – most obviously the likes of Aldi and Lidl on the high street.
So why, you might ask, has The Value Perspective developed this sudden interest in semantics? Why does all this matter? Well, it matters because disruption is now being used to justify some very high ratings among investors – as we saw in Storage issues – and, even if some parts of the market do not fully understand what it means, it is important to make sure that we do.
Perhaps the strangest thing about disruption is that, if you really believed in its power, you would not be paying far higher multiples for it than you have in the past but much lower ones. After all, if you believe the pace of disruption is picking up, it follows that barriers to entry are becoming lower and today’s disrupting businesses will themselves be disrupted sooner rather than later.
Or else you might just want to bear in mind, as Lepore points out, that three out of four start-up businesses fail while more than nine out of 10 never earn a return. One thing both the supporters and critics of unicorns and other supposedly disruptive businesses might agree on is that their valuations can be ‘egregious’. It just depends whether you go with the archaic or modern meanings of that word – respectively, ‘remarkably good’ or ‘outstandingly bad’.
Fund Manager, Equity Value
I joined Schroders in 2015 as a member of the Value Investment team. Prior to joining Schroders I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst.
The views and opinions displayed are those of Ian Kelly, Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans and Simon Adler, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated. They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.
This article is intended to be for information purposes only and it is not intended as promotional material in any respect. Reliance should not be placed on the views and information on the website when taking individual investment and/or strategic decisions. Nothing in this article should be construed as advice. The sectors/securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy/sell.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.