Looking at the number of years it took for different products and technologies to reach 50 million users, one can deduce that the pace of adoption by society has accelerated exponentially. For example, it took 46 years for electricity to be used by more than 50 million households, while Facebook reached the same number of users in 4 years, WeChat in 1 year, Fortnite in 4 months, and Apex Legends, a new Electronic Arts game, only took 1 month to reach 50 million users. But why this acceleration? According to Robert Almeida, global investment strategist at MFS Investment Management, in his presentation during the 2019 MFS Americas Advisor Investment Forum in Miami, this slowdown is due to the considerable reduction in the price of new technologies, which sometimes becomes free, in exchange for consumer data and information.
Thus, the manager assessed the sectors, industries and companies that have generated a profile of above-average margins that are not sustainable, because they have lost competitiveness and are only achieving growth in their profits through acquisitions and cost cutting.
Excess Supply of Content in the Media
An example of this type of companies are those belonging to the media, whose value proposition has changed significantly in recent years. "Today, Hollywood produces about 500 films a year, about 1,000 hours of film per week. While YouTube, which is a free channel with 2 billion users, produces 48 hours of content per minute. YouTube produces in 20 minutes the same length of content in hours as Hollywood produces in a year. Of course, quality is debatable, but when in economics you significantly increase the supply curve and there is no change in demand, prices decline. And it's precisely these companies that are subject to price pressures that we want to avoid," Almeida said.
"For example, SpongeBob has been the most monetized children's program in cartoon history.In the future, I don't know if the kids will continue to attend this program, but if they do, they will do it through YouTube or Netflix, for $13 a month," he added.
In this context, the main issue, according to the manager, is the selection of titles. There will be a number of companies that will not continue to add value and there will be another number of companies that will achieve greater value because of their scarcity. In the next decade, the current abundance of margins will not be such and those companies that cannot offer tangible value to society will decline and become extinct.
The Retail Sector
We all know that the disruption of e-commerce has had a strong effect on retailing, but that does not mean that department stores will be eliminated. In Almeida's opinion, there will be shopping centres, but these will have to offer a value proposition or they will be dispensable.
"E-commerce is easier and more convenient, you don't have to go to the mall, you don't need a parking space to get there, with just one click, the purchase is done. But what happens when you introduce more offer in the market? A price war begins. The difference now is that retailers have realized the need to build an online sales platform similar to Amazon's, so they are increasing their capital expenditures rather than their operating expenses to increase their sales. At that point are companies like Macys, Sears, JC Penny and ToysRUs. When will be the next time you go to RadioShack to buy a product? Probably never, you will make your purchase online," he argued.
"The market tells us that there are survivors and dinosaurs. Among the survivors is Costco, whose profits are growing by 5% while other retailers are experiencing losses by the same percentage. That's because even Amazon can't compete with its price-based value proposition. On the other hand, Tiffany, LVMH or Nike are also offering a different value proposition. These companies have recognized brands, intellectual property and pricing power.
The Marijuana Value Proposition
Although only two countries have legalized the recreational use of cannabis, with Uruguay being the first country in 2014, followed by Canada in 2018. In the United States, the situation is somewhat complicated. In 10 states, medical and recreational use is allowed, while at the federal level it is illegal.
"Two-thirds of the U.S. population has access to medical marijuana and one-fifth has access to recreational marijuana. By regularly increasing the legal amount available, the adoption curve is being transformed from an S-shaped curve, as was the case with the electricity mentioned above, which took 46 years to be massively adopted, to a J-shaped curve, like Facebook, which took only 4 years to get 50 million users," he said.
"Another point of view must also be considered: households have budgets. People often formulate a budget in relation to how much they can spend on vacations, shopping or meals during the week. If the cannabis adoption curve increases, what share of consumption will the budget take? What categories of products could be at risk if the cannabis market grows? In our opinion, the beer, wine and spirits sectors are the candidates to lose market share to marijuana. We are evaluating the model closely and examining the potential results. This does not change our view of Diageo, Philipp Morris or Altria, but it is something we are discussing and observing. That's what active management is all about," he concludes.