Introduction

We believe that many of the best potential opportunities for alpha generation arise in industries where there is either disruption or the threat of disruption taking place. Where established businesses are being forced to react to radically changing circumstances, it ought to be possible, through a combination of close financial analysis, deep market knowledge and, most of all, intense scrutiny of management teams, to distinguish between those who will embrace change and those whose businesses will be destroyed by it. Whether changes take the form of new end-markets, new technologies, or new competitors, what one company may see as a threat, another will embrace as an opportunity.

Shaving off the competitive edge?

One of the areas we’ve been watching closely in recent months is fast-moving consumer goods (FMCG). This is an industry of everyday items, where high volumes of products are sold at relatively low cost, and has previously been dominated by a handful of large multi-national corporations. However, new opportunities in direct, highly-targeted marketing provided by the Internet (and social networking sites) mean that suddenly barriers to entry have fallen, and the major incumbents are under pressure. News headlines about the purchase of Dollar Shave Club last year for USD1bn by Unilever seem to have generated much discussion in this area1.

If we take the example of razors – one of the most interesting and profitable areas of the FMCG market, and one of the most ripe for disruption – we can see that the traditional big brands here have previously been sustained by a number of factors which, in the age of the Internet, have suddenly become less supportive. For example, Gillette was bought for USD57bn in 20052, and has continued its new product launches and premium pricing (particularly of replacement blades). And yet, suddenly, this brand’s hegemony is threatened by a start-up that sources its blades from Korea.

There was a time when it would have been impossible for a small business to take on the established behemoths of the FMCG space. The multiple moats erected by leading brands seemed impregnable in a pre-Internet era. Brands like Gillette dominated through supply chain management – making sure their products were available everywhere and priced correctly – and through applying pressure to retailers to make sure they were prominently positioned in stores. This point-of-sale dominance has been augmented by a colossal marketing spend, so that, in the case of razors, every shave feels as if it’s personally endorsed by David Beckham (or Shoaib Malik, Derek Jeter, Park Ji-Sung or whoever).

From TV ads to viral videos – the transformation of marketing power

If you look at how big FMCG players have advertised in the past, it’s been very much a reflection of the dominant media – so major razor brands would have had sports stars and celebrities appearing on television advertisements and on the pages of men’s magazines, spending large amounts of money on TV advertising. Now, though, millennials are beginning to stop watching broadcast television (instead streaming content over the Internet) and read their news online, often through the portals of social media sites. Advertising is no longer the blanket blast-out of the television ad, but a far more selective proposition in which data can be sifted and sorted to target only those customers who are most likely to buy the product.

This is what companies like Dollar Shave Club recognized – that there was suddenly the possibility of advertising its product to exactly the market of men who it knew felt held over a barrel by the Gillette marketing machine, and were looking for an alternative that wasn’t the obviously inferior shave of the single-blade disposable. Dollar Shave CEO Michael Dubin put out a highly personal, compellingly irreverent advert stating clearly what the company was seeking to do. ‘Do you like spending USD20 a month on brand name razors? USD19 go to Roger Federer! I’m good at tennis. And do you think your razor needs a vibrating handle, a flashlight, a back-scratcher, and ten blades? Stop paying for shave tech you don’t need.’

Crucially, this advert was not aimed at a TV audience, but rather streamed on YouTube and Facebook. First, this allowed the company to channel its message directly to its target market – men between the ages of 18 and 45. Dubin also recognized that for Internet advertisements to work, they had to make people want to share them. His commercial went viral and has now been viewed some 24 million times. There had been other companies with similar offerings to Dollar Shave in the past, but none had managed to seize the Internet limelight quite so compellingly. Dollar Shave’s success is down to many things, but that commercial was first and paved the way for what came after.

Now people are used to doing some, if not most, of their shopping online, the supply chain position of the traditional big name FMCG brands actually seems like a disadvantage. Why go to physical stores with their aisles of traditional branded razors when you can get a cheaper alternative that many of Dollar Shave’s enthusiastic brand ambassadors claim offers a shave every good as these for a fraction of the price? Users are sent a new blade each month (more regularly than the once every three months that traditional razor users changed their blades in the US). In 2015, Dollar Shave secured 15% of the US razor cartridge market3, and traditional players have been aggressively slashing their prices in response.

Implications of disruption are far-reaching

What can we potentially learn from this story, and where else might we see this kind of disruption taking place? The answer to the first question is that this is a very typical tale of disruption, with all of the common elements in place: dominant, possibly complacent market leaders, and new forms of technology that cause a radical shift in market dynamics. Of course, we’re talking not only about the way that Dollar Shave was able to use the Internet to replicate the competitive advantages of traditional FMCG players, but also that this small business was able to source Korean-manufactured blades that provided a similar shave to the established market leaders. In an increasingly interconnected world, powered by progress in technology, we may see many further examples of this sort of disruption over the coming years.

As for other industries that could see similar seismic shifts? We’d turn first to the auto industry, where the simultaneous move to electric and self-driving cars may alter the landscape significantly in coming years, both in the auto industry itself and for those tech companies able to take advantage of the potential growth opportunities. There’s also the potential for widespread disruption in fintech (although it remains early days here); television, in which traditional broadcast TV is dying and media companies need to find ways of monetizing their content as well as competing with new OTT (over-the-top TV); virtual and augmented reality, with the possibility that new smart phones could have some augmented reality features very soon. This could have implications for advertising and gaming. We’re also looking closely at those technology companies who make crucial parts for AR/VR-capable devices – many of the real winners may initially be found here.

Identifying winners in FMCG disruption

Ultimately, we believe that some of the most compelling investment opportunities could be found in industries undergoing disruptive change. Innovation isn’t always destructive, but where companies don’t move swiftly enough to embrace it, new technology and new market dynamics can profoundly alter the competitive landscape. The challenge for investors in spotting the winners in this context is that they may come from any part of the supply chain, and will not always be the most obvious names. Equally, and an obvious point, brands are not the same thing as companies – and there are numerous examples in the FMCG sector where investable stocks will represent a wide range of individual brands: some of which may capitalize on industry change, and some may not. Overall, we believe selecting equities for a portfolio involves a deep understanding of a company’s management culture, structure and valuation – where bottom-up analysis trumps viral videos, newsflow and market excitement.

1. Bloomberg, 20 July 2016. Covered widely across financial news sources.
2. Bloomberg, 25 July 2005. Covered widely across financial news sources.
3. https://stratechery.com/2016/dollar-shave-club-and-the-disruption-of-eve..., accessed August 2017.

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