[Investing in growth is a fascinating business, especially when focused on the realm of business innovation – new trail-blazing products, new redefining industry services, new next-generation business models, new democratizing platforms. It can be likened to a multi-dimensional chess game with an eye towards the future that cannot solely rely on current mainstream investment metrics or analysis frameworks.
Innovation investing requires specialized knowledge on the innovation creation and delivery process — which is a very unique business dynamic — and persistent attention to uncovering meaningful nuggets of ongoing insights buried in overwhelming amounts of data and noise. It also relies on finding the forward-looking talents of company managements that can create new demand and provide supply profitably in extremely competitive markets that are now driven by accelerating rates of change.
To learn more about innovation investing and the unique investment mindset and approach it entails, we reached out to Institute member Alfred R. Berkeley III, chairman of the Investment Committee of Princeton Capital Management — a registered investment adviser and separate accounts manager for financial intermediaries, family offices, institutions, corporations, and endowments. Al and his firm focus on looking for companies that can discover and take advantage of major shifts in their markets and present key investment opportunities for growth investors. In our discussion, we explore their thoughts and perspectives on what indicators and frameworks they use to make better informed decisions that lowers risk and increases probabilities of innovation and investment success.]
Bill Hortz: From your perspective as investment managers, how do you characterize innovation? What do you look for?
Alfred Berkeley: First of all, it is important to note that innovation can occur in a product or service, in distribution, in marketing, in payment mechanisms, in client experience design, and in financing. When being successfully applied, innovation typically creates a new price-performance curve, often reducing costs while improving performance.
In our company research, we seek to understand whether a potential investment is “iterating” (doing more of the same); “innovating” (doing something new for existing customers); or “disrupting” (doing something new for previously unserved or underserved customers) thereby enlarging the market.
In general, we look for investments that fill important human needs, incorporate scientific and technological advances, and create compelling price-to-value combinations.
Hortz: Are there any sources of research that have informed your views on innovation and your investment process?
Berkeley: We are big believers in learning from the excellent academic analysis that has centered on business strategy with different academics focusing on various areas of business and innovation strategies. The academic community’s gift to the investment community has been the development of insights into the cause-and-effect relationships (theory) that lead to business success. These insightful theories or “signals” at times have emerged from what otherwise seems to be random “noise.”
We start with more questions than answers. For example, how should an investor think about market share? Emory Business School’s Professor Jagdeth Sheth’s work on the evolution of markets observed that markets move from local to regional to national to global with an observable characteristic: at each stage, just before the market moves to a larger arena, the dominant vendor has about twice the market share of the next largest competitor, which, in turn, has about twice the market share as the third largest, with all other competitors sharing the remaining scraps. When automobile markets in the United States were national, General Motors, Ford and Chrysler fit this pattern. Now the automobile market is consolidating on a global basis, with Toyota dominant, even in the US market. Frederick William Lanchester and Shinichi Yano’s work looked at market share from another perspective — that of “commercial combat” — and came to insights similar to Sheth’s.
Clay Christensen’s focus on disruptive technologies created theories about the value to be created by bringing unserved and underserved customers into the served market. Clay articulated theories about the basis of competition (capabilities, reliability, convenience, and cost) that are extremely useful in investing in evolving products, like batteries for electric vehicles. The theory of “jobs to be done” is another area in which Clay clarified ways for investors to understand the nature of demand for new products.
Mike Porter’s FIve Forces is a good way to assess the relative strength of an enterprise and look at which market participants garner the lion’s share of an industry’s profits. For example, many people observe that of the various participants in healthcare, it is the insurance companies that harvest the most profits even though we think that the doctors provide the most value added. Others might argue that drug discovery provides the most value added.