Tech Barbarians at the Gate?

As the global economy rapidly digitizes, the threat from radical new business models is critical for investors to understand. Plans to attack sectors from energy to banking are advancing rapidly and on my trips to Silicon Valley I’ve noted that the smartest software coders and entrepreneurs are often driven by an almost messianic libertarian zeal to overthrow the existing order. The top down, centralized paradigm from utilities to telecoms and banking will be gradually eroded by these new models which only have to take a tiny market share to create disproportionate damage on incumbent margins and valuations. Indeed, the smarter companies in vulnerable sectors like banking are already trying to co-opt Silicon Valley to improve their relative competitive position.

However, most corporate boards are thinking like French generals as they huddled behind the Maginot line in 1939, oblivious to the risk that German generals would simply outflank them. The role of rapid shifts in technology as a driver of macro trends in recent years remains largely overlooked, but as noted previously it has been a key factor driving weak corporate capex (as fast deflating IT gains a larger share – more data servers, fewer fixed structures to generate incremental revenue) to disinflation and weak wage growth/rising inequality.

In this new era, an unprecedented amount of economic power is concentrating in no more than 20-30 global tech companies through whose servers the key raw material of the information age passes i.e. consumer profiling data which can be process via proprietary algorithms to do anything from inferred credit scoring to targeted location based advertising. They’re driving tanks at breakneck speed while much of the non-tech corporate world is still digging trenches…
With the explosive growth in cheap smartphones and ubiquitous Wi-Fi bringing hundreds of millions of emerging economy consumers online every year for the first time, we’re entering an era when messaging platforms may dominate, as ubiquitous smartphones/free Wi-Fi mean that operating systems and carrier networks matter far less. The gatekeepers are companies like Tencent and Facebook collecting behavioural data on approaching 2bn potential customers between them. It’s not a question of if but how these huge audiences will be monetized.

The biggest issue for investors outside the tech sector to ponder on a 3-5 year view remains the trend toward tech enabled ‘unbundling’ in many sectors i.e. the value proposition underpinning many blue chip non-tech companies is disassembled and rebuilt as supposedly impregnable barriers to entry tumble (from wireless bandwidth to utility grids). The hugely complex logistics of ‘sharing economy’ models like Uber or Air BnB are only possible because of ever more advanced smartphones and fast advancing artificial intelligence and ever cheaper cloud based data analytics – those models can be extended to many more sectors as what works for taxis will also work for say parcel/food delivery.

In many ways, the popular  ‘secular stagnation’ thesis is largely missing the point as much innovation is now focused on radical new business models to optimize the utilisation of existing resources and the software platforms that support them, which thanks to the smartphone boom can explode to global scale at astonishing speed and low cost.  Like the horsemanship and mobility of the Barbarian tribes ravaging the outposts of the late Roman empire, that will eventually change everything…  

The ‘Sharing Economy’ Shock…

The bedrock of economic exchange is trust, and technology now allows a reliable degree of ‘crowd sourced’ trust to be established between total strangers in order to share resources, which has profound implications for investors. As I’ve highlighted many times, a range of new online services are reducing slack and redundancy in the economic system – the internet from its inception has been about reducing search costs and price asymmetries between producers and consumers i.e a fundamentally deflationary force. These ‘sharing economy’ business models are typically zero marginal cost in terms of adding inventory, simply acting as a marketplace brokering transactions between individuals and thus have a potentially exponential growth path, explaining heady venture capital valuations.

Opportunities for these business models to tap into idle or underutilized inventory abound – the average car in a large Western city sits unused 90% of the time, and the opportunity to tap into that unused transportation capacity is the target of numerous start-ups. One of the most interesting I’ve seen recently is a grocery shopping service, that for a small fee sends a freelance ‘personal shopper’ and their car to the supermarket of your choice, to be delivered to your home. No new depots or delivery vans as captured by conventional capital spending measures and yet incremental productive capacity unleashed – this trend will make the US and other advanced economies inherently ‘lighter’ over the next decade.

We are seeing hundreds of similar ‘sharing economy’ apps from parking space rental in unused urban front drives to appliance sharing (does every garden shed really need a lawnmower?). Aside from the incremental impact of underutilized capacity being monetized over the next few years (implying fewer new hotel rooms/cars etc.), we are seeing an interesting cultural shift among the under 30s in the desirability or need for ownership, whether of a property or consumer durable.

Meantime, drivers of London’s iconic black taxi cabs (the ones that spew out noxious diesel fumes and often equally noxious political opinions if you’re unwise enough to engage in conversation with the driver) are planning to paralyse the city next month in protest against Uber’s expansion to London with its smartphone app based private car hire service. With average earnings of £40-60k depending on hours and whether they own or rent their cabs, taxi drivers pull in up to twice national average earnings for a skill which was rendered obsolete by technology a decade ago i.e. memorizing a map of London. They are likely to go apoplectic when US service Lyft (which is more of a pure sharing economy model allowing private individuals to become ad hoc taxi drivers) inevitably arrives in the UK. It’s a bit like dockside stevedores fighting the advent of containerization back in the 1960s, the hopeless battle of a closed shop against technological innovation and another bastion of premium semi-skilled incomes being demolished by Silicon Valley invaders – the overachieving geeks love nothing more than blowing up barriers to entry with some clever code.

The original sharing economy shock hit the music and media industries a decade ago, as consumers dis-intermediated the industry giants to become producers of their own content, creating huge value for platforms that rode the trend like YouTube. As covered in previous posts, the financial world is now in the cross hairs of the tech giants monetizing messaging apps as well as innumerable well-funded start-ups; we’re seeing a surge in innovation from peer-to-peer lenders such as Lending Tree to angel VC funding. Fund managers won’t be immune – for instance, online brokerage start-up Motif Investing offers professionally weighted stock baskets based on crowd sourced top-down thematic asset allocation ideas.

I’m in Silicon Valley next month visiting VC and hedge funds and looking at the next wave of these disruptive business models, which bear close watching for their impact on established industries and the confusion they are already creating in interpreting increasingly outmoded economic statistics (e.g. the freelancing/self-employment trend distorting employment data). We’re entering a world where anyone in a major city can use these platforms to freelance as an amateur landlord, taxi driver, tutor etc. and derive multiple income streams but also in the early stages of a technology driven economic shift which will have major implications for trend inflation, capex and profit margins over the next decade and should be a key investor (and indeed policymaker) focus.