Innovation Isn't Enough: The Need for Strong Business Models
The brisk pace of technology adoption is contributing to even greater disparity among the winners and losers of innovation, including in telemedicine, e-commerce and virtual conference platforms. We believe this raises the potential to generate strong investment returns from successful stock picking.
EATHERBIE CAPITAL e-commerce and virtual conference platforms (see Figure 2). We believe this raises the potential to generate strong investment returns from successful stock picking. The power of innovation is also illustrated by the stock price outperformance of companies that are committed to research and development (see Figure 3). Early Innovators Face Significant Challenges Simply investing in companies with innovative products may generate disappointing results given the high failure rate of new product adoption. Essential Products was a promising company that had raised several hundred million dollars and was led by the legendary creator of Google’s Android operat ing system, yet it folded earlier this year. i The company had launched a smartphone and sought to integrate computing more seamlessly in individuals’ lifestyles but lacked a strong distribution strategy. The demise of Essential Products isn’t unusual, with studies showing that up to 90% of new products, representing billions of dollars in investments, fail. ii New products face the challenge of consumers’ biases regarding losses and gains, according to researchers Daniel Kahneman and Amos Tversky. They found that individuals experience monetary losses more acutely than monetary gains, creating loss aversion, while researcher Richard Thaler has found that consumers place a higher value on products they own than identical products that they don’t own, so even if the real value of a new item is somewhat better than an existing item, individuals may perceive that purchasing it will create a financial loss. iii Companies introducing new products must therefore overcome individuals’ loss aversion and distorted perception of the value of existing items. Crossing the Chasm Geoffrey Moore’s timeless 1991 book “Crossing the Chasm: Marketing and Selling High-Tech Products to Mainstream Customers” provides additional insights. The organizational theorist maintains that the biggest obstacle for innovators is crossing the chasm between product acceptance by “Early
Figure 3: Innovation Drives Excess Performance
% of R
Figure 3: Innovative Companies Have Outperformed Over the Past Decade
Figure 2: Corporate Sales Dispersion Has Jumped
Most Innovative +6% per year
The Rate at which Sales Are Shifting Between U.S. Companies
Higher Sales Dispersion
Cumulative Excess Return
Least Innovative -3% per year
Lower Sales Dispersion
Source: FactSet. Most/least innovative stock excess performance is derived from highest and lowest S&P 1500 quintiles based on R&D as % of sales, normalized for market value, using one month returns for 10 years ending August 2020.
Source: Survey of Business Uncertainty conducted by the Federal Reserve Bank of Atlanta, Stanford University, and the University of Chicago Booth School of Business to calculate the Expected Excess Sales Reallocation Rate through August 2020.
Source: Ponemon Ins
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