Amazon, Alphabet And Facebook See Innovation Pay Off

by: D.M. Martins Research


“Focus on the core” is the traditional way of thinking in the business world.

Some of the most respected tech companies are not following this strategy. Are they wrong?

Data shows that investors approve the Big 3’s move to boldly diversify away from the core.

If you have ever attended business school, you've probably heard the old saying: to succeed, companies need to focus on their core competencies - or some variation of it. "What does your company do best? Focus on it and drop everything else."

But it looks like some of the most well-known and respected tech companies of today - Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL) and Facebook (NASDAQ:FB) - are not following this mantra. AMZN, originally a book seller turned one of the most successful one-stop-shop e-tailers in the world, has been providing cloud computing services through AWS (Amazon Web Services) for about a decade now. GOOG, more than a search and internet services platform, has been in the life sciences and venture capital business (just to name a few) since 2010. And FB is starting to stray away from the social media world to get its feet wet in virtual reality and artificial intelligence.

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Are these companies making a mistake? Shouldn't they stick to what they know best - e-tailing, web searching and social networking - and execute strongly on their core businesses? What could be motivating these highly-successful leaders in their markets to step into the unknown, risking their hard-earned profits and their credibility with shareholders?

The contrarian argument: "Big 3" Internet companies are challenging conventional wisdom

One of my favorite digital media experts and entrepreneurs, Gary Vaynerchuk, is a non-believer in the idea of focusing on the core. The NYT best-selling author of books like "Crush It!" and the most recent "#AskGaryVee" said on a recent interview that "every day, (he) tries to put himself out of business". He explains: "when people say that you have to focus, many interpret that as 'don't innovate'. Focus means: whatever you are making money on right now, triple-down on that. And what I say is: be on the offense (…) Look at how you are making money right now and think about the vulnerabilities around that (model)."

What Gary is really saying is that, if a company does not innovate, it will be left behind. Focus only on the core, forget to innovate, and soon enough a downcycle or, worse, the maturing and decline of a product category will put a company out of business.

AMZN, GOOG and FB seem to subscribe to this idea.

Data suggests that shareholders encourage diversification away from the "comfort zone"

This idea led me to my next set of questions: does innovating away from the core pay off? Are the bold innovators in tech being well compensated for taking these risks? To try to answer these questions, I looked at the stock performance of the Big 3 before and after they kicked off their innovation journeys.

A clear and telling picture started to emerge. Shares of the Big 3 seem to have taken off around the time that each company began to implement their ideas for non-core expansion.


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Source: DM Martins Research using data from Yahoo Finance and SEC filings

The vision around Amazon Web Services started to be discussed around 2003, but AMZN did not officially launch the new venture until 2006. The chart above illustrates the performance of AMZN three years before the start of AWS (between 2003 and the beginning of 2006) and three years after (between 2007 and 2010).

Notice, on the graph above and to the left, that the stock surged after the introduction of AWS. The chart on the right shows that revenues for the forward-years leading into the launch of the new venture (between 2004 and the end of 2006) did not suggest that a slowdown in the company's core business was imminent. The 20%-plus growth rates during the period seems to drive this point home.

The sideways stock performance of 2003 and 2006, therefore, does not appear to be explained by a deterioration in the company's core e-tailing business. More likely than not, investors were simply looking for the "next big thing." And they rewarded AMZN when the company shared and implemented its vision for it.


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Source: DM Martins Research using data from Yahoo Finance and SEC filings

Alphabet started to branch out of its core internet services business more decisively in 2010. Google X's labs, responsible for developing a driverless car, Google Glass, Project Wing and Project Loon, was the company's first large-scale attempt at diversifying away from the core. The chart above, on the left, illustrates the performance of GOOG three years before the start of Google X (between 2007 and the beginning of 2010) and three years after (between 2011 and 2014).

The stock spiked after Alphabet started to branch out - although the end of the 2008-2009 crisis likely played a crucial role in the rebound of the company's shares as well. On the right, the bar chart shows that revenues for the forward years (between 2008 and the end of 2010) leading into the start of Google X were generally very strong, and remained resilient even during the recession - which probably does not fully explain the relatively poor performance of the stock between 2007 and 2010.


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Source: DM Martins Research using data from Yahoo Finance and SEC filings

Lastly, FB is much younger than AMZN and GOOG, having gone public only in 2012. But even the Menlo Park company has enjoyed the upswing in stock prices that seems to be associated with seeking innovation.

CEO Mark Zuckerberg started to share his vision for the future of the company outside the realm of social networking as early as 2013. He wanted people to be able to "easily ask any question to Facebook and get it answered." This was the beginning of FB's journey into the world of AI (artificial intelligence) that later expanded into the 2014 acquisition of Oculus VR and marked the start of the company's virtual reality era.

The chart above illustrates the performance of FB one year before the announcement of the company's expansion into AI (between 2012 and 2013) and two years after (between 2014 and today).

Notice the similarities. The graph on the left shows that the stock flattens out before and surges after FB decides to launch itself outside the pay-per-click business model. Meanwhile, revenues for the forward-years leading into 2013 show that all seemed very well with the company's core business.

Conclusion: investors seem to believe that innovators will be the ultimate winners

The logical conclusion that I draw from looking at past data, at least in the case of the Big 3, is that investors tend to agree that innovation is the path to success - and they have been betting money on it. AMZN and GOOG have seen their stock prices skyrocket after they made their moves toward non-core innovation and so has, thus far, a much younger FB.

Media expert Gary Vaynerchuk may turn out to be right about "playing offense."

Whether this trend will continue in the future is the topic of a different conversation. But at least the findings above seem to suggest that seeking innovation and being bold about pursuing it is a move that tech investors welcome and most likely will be willing to put money behind.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.