One of the more interesting ideas to come out of economic and business literature is that of “creative destruction,” which is closely related to the concept of “disruptive innovation.” Distilled down to its most basic form, “creative destruction” is the concept that something new, whether a technology, manufacturing process, or business practice, can disrupt the established market and upset the market power of entrenched companies. History is rife with examples: the industrial revolution, personal computers, and smartphones, to name a few, each made existing industries and technologies obsolete. As a result, those companies invested in the prevailing order often fall by the wayside.
As the name implies, this replacement is an inherently destructive process. Established companies and industries often struggle to survive, and some are completely eliminated. Some are able to see the writing on the wall, adapt, and survive. In most cases, however, this process wreaks havoc on those companies and individuals that cannot or will not change — once mighty giants of their respective industries — Kodak, Research in Motion (BBRY), and Circuit City, for example, crumble away. Often, such companies will try to leverage market power or even government, through lobbying and legislation, to stave off their demise; but in the long run, they almost never succeed. Innovation is almost always beneficial to consumers and to those who become a part of the new market order — at least until new opportunities arises.
Beyond the interesting theoretical aspects of “creative disruption,” however, there is an edge of practicality for investors to consider. Innovative, cutting-edge companies that are poised to fill a market void, especially ones they’ve created, regardless of whether they are lean start-ups or established players, generally have immense growth opportunities; therefore, they are potentially very lucrative (albeit, somewhat risky) investments. As with any investment decision, all risks should be considered carefully. Thus, companies that are poised to wreak havoc through “creative destruction” require two particular areas of research.
First, investors should understand that growth processes do not take place overnight. It takes time, often far longer than many think it should, for new technologies to be universally adopted, regardless of their practicality. In some cases, the innovation may be years ahead of its time; even if its potential is not oversold, it may be too early, too expensive, and too new to be truly destructive.
Second, the aforementioned resistance from those who currently dominate the market can make it incredibly difficult for revolutionary ideas to succeed. Entrenched companies, if they do not dismiss the coming change outright, will do everything in their power to protect themselves. Innovative companies with great potential for growth, such as Uber, Lyft, and Airbnb, have been fighting with regulators defending the established market order.
However, as long as these potential setbacks are weighed carefully when making investment decisions, disruptive innovators can be excellent opportunities. Everyone wants to get in early on the next Apple (AAPL) or Tesla (TSLA) that completely reshapes the market. Just be cognizant of revolutionary start-ups.