While "disruption" may sound like a pervasive buzzword cliche that has ubiquitously, and hopelessly penetrated investor jargon in recent years, the reality is that there is nothing new today that wasn't just as annoying innovative over a decade ago, only instead of batteries and LEDs, the two categories now seen as most "disruptive" (another word for deflationary) , it was Wind, Solar, 3D printers and various other fads, as the following chart from Goldman summarizes:
Yet while their coolness may rise and fall, these buzzwords all have one common them: they result in sharp cost-reductions in any industry they touch, leading to narrow and in some cases broad deflation as industry efficiencies rise, and as entrentched competitors find themselves cutting prices to stay competitive with new technologies, even as early equity investors tend to get wiped out as only later iterations of the underlying technology emerge as viable, or as Amara's Law states:
"We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run."
That statement is the basis of how a recent report by Goldman assesses the lifecycle of any technology. The initial conception stage for a new piece of hardware is usually followed by a phase of high expectations. This ‘hype’ part of the cycle is notable for the innovators or the hardware manufacturers outperforming, not just because of the excitement around the new product, but also because demand growth tends to outpace the supply-side response, supporting high prices.
Over time, however, these conditions deteriorate as high prices and a growing addressable market inevitably attracts competition, scale and commoditisation, dragging down the pricing power of hardware providers.
3D printing is a good example of where this has happened recently. As the first chart below shows, 2013-14 was marked not just by high ASPs, but also by strong share price performance for the sector. Since then, however, competition has intensified and both these metrics have declined, much like the number of investor questions we’ve received about 3D printing. Does that mean it was an overhyped product? No. Matthew Cabral writes on page 20 that 3D printing is a growth industry and is attracting larger players such as GE and HP; i.e., falling hardware costs are increasing the probability that it will be broadly adopted and disrupt existing technologies.
When new technologies become more economically viable, we view it as the end of the hype cycle and the beginning of the theme cycle. In this phase, opportunities lie among the enablers and users of the
tech. Solar is a technology that is crossing this threshold, potentially benefitting enablers such as smart grids, batteries and infrastructure plays, and the users (from electric vehicles to households to industrial companies).
The final stage sees supply and demand dynamics reversed, as the scale of demand eventually pushes down hardware costs sufficiently low that the technology becomes mainstream. At this stage, there is often a revival among hardware manufacturers: those with a cost advantage benefit from rising demand, while others that can innovate are able to enjoy relative pricing power. Wind energy is an excellent case in point here; as the second chart below shows, over the last two years, turbine prices and share prices have decoupled, as the technology has become more economical.
Of course, it’s never as simple as this. For products to make it out of the lab and succeed commercially, they need to make a compelling economic case relative to existing alternatives. While innovation and demand-driven scale are ideal catalysts for costs to decline, most new technologies require external factors to resolve the chicken-and-egg situations that often deter commercialisation.
Ultimately, if successful, the outcome is broad-based cost (and price) reductions, prompting the Federal Reserve to speculate whether or not it ever had a firm grasp on the concept of inflation (or deflation) in the first place.