Disruptive innovation

About Rose Park Advisors

Rose Park Advisors, LLC is a boutique investment firm based in Boston, MA, and specializing in identifying investment opportunities by applying the disruptive innovation concept. More information at http://www.roseparkadvisors.com.

The investment management industry faces constant change. We interview Matt Christensen, CEO of Rose Park Advisors, for his insights into how firms can learn to identify opportunities for disruptive innovation, how disruption is shaping the industry, and how to operate successfully within this game-changing environment. 

Journal: Please describe Rose Park’s business activities in the context of the ‘disruptive innovation’ concept as defined by its co-founder, Professor Christensen, who as your father is also clearly a source of professional and academic inspiration.

Matt Christensen: Our investment decisions are driven by my father’s theories in disruptive innovation and related fields. Hence, we invest exclusively in companies where his research gives unique and differential insights into the investment thesis. So rather than identifying the phenomenon of disruptive innovation in hindsight, we look at ways to apply it prospectively. For over seven years now, we have been investing in companies we believe have the ability to act on disruptive opportunities. This could be anywhere in the world, and in any industry.

Journal: What exactly is disruptive innovation and how does it apply to your operations?

Matt Christensen: Disruptive innovation describes a process by which a product or service takes root in simple applications at the bottom of a market and then relentlessly moves up market, eventually displacing established competitors or completely removing competition. Many of the firms that grow from start-ups to become industry giants are built around innovations that create new markets or reshape existing ones. They enable change. Just as established firms systematically underestimate how large entrant competitors will become, tools of financial analysis systematically underestimate their growth potential. Because these entrant firms tend to be misunderstood, the market misjudges their impact, presenting us with an investment opportunity. However, it is important to note that disruptive product innovation can ensue in large existing companies, such as global institutional investment managers, just as well as in changing innovative business settings.

Journal: You mentioned change: how can disruptive innovation be perceived as a force for change?

Matt Christensen: In our market, change is constant. The type of firms we are interested in investing in must be geared to absorb and grow through change. We look for companies that are able to successfully manage the processes of identifying disruptive innovation opportunities, measuring option value, and acting on the outcome of the result analysis. Our investment approach stretches over years, even with public companies, so we put a lot of time into the due diligence process and expect to be long-term holders of stocks. On the long side, we apply the disruptive innovation framework to identify companies whose strategy is well suited to take advantage of change and will consistently beat the market with superior earnings. On the short side, we identify incumbent companies whose future vitality is threatened by disruptive attackers. This investment strategy has enabled our portfolio to consistently achieve superior performance since its inception.

Journal: In the article ‘Reinventing Your Business Model’, Professor Christensen asks: “Why is it so difficult for established companies to pull off the new growth that business model innovation can bring?”  Drawing on your own experience, how does this apply to investment management firms and the type of operating models they choose?

Matt Christensen: There will always be disruptive activity altering one or another segment of the investment management industry. To take one example, the introduction of exchange-traded funds (ETFs) disrupted long-established ways of doing business in the mutual funds sector. Firms arose that employed disruptive index-fund strategies to gain competitive advantage over their competitors in the sector. This process allowed individual investors cheaper and easier access to investment vehicles that were previously the exclusive preserve of professional asset managers.

There will always be disruptive activity altering one or another segment of the investment management industry.

Journal: How and in what ways did the ETF example make it hard for firms to reassess their business models?

Matt Christensen: Essentially, you were able to tap into a new market that was unattractive to the existing players, because an ETF’s fee structure is much lower and makes it hard for any firm that does not have enormous volumes to make money doing it. If you have an index fund, even an actively managed fund or something similar, you risk cannibalizing your cash cow. The key problem here is always going to be that the incumbent firms have a fee structure they are inclined to protect rather than undermine. This is what makes it so hard for them to change – the overhead they have and the processes that have helped them succeed in the past all wind up preserving the existing model rather than reinventing it.

Journal: Are there any other examples where you see this happening?

Matt Christensen: It remains to be seen, but there’s a good possibility that we will see this happen again with efforts at hedge-fund emulation that provide hedged strategies through retail investors. It is a model that undermines the fee structure of an incumbent firm and provides a security or a service to a group of investors that is new, that has historically been outside of the capital market, and that has the opportunity to be disruptive.

Journal: How does disruptive innovation assist Rose Park Advisors in its everyday investment management operations?

