Digital Disruptions - Moats In The Age Of Disruptions

by: Baijnath Ramraika, CFA

Digital disruption is a potent force as it has quickened the pace of customer adoption.

Advances in mobile technology and increasing use of social media have quickened the pace of customer adoption, giving rise to the age of digital disruption.

Using a case analysis of four companies, we show that a well designed analytical process can segregate the disruptors from the disrupted.

This article first appeared on Advisor Perspectives.

When people say that an entrant is disruptive in an industry, what they really mean is that customers are adopting that new way. At Amazon, we've had a lot of inventions that we were very excited about, and customers didn't care at all. And believe me, those inventions were not disruptive in any way. The only thing that's disruptive is customer adoption. If you can invent a better way, and if customers agree that it's a better way, then they will use that."

- Jeff Bezos, emphasis ours

We live in interesting times. There have been significant advances in automation, artificial intelligence, and robotics. Experts are of the view that these advances have the potential to dramatically increase the velocity of change and that the rate of innovation has already increased substantially. As investors in high-quality businesses, we seek to invest in those that possess durable competitive advantages. Clearly, as these advances achieve their expected outcomes and the pace of innovation quickens, they will result in disruptions to many existing business models and give rise to a few new durable ones.

However, as Bezos' quote highlights above, technologies and innovations are not disruptive on their own. Disruptions occur because of customer adoption. In that respect, potential disruptors are no different from any other business. They have to identify customer's pain points and offer a way of satisfying the customer's needs in a manner that appeals to the customer.

Smartphones, social media, and the road to consumers

Proliferation of smartphones globally and the increasing use of social media platforms have resulted in new means of reaching consumers by bypassing traditional channels. The effect of these technologies has been to dramatically increase the rate of adoption. This, in turn, allows businesses to scale up relatively quickly, especially those that don't need large physical infrastructures to scale up. As is seen in Figure 11, whereas it took nearly 75 years for the telephone to reach 50 million users and it took 14 years for the television to reach that milestone, it took all of 35 days for Angry Birds to reach 50 million users.

Figure 1: Declining adoption rates

Innovators, equipped with advanced technological systems are able to innovate rapidly and by employing digital distribution mediums, are able to garner market share far quicker than was possible in a largely physical age. Figure 2 shows the impact of WhatsApp on the traditional SMS businesses.2 WhatsApp designed a better way for its customers to communicate than preexisting technology. Its adoption rate was heightened by smartphones and social media.

Figure 2: SMS Business Gets Disrupted

Digital disruptions: Increasing recognition

Not surprisingly, disruptive innovation has occupied an increased amount of the mind space. As is seen in Figure 3, the term "disruptive innovation" has acquired increased significance over the last few years.

Figure 3: Interest in Disruptive Innovation

This same behavior is seen in the expectation of business executives. As seen in Figure 4, an increasing proportion of companies are starting to recognize that digital disruption will have a significant impact on their industry. Nearly 30% of executives surveyed expect digital disruption to be transformative as compared to a near dismissal of such a prospect two years earlier.

Figure 4: Increasing recognition of digital disruption risk

Digital disruption does not spell trouble for everyone

However, the extent of disruptive force is not the same for all businesses. Figure 5 shows industry rankings by the expected impact of disruption with industries in the center facing more disruption than those on the edges.3 One of the key differentiators is that businesses that are facing the highest impact of digital disruption derive most of their revenues from business-to-consumer (B2C) business models.

Indeed, considering that the digital disruption as discussed here is primarily about access to the consumers, these transformations have a more significant impact on B2C business models versus business-to-business (B2B) business models.

Figure 5: Industry ranking of the expected impact of digital disruption

Moats and the digital disruption wave: Benefitting from disruption or getting disrupted

As discussed thus far, digital disruption is a potent force. However, it is not a net negative force for businesses. For every business that is being disrupted and for which such disruptions are a negative force, there are others that are benefitting.

In the discussion that follows, we provide short case studies on four businesses. One of these is treated as a high-quality business by those who rely primarily on historical profitability of the business. The other three are a part of our high-quality investment universe. These case studies highlight that careful analysis and application of a structured decision-making framework are helpful in identifying disrupted business models and staying clear of those that are being negatively impacted.

The disrupted: Campbell Soup Company

Campbell Soup (NYSE:CPB) is a leading packaged foods producer with brands like Campbell's, Page, Prego, V8 etc. The company has a long history of successful operation with superior profitability. As is seen in Figure 6, Campbell has had healthy profitability and returns on capital over the years. Campbell's strong historical financial performance means that purely quantitative systems designed to identify high-quality companies are likely to identify Campbell as such a business.

Figure 6: Campbell's high profitability

Many other investors categorize the business as a brand-based moat. However, as we discussed in our article on consumer preference moats4, we do not use the brand-based moat classification. Our rationale is that such a classification gives rise to the possibility of behavioral errors. We do not find a strong consumer preference to be associated with Campbell's products. As a result, Campbell failed to meet our criteria for a high-quality business and has not been a part of our proprietary universe of high-quality businesses, namely the Global Moats Index.

Campbell is currently facing challenging operating environment as the traditional retailing model which was the primary source of its distribution is experiencing disruption. To compound matters further, social media has accentuated the trend towards healthier food. Additionally, the ability to reach consumers through social media is allowing locally produced food items to take market share from commercially produced food. When combined, these factors have resulted in disruption to a business that has been around for more than 100 years.

