When established companies invest in new technologies, investors shrug. Why is that happening? asks Matthew Lynn.
Over the past couple of decades, business strategists have struggled to understand why huge companies so often fail to cope with change. Kodak couldn't survive the arrival of digital photography or Nokia the smartphone. Neither could the newspapers cope with online news. Right now, the banks look about to get rolled over by fintech start-ups and the broadcasters by streaming upstarts such as Netflix. It is not as if they can't see the competition coming it is just that they can't adapt quickly enough.
One explanation is that they are tied down by their existing customers. But another is that they are actively punished for trying to innovate. A new study in the Harvard Business Review, led by Anandhi Bharadwaj, crunched the numbers for the major US companies and measured their rate of innovation by calculating the number of digital patents filed between 1998 and 2010. It then compared that with how the valuation of the business had changed over time. "Whereas the digital leaders in the high-growth group were rewarded for their digital investment by the stockmarket with higher valuations, the digital leaders among the high-profit group were punished with much lower stockmarket valuations," the study argues.
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Punished for making the effort
There are plenty of examples of this finding. BMW, for example, makes as many electric cars as Tesla does every year and has invested just as much in the technology. But Tesla now has a larger market value, even though the German company also makes hundreds of thousands of petrol cars every year. The same is true elsewhere. Netflix is now more valuable than Disney, even though the older company has far more programming in its vaults and theme parks as well. Amazon is worth hundreds of times more than any other retailer, no matter how much its rivals invest in their websites. In this country, BT has hardly been rewarded for its investment in broadcasting, Pearson for its attempts to create a major business in online education or Sky for its push into streaming, even though those are all brave attempts to build for the future. The people running those companies are probably sometimes left wondering why they bother.
Why does this happen? Investors put money into big established companies because they expect a steady flow of profits and dividends. They don't always trust the managers to deliver on new technologies and fear that money invested will be squandered. They don't believe the people running them have the same kind of energy and vision as the entrepreneurs running the tech challengers. Those are all valid reasons why you might put a higher value on Tesla than BMW or Netflix than Disney.
Investors are missing a trick
Even so, it is surely a mistake. If the stockmarket is going to routinely punish corporate managers for investing in the future and drive down the value of their share options, they are not going to bother.
There are plenty of big British companies that should be investing more in the future. The major banks need to be developing fintech divisions as fast as possible. Insurance giants need to find new ways to cover different types of risk. Consumer-goods giants need to respond to the internet's ability to finance thousands of artisan brands, all of which are chipping away at their market. If they don't, sooner or later they will be in deep trouble.
Major companies need to get better at innovating and reinventing themselves. But that won't happen until they are rewarded for it. The City might complain there is not enough growth for it to buy into. Perhaps it only has itself to blame.
