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Incumbents with excellent business franchises are adopting innovative technologies to extend their competitive advantage and beat disruptors at their own game.

Our last two commentaries focused on the forces of disruption and how investor perceptions have created an exploitable gap in valuations for companies with durable business franchises. In this quarter’s commentary we examine how emerging technologies in banking, autos, and industrial distribution are enabling incumbents to provide enhanced user experiences and reduce costs, improving their value proposition and widening their competitive advantage. Valuation reflect Investor uncertainty, but these are situations where we believe the franchises were excellent to begin with and where they are adopting technology to stay well ahead of their would-be disruptors.


Banking is an industry where technologies known as fintech that were meant to displace existing business models have in many cases been co-opted by the incumbents.

Fintech startups were always at a major disadvantage due to a complex regulatory regime that presented almost un-scalable barriers to entry. The major banks also have overwhelming resources to deploy into new technologies. The four top U.S. banks (JPMorgan, Citigroup, Bank of America, and Wells Fargo) will collectively spend over $35 billion on technology in 2018. This spending encompasses back-end and front-end systems that enhance the customer experience while simultaneously reducing costs. For example, mobile banking is a service that is helping to create loyal customers of millennials1 due to its speed and convenience, while costing the banks a fraction of an in-person transaction (Figure 1). Wells Fargo has initiatives spanning digital acquisition, payments, personalized advice, and mobility. To supplement home-grown efforts, Wells has also created a startup accelerator that invests in early stage companies where emerging technologies can be powerful and where those technologies can be leveraged to create experiences and capabilities that keep the bank ahead of customer expectations. Wells currently has 19 of these companies in its portfolio.

Blockchain technology is also viewed as a potential gamechanger. Seeing the power of distributed ledger technology, trust banks are making major investments in the area. State Street has been actively developing applications that have the potential to deliver significant efficiency gains in a business that currently requires 20,000 manual interventions on trades every day. Automation of these processes would enhance the scale advantages that the trust banks already enjoy and likely reinforce the industry’s oligopoly structure. In addition, “know your customer” and antimoney laundering regulations make trust banks the natural owners of any blockchain-based platform for financial transactions.


Electrification of the fleet and autonomous driving are the two main disruptive forces pressuring the auto industry. Every major automaker is making serious investments in these technologies, as are startups ranging from Tesla to Waymo, which focus on fully integrated systems, to companies that focus on individual components. The question is whether the startups will displace today’s market leaders or provide inputs to the automakers that enhance their product offerings and competitive position. We’ll use Volkswagen to illustrate how automakers add value and why their businesses may be uniquely positioned to benefit from these emerging technologies.

Volkswagen adds value through scale advantages and expertise developed over decades across a range of activities that drive profitability:

Branding – Volkswagen’s nameplates, which include Audi and Porsche, are leading global brands with high customer loyalty, particularly at the premium end. In many segments this can be thousands of dollars per vehicle vis-à-vis weaker brands.

Product design and quality – Volkswagen’s brands have been recognized for years as leaders in design and performance. This is a function of many years of investment and testing.

Manufacturing efficiency, especially at scale – VW is the world’s largest auto manufacturer and can spread R&D expenditures across a global manufacturing base. Automation is already incorporated in many phases of assembly.

Systems integration – VW routinely integrates systems from hundreds of suppliers into its products, giving VW the ability to offer “best of breed” technologies developed by a global supplier base.

Distribution capability – a global network of dealers and distributors provides a formidable barrier to entry for any new competitor.

We believe the move to electrification plays to VW’s scale advantages and core competencies. Scale will be increasingly important in electric vehicles, as a cost advantage in battery purchases can only be gained at much larger volumes than for internal combustion engines. Battery technology is not differentiated, and electrification is not changing how consumers buy or use their vehicles, so we expect the factors mentioned above should continue to play an important role in the consumers’ purchase decision and the company’s profitability, even as VW introduces many fully electric vehicles in coming years. One need look no further than Tesla’s experience to see the trouble with trying to overcome the advantage of incumbents as seen in Figure 2. Tesla has successfully built a brand, but it has burned through over $17 billion attempting to create a fully integrated design, manufacturing, and distribution capability. Persistent production difficulties may yet end up tarnishing Tesla’s brand and weakening its competitive position in the emerging electric vehicle market. Profitability is nowhere in sight, and we suspect that VW will produce a larger number of fully electric vehicles than Tesla at a much lower development cost per unit.

Autonomous driving could significantly change the dynamic of vehicle ownership and use. However, we believe it is unlikely to have a major structural impact until full autonomy is achieved with high reliability and safety, and enabling technologies (e.g., 5G wireless communications) become ubiquitous. In the meantime, driver assist technologies are rapidly being integrated by the incumbents as improvements in safety and convenience, in many cases as high-margin options, which is benefitting automakers.

Industrial Distribution

Industrial distributors are proximity businesses where product knowledge and the ability to service a customer quickly and conveniently with a broad range of in-stock products is the bedrock of the franchise. Investors fear that Amazon, with its on-line capability, distribution expertise, and scale advantages, will take over the industry. We’ll focus on electrical distribution and the French group Rexel, a leader in the industry, to illustrate why incumbents have a wide moat around their business and how they are deploying technology to gain further advantage.

Rexel’s customer is the electrical contractor whose cost of materials is typically a pass-through to its end customer. As such, convenience and a one-stop-shop is key, as contractors seek to minimize their time committed to sourcing materials and avoid construction delays. With 16,000 sales people and 2,000 branches, we believe Rexel is well positioned to deliver on this value proposition. There is also a virtuous cycle when a distributor attains critical mass in a geography. The ability to support a dense branch network creates greater value for customers, as higher volumes drive discounts from suppliers that lead to lower prices. These advantages also result in greater customer satisfaction and retention and improve the distributor’s profit margins. While a newcomer might try to enter with lower prices, the service elements are the most difficult to replicate.

There are other barriers to entry beyond physical proximity that pose challenges to Amazon or any other market entrant. Any viable distributor needs a critical mass of suppliers for a wide array of products. Amazon has tried to break into this market, but electrical equipment manufacturers are deeply embedded with distributors, who handle more than just their high-volume products, and work closely on product rollouts, distribution strategies, and customer support, making them reticent to deal with Amazon on anything other than pure commodity offerings. Regulatory barriers are also an impediment to potential competitors due to permitting requirements on large projects.

Technologies such as mobile ordering and the click-and-collect model are likely to be positives for the incumbents. They enhance the customer experience by enabling end-of-day ordering and next-morning pickups, as well as increase efficiencies in their own operations. Rexel’s own experience suggests that adoption of on-line ordering correlates with materially higher sales per order and higher margins in regions with greater penetration of on-line sales (Figure 3).


Scale, regulation, proximity to customers, and expertise gained over many years are some of the factors that contribute to the sustainability of a good business franchise. If a business serves a customer’s needs better than a disruptor, it stands to reason that the incumbent wins. It is also the case that the monopolistic nature of some disruptors may be less certain than assumed. When valuations plunge due to the threat of disruption, our research focuses on identifying businesses where the negative outcome is already assumed by investors, yet the reality is that the potential disruption may be co-opted by the incumbents, providing both their businesses and investors significant upside potential



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