We know companies come and go. No companies can last forever if they do not innovate. The basis of human advancement is about finding a better way to do things, either more effectively or more efficiently. And by doing so, certain industries would be obsolete and replaced by new industries. Joseph Schumpeter coined the term, “Creative Destruction”, to describe this process.
Let’s take the music industry as the first example. The first commercially viable music recording was the vinyl records and gramophones. These were considered mechanical mode of recording. With the advent of magnetic storage media, the creation of cassette tapes ‘destroyed’ the vinyl market. Companies which were unable to move on to cassette tapes became obsolete. Thereafter, the ability to digitize music and store them in Compact Disc replaced the cassettes. Cassette makers were out of job. Soon, internet came around and file transfer were enabled. This allowed internet users to download music in MP3 formats and piracy proliferated, endangering the profits of music makers. Where do we move on from here?
Likewise, you can also think about the evolution of storage media for moving images. VHS -> Laser Disc -> Video CDs -> DVDs -> Bluray -> ?
How about our computer storage? Hard Disk -> Flash Memory – > Cloud Computing -> ?
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Creative destruction is happening in the background and we adapted new technologies unknowingly. Are you able to spot the trends such that you can avoid investing in declining industries and put your money in future industries? It is easier said than done.
First, we must be very familiar with the developments of various industries to be able to make certain predictions of the future. And we know how accurate prediction is. There are many inventions that failed to materialise as well. I can think of Plasma TVs, Mini-Discs and HD-DVDs.
Second, adopting new technologies and commercialising them require high capital investment. Success is not guaranteed and companies are taking high risks. It would take a few years to recoup the capital outlay and achieve economies of scale in production. The initial stage would also attract a lot of competition and you would not know which companies would gain the biggest market share eventually. For example, during the internet boom, everyone recognised the prospects of technology companies but many of them were not profitable at that point in time. The exuberance was too early. It was after a few years after the internet bubble that Google and Amazon emerged as truly profitable IT companies.
With all these uncertainties, are you willing to take the risks and put your money where you think is going to be the next big thing? I personally would not as the success rate is too low. On the other hand, we must also understand how developments can affect the companies that we have shares in. You would not want to hold on to shares of companies that are likely to be obsolete.