Disruptive technologies come along every generation. They herald the end of one era and the beginning of another. Some common examples of disruptive technologies include railroads, telegraph, telephones, Colt revolvers, breech-loading rifles, magazine-loading guns, automobiles, machine-powered looms, television, computers, and the Internet.
If you are an investor looking for a “ground-floor” opportunity, you are looking for a disruptive technology. But how do you know a technology will be disruptive before it launches the revolution that is to follow?
There are three signals to look for. Of course, even if a new company can match all these signals there is no guarantee it will be successful. Â Someone else could come up with a competitive idea that becomes the real disruptor. Â Think about the battle between the Betamax and VHS video formats. Â Betamax by all accounts had the superior technology and yet it was the VHS video format that won out in the long run. Â Even laserdisc technology could not dislodge VHS tapes and players from the consumer marketplace. Â But Betamax reached the marketplace first.
The first signal of a potentially disruptive technology is that it performs an already common task in a new way. Take railroads, for example. These were self-propelled vehicles running on steam. Railroads replaced slow wooden wagons with iron steam engines and freight cars. Although wagons remain in widespread use today they are no longer used for hauling cargoes long distances over land.
Railroads themselves had to give some of that market to automobiles. Millions of semi trucks now haul trailers across the highways of our nations on all six inhabited continents even though railroads continue to haul freight and people, too. Automobiles made it possible to replace wagons and beasts of burden in distributing goods and people away from the rail lines.
The new way of doing things should amplify the payoff sufficiently enough to attract investment. If there is no significant improvement in efficiency then it will be much harder to draw customers away from the older methods.
The second signal of a potentially disruptive technology is that it can be produced with economies of scale. Economies of scale mean that as you put more resources to work producing goods and services the growth in your output increases faster than the growth in your resources.
One way to imagine that is to think of building 100 small machines that each turn out 1 widget per hour. These machines, working together, can produce 2400 widgets per day, or 876,000 widgets per year. Now let’s say that it costs you $10 to produce each widget this way (covering raw materials, power, maintenance, and labor). So you need to spend $8.76 million to manufacture your 876,000 widgets every year.
Now someone comes along with a machine that can produce 10 widgets per hour at a cost of $8 per widget. Suddenly your capacity is increased 10-fold but your costs do not increase correspondingly. Instead of needing to spend $87.6 million per year to produce 8.76 million widgets you now only need to spend $70,080,000 per year to produce your 8.76 million widgets. That is how economies of scale work.
If you can see that economies of scale will help bring down production costs, then you have a good strong signal.
The third signal of a potentially disruptive technology is that it will simplify the lives of and reduce expenses for millions of people. Take cell phone technology, for example. It has made it possible for billions of people around the world to stay in touch with each other at minimal cost. We don’t have to look for telephone booths any more. Telephone booths have all but vanished thanks to portable telephone technology.
But our cell phones can also bring us a constant stream of free-to-read news. We no longer have to buy newspapers or watch scheduled news shows in order to find out what is going on in the world. We can find out any time we want to. Cell phones don’t just make life simpler for us; they make life less expensive.
We have learned to use cell phones to search for products in our local stores, to find the best prices on items we intend to buy, and even to plot our courses across road systems to help us save time in traffic.
- Change how we do things.
- Produce the new technology in scalable ways.
- Help people save time and money.
These are the signs of potentially disruptive technologies. If a new company can touch on all these points, you have a great opportunity to invest in the future.
One example of a recent disruptive technology is the QuikTix airline and hospitality industry ticketing system. QuikTix was developed in the late 1980s by a man named Nicholas Bredimus. Bredimus had worked for many years in the airline industry overseeing computer operations and an employee travel bureau for a major airline. He saw the need to simplify ticketing processes for travelers around the world. He founded a company that made it possible for airlines and travel agents to change how they sold and managed flight and hotel reservations, he was able to scale the technology up, and he helped people save time and money.
IBM is a major company that also disrupted technology. IBM is one of the few corporations in history to successfully disrupt its own business model twice. The company originated in the late 1800s when Herman Hollerith started a company that sold mechanical tabulating machines to the US Census Bureau. After some mergers and acquisitions the company became known as International Business Machines and it was quite successful. But with the development of true computers during World War II IBM’s CEO, Tom Watson, saw that computers would shape the future of business operations and he led IBM into the computer design and manufacturing business in the 1950s.
In the 1970s IBM saw another opportunity when it became practical to develop small computers that people could buy for their homes. The IBM PC was not the first personal computer but it was the first truly successful and expandable personal computer. An entire generation of people around the world grew up using IBM PCs and copycat products. IBM’s mainframe computer business began to decline as PCs were increasingly networked together to create distributed computing systems used by businesses of all sizes.
eBay is a company that introduced a disruptive technology in the late 1990s: Internet-based auction systems. eBay was not the first company to provide online auction services but it was the first company that scaled up these services and made it simple and cost-effective for millions of people to buy and sell things online.
In 2005 Kyle MacDonald set out to trade a paperclip for a house just using awebsite, and he succeeded. He took the eBay concept to a whole new height and in doing so vindicated the independent Website. Anyone with a Website can accomplish anything they set out to do.
Any innovation may become disruptive but in order for it to succeed it has to solve more than one problem. When you choose the next ground-floor investment for your portfolio, look for the signs that your new acquisition is indeed solving more than just one problem.
