Superstar firms are desperate to diversify, explore new markets and new territories. Is this essential to their survival or can it damage overall performance? Investigator examines the ups and downs of branching out.
8am, July 2028. Alexa wakes you up and confirms that the Amazon drone has delivered your breakfast. You jump out of your Samsung bed, pack your Google document case, make a quick Insta-call and then hurry to catch your Uber Airlines flight to Paris. Just time to take a quick bite of your Apple™ apple…
The Superstar companies are diversifying. Amazon started by selling books, branched out into almost every retail sector, diversified into TV and, even more profitably, it is now the world’s leading cloud computing platform. Apple has evolved from computer hardware to phones to streaming services and programme production. Samsung sells life insurance, Google streams video and generates advertising, Sony makes movies, the list goes on.
The ability to successfully export their business model to new sectors is one of the defining characteristics of a superstar company. Successful companies, like successful people, have a strong belief in their own genius and superstars often come with a streak of arrogance. Most believe that the innovation, entrepreneurial mindset and unique spirit that made them dominant in one sector can be translated to another. They are often right.
Competition from other superstar companies as well as the threat from newer, more nimble challenger businesses, fosters a culture of ‘adapt or die’, the belief that any business that stand still is doomed to extinction. Superstars stay at the top because they never rest on their laurels.
The lessons of history
A glance through the annals of recent business failures gives plenty of evidence to support this idea. Blackberry, Blockbuster and HMV never managed to break away from the confines of their core products and paid the price. MySpace and Napster failed to find a model that could convert innovative ideas and technology into profit and business success. The true superstars have managed to change with the times and adapt to new technologies and consumer demand. They refuse to stand still.
To succeed you must learn to fail
As Amazon founder Jeff Bezos has observed, ‘Amazon will be experimenting at the right scale for a company of our size if we occasionally have multibillion dollar failures’. The superstars have the size, resources and funds to experiment and the scale to bounce back if those experiments fail to come off. Sometimes it’s a matter of the right products at the wrong time. The Sony Betamax, Apple Newton and Microsoft Bob were all hugely innovative products that failed to find a market, arguably because the world wasn’t yet ready for them.
Sometimes, even the biggest companies bite off more than they can chew and attempt to penetrate markets where the dominant brands are too strong (anyone remember Virgin Cola? Thought not). The strength of the superstars is that they can afford to fail and can often channel failure into success – for example, some of the technology of the Apple Newton resurfaced a decade later in the Apple iPad.
Competition keeps superstar firms sharp
What happens when one superstar company enters a market sector occupied by another? The existing market leader is forced to raise its game to defend its territory and this can lead to conflict, price wars and rapid product and service innovation. Often the consumers are the winners – Netflix is defending its leadership in the TV streaming market from a number of high-profile contenders by producing innovative Oscar-winning programming. Sometimes there are casualties but there is room for more than one superstar to co-exist in the same sector; the mobile cellular phone market has space for Apple, Samsung and others, all happily making profits and trying to outdo each other in product innovation and brand loyalty.
The investment challenge
Investors often get nervous when companies venture into new territory and risk failure, especially if it’s a high-profile one and gets adverse publicity. But perhaps they shouldn’t. Companies that are scared to fail, almost certainly will. Conversely, there are times when a superstar firm finds the flight to new pastures drains it of its energy and preoccupies its key people to the detriment of the core business. Ongoing monitoring of this venture’s financial feasibility, senior commitment, commercial focus or market take-up could help flag up any potential signs that all is not bright and positive.
If we take a specific look at tech stocks, these now account for around 25% of total US stock market value, which is close to the peak reached in the dotcom bubble. If concentration levels increase, passive investors may be taking on more risk than they realise. An abrupt Superstar bubble burst could leave investors vulnerable.
So, a question to ask ourselves is whether a superstar business is seizing the day or overreaching itself? At BNP Paribas Asset Management we look at these businesses from all angles, watching for any signs of overstretched ambitions and capabilities as well as potential profit opportunities. We investigate before we invest and look beyond the headlines to uncover the powerful and the vulnerable. It’s an approach we believe will provide long-term sustainable returns for our clients.