Matt Christensen: We have a very broad investment mandate in some ways, and in other ways a very narrow one. It’s broad in that we’re allowed to invest in any type of security, any geography, or any industry. By far the most important selection criterion is whether the company we choose to invest in matches the framework of disruptive innovation. This is critical for us.

Journal: What about start-ups? Are all start-ups potentially disruptive and able to succeed?

Matt Christensen: Not all start-ups follow a model that I would describe as disruptive. If your strategy as a new entrant is to leap ahead of incumbents and beat them at their own game, it’s a very hard thing to pull off. But if you target a new concept, a new market, or a new business model as a start-up, I think your chances are much better. Here I think that what we are really good at is evaluating the disruptive potential of business models; we look for companies that have disruptive business models that allow them to target new markets.

Here I think that what we are really good at is evaluating the disruptive potential of business models; we look for companies that have disruptive business models that allow them to target new markets.

Journal: How can the disruptive innovation framework help investment managers create new growth opportunities? Are there any basic steps to follow here?

Matt Christensen: There are two aspects to that. One is evaluating the investment; the other is trying to serve your clients better or broaden the client base. In relation to the first, I really think it is not enough to just focus on looking for growth among companies that are seeking out new markets and hoping to grow in these. What you should be looking for are firms that are seeking to grow on a sustained basis over the long term by building a new market through addressing different potential needs or product areas.

Journal: What benefits does successful application of disruptive innovation bring to the table apart from competitive advantage? Can you cite any working examples drawn from the investment management industry?

Matt Christensen: I think some working examples can be found in the industry. One is in the area of big data. Companies that engage in data visualization, like Tableau Software, produce interactive data visualization products focused on business intelligence (BI). What they do is put analytical decision-making powers in the hands of middle managers who are usually not particularly sophisticated data analysts. By presenting these analytics visually in the way of dashboards and the like, they make it easier for front-line managers and others to reach decisions that are based on swift and accurate data. It’s also worth mentioning the rapid adoption of real-time payments, trading, and settlement systems that will foster innovation in the industry and meet client demands for greater ease of use and personalized service in the digital age.

Journal: Where do you see other potential industry-related areas for disruptive innovation when it comes to the operating model?

Matt Christensen: One area for consideration here would be Software-as-a-Service (SaaS) that is targeted at specific industry verticals. It’s interesting to observe that if as a manager you had to buy a permanent license for a software suite and the cost was fully paid up in advance, you are likely to be more reticent in deploying software solutions because of the high investment required upfront. If you buy the license and the software doesn’t work the way your firm wants, you can risk your career as an IT professional. But if a software service exists where you pay by the month, you can start to roll it out and if it looks like it’s not working, you just cut it off and limit your losses. A solution like this lets your IT try different things and see what works and what doesn’t.

Journal: Looking ahead, what do you foresee are the main challenges for investment management firms in general – and the growth opportunities?

Matt Christensen: I think the main challenge in the long term is regulation. It would be delusional to think that you could have a market with no regulations. But the cost of doing business has grown so much that many opportunities rarely get off the ground, because what is required of them from a regulatory perspective seems so onerous. However, this is also where the opportunity lies. You must look for opportunities to proactively use disruptive innovation to turn regulatory change, market shocks, changing client demand, and moves away from regular business models, into competitive advantage. When you ask about growth opportunities, there is no doubt that emerging markets are very attractive. Here we see markets that lack services and products and you can compete against nothing – now that’s an attractive opportunity. In a lot of instances, you have to develop a different model to provide the goods or services you are seeking to deliver profitably.

Journal: To summarize, what do you regard as the steps firms need to take to deliver on the promise of disruptive innovation?

Matt Christensen: Disruption is happening all around us, there are many opportunities in the investment management industry as well, and it is possible to deal with disruption. As the industry continues to experience repeated market shocks, client demands, and regulatory pressures, the success of individual firms will hinge on proactively responding to these changing business conditions. Those that fail to act will lose – clients, business, and competitive advantage. Understanding and using disruptive innovation as a tool can enable investment managers to optimize their business by adding new clients, new products, and hence securing competitive advantage. If you want to harness the growth potential that disruptive innovation offers, key is building disruption into your corporate ecosystem and acting on disruptive opportunities in a systematic, ritualized way. (See box on ‘How Investment Managers Can Succeed in Disruptive Innovation’).