Disintermediation: disruptor or disrupted

Why would a client pay for intermediation that adds no extra value to a final product?

In 1985, Michael Porter described in his book “Competitive Advantage: Creating and Sustaining Superior Performance” that a consumer was willing to pay a margin for a product whose final price would be higher than the mere sum of the costs of all activities in the value chain.

Thirty years later, the economic models of scarcity have derived to models of abundance. Some sectors and especially some goods and services are exposed to an increasing risk of disintermediation. Items like music, films or books that in 1985 were tangible and limited; with the development of new technologies and digitalisation have morphed into unlimited intangible products. Disintermediation is the process of supplanting intermediaries by technology, undermining the established structures.

The new era of intangible goods has shifted the consumption habits not just by the type of goods created, but by the rapid turnover. From novelty to obsolescence in a record time. The faster pace of consumption requires speedier and shorter distribution processes. This is where room for disrupters appears.

A simple app brings any good just one click away from the final consumer. Change is challenging. And success is restricted to the firms that adapt to those changes; firms profiting from the shortened process facilitated by the new transparent virtual marketplace.

Barriers to entry are replaced by “peer-to-peer” relationships under the rule of the free cooperation principle, where any participant has access to the whole network with a single click. Value creation has evolved using social media, bypassing traditional middlemen such as importers, wholesalers and retailers. The common denominator of the companies leading this process is the quality of their revenue and earnings growth, achieved by low or nonexistent inventories, low fixed assets, high intangible assets and high levels of cash. All these increase the leeway for reinvestment or acquisition and integration of new start-ups to quickly adapt to changes.

The most innovative firms within each industry are reshaping their business models and sweeping their rivals. Trivago and Priceline dominate click-based travel transaction. eBay, Alibaba, Baidu, JD.com or Tencent have displaced brick and mortar retailers. Netflix is disrupting the linear TV market. Workday and Oracle are exploiting cloud-based technologies, and Salesforce winning the cloud platform race. LinkedIn and Facebook attract advertisers in Internet and social media. Tesla has reinvented the automotive industry and more. But Amazon has become the biggest disrupter with virtually unlimited growth possibilities. The undeniable leader in eCommerce with 12% of US market, across sectors from books to groceries and its most innovative project of telemedicine; video calls with doctors able to prescript remedies via Amazon.

The most direct consequence of this phenomenon is a higher concentration of firms dominating the markets, where the winner takes it all. Investor’s flows are directed to a handful of high-growth tech stocks that 10 years ago barely existed. Down to market facts, 30% of the S&P 500 year-to-date performance is explained by the FAANG stocks. And the market capitalization of these five firms encompasses 10.5% of the entire index. The weight of the technology sector is nearly 25% of the index and its correlation with it is close to 0.86.

There is a trade-off between risk and opportunity cost. Crowded trades can be as risky as staying aside of the bullish market consensus. Around 90% of the analysts following FAANG stocks are giving them a buy rating, versus a mere 2% of contrarians who recommend to sell based on the elevated price multiples and the threat of a coming correction.

It is no coincidence that the eight largest companies in the world are technological and at the same time, the main global disintermediators. Five are American, two Chinese and one Korean. Never such a small number of companies have concentrated so much power. With individual revenues well above the GDP of 90% of the countries, they draw on their own user’s data to continue growing in size and influence. Their valuations based on traditional patterns are excessive and investors know it, but they are not willing to get off the winning horse.

Rafael Vicario, CFA


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