Dividends and Where is Growth in the economy part 2

One of the Harvard Business School Professors has thought and done work on where does growth come from in the economy? It is an very interesting question given the state of the economy and the election cycle – where promises of growth are given easily. The professor is Clayton Christensen and some of his talks are available on You Tube. There are 4 general methods which you can think about products:

  1. Potential Products –  new ones to answer the question which job does it do?
  2. Sustaining Products – make good products better
  3. Disruptive Products – transform complicated expensive products into simple and more affordable one  (products move from very expensive to affordable by the majority of consumers)
  4. Efficiency Products – same product with same customers but made less expensive or improve gross margins.

To define the terms:

Potential Products – an interesting way to look at what you buy is what job is it doing? People buy things or a brand for a reason – to fulfill a job that needs to be done. An example Mr. Christensen gave is people buying a McDonald’s milkshake in the morning. McDonald’s collects all types of metrics on what people typically will buy, but why were they buying milkshakes in the morning? After watching, interviewing customers the team with Mr. Christensen noted the job is what to do with the second hand on the commute to work? The alternative is donuts or some food group. It was discovered commuters liked the time it took to drink the milkshake, it was filling until lunch or break, it fitted nicely in the cup holder and used their hand in the morning. Note: the reason or job for the buying a milkshake in the afternoon was different than the morning.

Note: it is rare for the reason the company thinks the person buys and the reason the person buys match. Sometimes people will buy the premium price because the alternative that does not do the job is more costly in time and money.

Most jobs today are the same as yesterday however technology changes. For example ” I need to get this to there as fast as possible with perfect certainty”

Cesar – used horse and chariot

Queen Victoria used telegraph and railroad

Churchill used planes

Bush used FedEx or DHL with a tracking number for your computer.

How disruptive products change a Industry using steel as an example:

Until the 1990’s the integrated steel companies were the dominate business in the steel industry then something happened, but the writing was on the wall.

Pursuit of Profit

sheet steel   25-30% margins

structural steel  18%

angle steel          12%

rebar                     6%

When mini mills were developed they had a cost advantage because they recycled steel, however the first few years, the quality was not great. They could compete in the rebar which is mixed with concrete to hold up walls and floors of high rises, etc. The integrated companies considered rebar low margin but very price competitive business and were not disappointed to give that portion to the mini mills for they had the higher margin business and profits improved. As time goes on, new technology plus improvements allow mini mills to improve quality as soon they are taking the business of the angle steel. Once again the integrated companies do not see the mini mills as a threat and they have the higher margin business and profits are up. The process continues and by the mid 1990’s the integrated steel companies are in bankruptcy, because now mini mills quality is high and they have a built in 20% cost advantage and it cost less to step up a mini mill than a billion dollar integrated mill.

Was the writing on the wall? could they have done something about it before?

There are many other examples – the easiest for most to see is technology and cars.

Toyota – enters the US with a $2,000 car. Its quality was not great but it was inexpensive which opened up a new segment to the auto industry. The next car was built better and as people made more money they moved up to the better quality Corollas and eventually Lexus.

Main frame computers – before servers there was mainframe computers and on a sale of $2 million. the gross margin was $1.2 million. It is not surprising those companies did not want to be in the personal computing business were the costs was $2,000 and the gross margins was $200. And it was not surprising those companies did not want to be in the cell phone business where the gross margins is $80. The cell phone and personal computer industries opened up the markets and made the process simpler for all to use – they were disruptive products.

Linking to dividend paying stocks, Mr. Christensen does not have all the answers but often in our economy it is often different companies doing the disruption because similar to the steel industry example why focus on the small margin items and not focus on the larger margin products? If you focus on what you making more money on, you will enjoy higher profits given similar sales next year. It is a very tough circle, so if you see your company focusing on less items, perhaps the writing is on the wall. If your company is not investing in disruptive products, unless it has a monopoly or very wide moat it maybe time to look for alternatives even though the company’s profits are rising.

There are more questions than answers, till the next time – to raising questions.

 

 

 

 

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