Disruption is a hot topic. There isn’t a single industry that isn’t - or won’t be - affected by the relentless march of technological innovation.
So what does disruption mean on a portfolio level, and how does it help generate returns? What does disruption even mean?
According to Edi Truell, Executive Chairman at Disruptive Capital Finance, when speaking at SuperInvestor, disruption means the complete transformation of an industry in under a decade. But the key thing to remember is that it was not about the technology itself – it was about the application of that technology. That’s where value creation originated.
Lucian Schönefelder, Director, Member of TMT Team at KKR agreed, outlining how their investments cover a lot of “old economy companies” such as consumer, healthcare, and information services. “Technology and digitisation are an important tool to increase value, because they bring those companies up to the next level,” he said.
What are the drivers of disruption?
Warming to the theme, the panel agreed that the benefits of disruption could best be achieved within existing businesses. Edi explained that you have to look at the disruption as part of an end-to-end system within a company, that ultimately delivered cost savings to the customer. He cited TNT as an example, who had reduced their insurance and fuel costs through new technology: “That’s how to get a successful business,” he said.
"It is important not to think about disruption as being based on any one particular innovation, but rather, how innovations combined together."
Here was also the case of older, more established companies having attractive valuations when new technologies emerged. “The really good thing is where you have an established business, which is just as good an investment, and you can reinvest cash flows around innovation to accelerate top line growth, which gives you a better multiple on exit,” said Simon Patterson, Managing Director at Silver Lake.
Lucian said that having a combination of investments in traditional private equity funds, as well as smaller growth funds, helped them make better decisions. “It’s really interesting to invest in existing businesses with real cash flows and accelerate growth through technology, but also in the pure play disrupters, because we are able to see what’s going on on the more disruptive startup space and younger company space.”
It is important not to think about disruption as being based on any one particular innovation, but rather, how innovations combined together, as Simon explained:
“We are in a special time of innovation where things are coming together as a package, causing a tremendous acceleration of impact in every industry. For instance, cloud computing, plus mobility, plus the march of Moore’s law – which is bringing down the cost of computing and storage – combined with AI, can all come as part of one package.”
How easy is it to disrupt an established company?
Given that investing in existing businesses and disrupting them from within was such an important strategy for investment - how easy was it in practice?
We had already heard earlier in the day how CEOs can present the biggest stumbling block to change. This panel agreed that there could be a real lack of ambition in portfolio companies, led by a Chief Executive that has built up their own value and becomes ever more reluctant to take big risks.
“A company has to change every two to three years,” reckoned Delaney Brown, Senior Principal, Funds, Secondaries & Co-Investments at CPPIB. “Just look at Nokia, that’s a cautionary tale. We have to go in there and make change happen.”
CEOs can present the biggest stumbling block to change.
Simon employed a strategic approach: “Tech is not an end in itself. You need to look at what capabilities the organisation has. The common theme in our engagements is modernising the infrastructure.”
Delaney turned the lens inwards, however. “It’s thinking less about the underlying companies but about ourselves and what we can do. How do we better position ourselves to play in a disruptive sphere? Do we have to rethink the investment process or do we rely on outside experts? What about recruitment - do we spin that on its head and go to completely different universities and people with different vocational backgrounds and bring them into our organisation? Once you have a disruptive mindset in the organisation then you will be more successful applying that in the portfolio companies,” he said.
The VC world
Since much technological innovation originates in start-ups funded by VC, how important was it to keep tabs on VC?
Lucian said that they had made technological disruption part of the investment committee: “If we are investing in insurance or retailers, we ask what the disruption risks might be, and who the new players might be. In addition, we access VC through our growth fund and we try to filter that network into the rest of the organisation.”
It was somewhat more straightforward for Simon, who only invests in tech: “We eat, drink, sleep and breathe tech all day, every day. The bigger companies are spending big on R&D, and all our partners are plugged into the different ecosystems.”
“It’s a question of creating the time and discipline to go and meet interesting people and companies, even if they do not yield an investment immediately,” he added. “That’s where some of our ideas come from, we may have been tracking the company for three to five years before we invest in it.”