How We Think About the Innovation Hype Cycle
Until the 19th century, humans got from Point A to Point B in limited ways. They could walk, ride a horse, or get on a boat. That’s about it.
So, imagine what it must have been like to see a self-propelled locomotive for the first time. Here’s the reaction of a parish clerk in Victorian England: “That was a sight to have seen; but one I never care to see again! How much longer shall knowledge be allowed to go on increasing?”
We can laugh at the clerk’s reaction with the benefit of hindsight, but his reaction is undeniably human. The idea that the world is rapidly changing in your lifetime or your children’s lifetime can be concerning. We see similar reactions today regarding emerging technologies like autonomous vehicles, robots, and artificial intelligence.
How do we prepare ourselves and our children for this great unknown? What will happen to my job? What kind of jobs will my kids have?
And these reactions are precisely what Amara’s Law would predict: “We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.” Indeed, this is a similar concept to hyperbolic discounting and the Gartner Hype Cycle (chart below).
Someday becomes today
At Ensemble, we try to follow Amara’s Law and filter out the excitement from the “inflated expectations” phase of a new technology. At the same time, we don’t want to ignore or discount the technology’s potential longer-term implications.
Instead, we ask: “How might the technology impact the company’s moat over the next decade?” Ultimately, we want to own companies we believe can maintain or widen their economic moats over the next decade and produce high returns on invested capital (ROIC). As such, we want to understand the ways the technology can be a long-term opportunity or a threat.
Put another way, we’re more concerned with the “slope of enlightenment” and “plateau of productivity” phases in the above chart. And while they may be years or a decade away, those phases matter to us now, as they impact our terminal growth and ROIC assumptions that drive our valuation models.
Life comes at you fast
Just as important, once the technology gets through a certain level of adoption, the market, being forward-looking, quickly catches on. Consider that a 2006 documentary entitled “Who Killed the Electric Car?” discussed how previous versions of battery-powered electric vehicles failed to gain traction in the U.S. At the time, the dream of EVs in the U.S. seemed lost. This was a classic “trough of disillusionment.” Just five years later, the same filmmaker produced “Revenge of the Electric Car” on how EV enthusiasm was reborn.
We’re now on the “slope of enlightenment” phase of the EV hype cycle.
Indeed, a recent Morningstar report shows that EVs could become the standard for new car sales in the not too distant future.
This is exactly why we’d be negligent not to consider the potential long-term impacts of emerging technology here today.
Technology and our portfolio
Though autonomous vehicles (AVs) are likely in the trough of disillusionment phase of the hype cycle, we think they are inevitable. There’s still much debate about who will own the AVs – fleets, individuals, or both – but once they become more common on our roads, they will have a major impact on some of our portfolio companies, in potentially good and bad ways.
As passengers eventually spend more time hands-free on trips, they’ll seek more in-vehicle comfort and entertainment. This could be a positive for Starbucks and Netflix. We can imagine Starbucks sending coupons or drink deals directly to AVs that are approaching one of their restaurants. An impulse trip to Starbucks may eventually be akin to an impulse candy purchase at the grocery store checkout today.
Passengers may also want to spend the time with their favorite Netflix shows. Netflix CEO Reed Hastings has famously said that his biggest competitor is sleep, but commuting is probably his second-biggest competitor, as the average American spends about 50 minutes driving to-and-from work each day.
On the other hand, autonomous trucks could present a threat to freight logistics company, Landstar System. If freight carrier supply outstrips shipper demand, it would drive freight prices lower. This would, in turn, reduce the value of Landstar’s network of drivers and agents.
It’s a real risk, but the main reason Uber and AirBnb were so successful is that they unlocked massive dormant supply of drivers and properties. The same cannot be said for big rig drivers. We also believe trucks will continue to need human navigators, much the way planes, trains, and other heavy transportation systems use autopilot but still have a human in charge. There’s also more to truck driving than steering, such as loading and unloading, processing, and load management.
We might be wrong about these potential outcomes, but we’d be remiss not to think about them or give them serious consideration right now. It’s not so much that these emerging technologies will have immediate impacts to our holdings. But, when they do, the impacts will be far bigger than imagined.
As of the date of this blog post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Starbucks (SBUX), Netflix (NFLX), and Landstar System (LSTR). These companies represent only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.
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