The negatively affected: Coca-Cola

As against Campbell, Coca-Cola (NYSE:KO) is indeed associated with a very strong consumer preference endowing the company with a strong moat. Having enjoyed the advantages of its moat and having compounded shareholder's money at above-average rates for nearly a century5, Coca-Cola has recently started to experience stagnating to declining volume trends. As seen in Figure 7, Coca-Cola Company's volume growth has been trending downwards and has been coming in close to zero percent.

Interestingly, Coca-Cola's slowdown is not driven by any new disruptive product that is serving the cola needs of the consumer in a better fashion. Instead, the carbonated drinks market is declining as consumers steer towards healthier options due to growing concerns about the health effects of sugar. A modern audience with access to instant information has been able to quickly obtain and spread awareness regarding the health effects of sugary drink.

Figure 7: Coca-Cola Company's Volume Growth Trends

As we discussed in our framework for consumer preference moats6, an important element in assessing the strength of such moats is the customer interaction delta, i.e., the number of customers and the number of times on an average that a customer uses the product. The negatively trending volume growth for Coca-Cola highlighted to us a weakening of its competitive advantage.

No real impact: Givaudan

Givaudan (OTCPK:GVDNY) (OTCPK:GVDBF) is the dominant player in the fragrance and flavors (F&F) industry with a 25% market share globally. As against both Campbell and Coca-Cola that are both B2C businesses, Givaudan is a B2B business. As shown in Figure 8, while fragrances and flavors account for a relatively small portion of the customer's COGS, they act as the most dominant criteria in the decision-making process of the end consumer. As a result, a company like Givaudan becomes an indispensable part of the customer's business processes.

As we discussed in our article on our process for evaluating mission-critical products and services-based moats7, one of the keys in understanding the risks such businesses face is related to the demand for the customer's end products. While it is possible that the ongoing wave of disruptions could end up disrupting the businesses of some of its customers, as long as consumers continue to consume perfumes and products that utilize flavors, Givaudan will likely be immune to such disruption.

Figure 8: Fragrances and flavors act as key drivers for consumer's decision-making8

Benefitting from disruption: Wabco

Wabco Inc. (NYSE:WBC) manufactures and sells control systems, including advanced braking, stability, suspension, transmission control etc. to the commercial vehicle industry. The advanced braking and stability control systems are mission-critical products as they play an important role in vehicle safety and performance that requires technological know-how and expertise. Wabco collaborates closely with major OEM customers to design and develop the technologies used in the end vehicles.

With increasing convergence towards autonomous driving, Wabco will likely be a beneficiary as these technological advancements require better stability mechanisms. Figure 9 shows that Wabco's growth will likely be driven by the convergence of content per vehicle across regions and the content per vehicle itself will be driven upwards by technological adoption. Wabco continues to stay at the forefront of innovation and is continuing to develop advanced driver assistance systems which help avoid potential collision as well as other mechanisms for functioning and evolvement of self-driving vehicles.

Figure 9: Technological adoption expected to result in higher content per vehicle for Wabco9


Technological advancements, smartphone ecosystems, and social media are combining to create potent disruptive forces that are causing many existing business models to become obsolete or finding themselves in the need to reinvent. However, disruption is not a result of technological advancements. Instead, it is driven by customer adoption. This, in turn, means that digital media are truly potent disruptive forces as they have the ability to accelerate the rate of customer adoption.

However, as we have shown via the summary case studies, it is incorrect to assume that all moats are being disrupted and that all moat businesses are under threat. The disruptive forces currently being observed don't mean that moats are not relevant anymore. What they do mean is that a process that equates high past profitability to a high-quality business will be unreliable as it will end up acquiring many businesses that face disruptions.

Importantly, the thinking that a high-quality investment strategy is equivalent to a buy-and-hold strategy is erroneous. The analyst needs to not only identify a high-quality business but also needs to regularly evaluate the business for signs of disintegration of its moat and how digital disruption is affecting the strength of the moat via changes in customer adoption.

As we continue to point out via our articles that lay out our framework for evaluating competitive advantages, factors that need to be monitored for signs of disintegration are different depending on the source of the competitive advantage of the business and accordingly will behave differently to the impulses of digital disruption.

[1] Source: TechToday, Reaching 50 million Users: The Journey of Internet and Non-Internet Products.

[2] Source: Digital Vortex, How Digital Disruption is Redefining Industries, Global Center for Digital Business Transformation, June 2015

[3] Source: Life in the Digital Vortex, The State of Digital Disruption: 2017, Global Center for Digital Business Transformation, June 2017

[4] Sustainable Competitive Advantages: Consumer Preference; Sustainable Competitive Advantages: Consumer Preference - Articles - Advisor Perspectives

[5] The Coca-Cola Company made its IPO in 1919 at a price of US$ 40 per share. It is estimated that if dividends were reinvested, the value of this investment would have grown to US$ 9.6 million by 2015; representing a CAGR of nearly 14%. If You Had Invested Right After Coca-Cola's IPO (KO)

[6] Sustainable Competitive Advantages: Consumer Preference; Sustainable Competitive Advantages: Consumer Preference - Articles - Advisor Perspectives

[7] Sustainable Competitive Advantages: Mission Critical Products & Services (MCPS); Sustainable Competitive Advantages: Mission Critical Products & Services (MCPS) - Articles - Advisor Perspectives

[8] Givaudan Investor Presentation 2017

[9] Wabco's Presentation, Sustaining Differentiation, KeyBanc Capital Markets Industrials & Basic Materials Conference 2018

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. I have no business relationship with any company whose stock is mentioned in this article.