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 Innovation adoption tipping point

 Innovation and financial capital

 Outperformance potential with unprofitable but disruptive companies?

 Private markets overheating?

 Contrarianism and paradigm shifts

Capitalism has always been about change and disruption. Joseph Schumpeter, the well-known Austrian economist, formulated his theories on innovation and capitalism back in the early 1900s. Popularizing the term creative destruction, Schumpeter conceptually described the path of innovation and its effect on the economy, specifically economic growth. Innovation comes in waves or cycles with every major innovation producing disequilibrium in the economy. At the same time, innovation creates new opportunities as new businesses are born and older business models are disrupted. As one innovation goes from idea to production to early adopter to mass use, the original innovation spurs new ideas and they develop on their own life cycle, eventually sending the original innovation into decline. There is a continual process of human innovation spurred by a capitalistic system that rewards innovation due to the ability to make money. This process of creative destruction has been occurring for decades and is generally positive for society.

At the heart of capitalism is creative destruction.

—Joseph A. Schumpeter, economist

The question for investment managers is,

Why is the faster pace of creative destruction more important to active investing today?

What Schumpeter could not have had much insight into was how these waves of innovation would change in length of cycle and the amplification of their effect on economic development and disruption. There are two major factors that determine the speed of new innovation and their speed to mass use: technology and capital.

Many leaders in the technology field believe the nature of recent technologies themselves are shortening the length of innovation cycles. New technologies and discoveries are building on themselves to quicken the pace of innovation and adoption. Gordon Moore of Intel formed the hypothesis that the number of transistors in an integrated circuit would double every two years, and this theory has held in the electronic circuit industry. It may not hold for all technological innovation, but the core of the idea is that technology compounds on itself, and whether it will double every two years or four years, there is an amplification process.

At least 40% of all businesses will die in the next ten years… if they don't figure out how to change their entire company to accommodate new technologies.

—John Chambers, Cisco Systems

Figure 3.1 provides a simple chart demonstrating recent innovations and each innovations' time in years to adoption by 25% of the US population. In an analysis done by Ray Kurzwell, the famed futurist, it took 46 years for 25% of the US population to have electricity in their homes, 26 years to put a television in 25% of US homes, and 7 years to get 25% of US homes on the web. The speed of adoption is clearly accelerating. The tipping point for investors is that the time of adoption is now within one business cycle. Disruption and paradigm shifts occurring faster than business cycles leave investing with a contrarian or mean reverting thesis open to large losses. When there is a higher probability that an industry is being disrupted, reversion to normal is less likely to happen.

FIGURE 3.1 Innovation adoption: Number of years to 25% US population adoption

Source: Ray Kurzwell, “Singularity Is Near” (2005).