Active investment commentary & analysis

What makes a winning disruptor?

What makes a winning disruptor? Investors would be wrong to focus just on technology. Success across a wide range of sectors is often driven by the potential for rapid business scaling using limited additional capital. Opportunities arise when consumer tastes change – and not just millennials; customers of all ages share a lack of respect for traditional brands and long-established businesses.

Often a business model gains significant first mover advantage if customers gravitate to a single platform. This is particularly effective in areas where customers want to be with the biggest provider of its type. Investors should think in terms of the potential for network effects; popularity can create a moat that helps to build and protect margins. Fevertree Drinks is probably the best known beneficiary of this, creating a new niche of premium mixers. But retailing offers many examples where new businesses enrich customer experiences.

Traditional retailers are burdened by the drag of their legacy businesses; rates, property, leases, transport and parking are not fully within management control. This has made many established chains slow to respond to changing consumer tastes. Retailers need to move from pure price competition to develop unique offerings and experience. Yet, when online retailers have established a business model that works, usually it can be scaled-up rapidly.

This year, distributor, Ocado has finally proven its business model and seen a re-rating. Investors are beginning to recognise Ocado as a standard platform for retail logistics. Already, its delivery technology has attracted a number of major international grocery chains as partners. The platform can improve operational efficiency for partners and also raise customer satisfaction. The addressable market globally is large, even though there will be risks in execution. Currently analysts are struggling to agree on the opportunity for Ocado, but valuing this type of business needs some new metrics. Ocado has now joined the FTSE 100 Index, with a capitalisation matching Morrison Supermarkets and ahead of Marks and Spencer.

Mid-cap filling station operator, Applegreen, is based in Ireland, but also serves customers in the UK and US. It has grown organically and by acquisition, using a consistent model, focused on a more attractive competitive food offering. Applegreen plans to buy a majority stake in UK motorway service operator, Welcome Break, funded by debt and new equity. Management vision is about improving the retail experience at motorway sites, rather than relying on high petrol prices. Often retail innovation is about taking a new view of customer experience.

Online clothing retailer, ASOS, distributes branded and own-label products globally. It now has 16 million customers globally. Around 60% of its business is overseas, but it offers localised buying in international markets. ASOS aims to offer customers a frictionless experience, and, as more customer activity moves mobile, there is greater potential to leverage customer data and enhance the experience. Better use of data, and service delivery using the cloud and mobiles are a feature of many retail disruptors. This should enhance the lifetime value of customers if customer satisfaction can be maintained. ASOS’ sales have grown more than 25-fold in the last 10 years.

Understanding disruption involves new metrics, and an appreciation of where a business model can get to. Today’s profitability matters much less than sales momentum, technology implementation, adding customer value, and achieving lower unit costs with growth. Some of today’s mid cap companies are set to become tomorrow’s best in class retailers.

Disclaimer: At the time of writing, SVM Asset Management and its clients held positions in Fevertree Drinks, Ocado, Applegreen, ASOS and Morrisons Supermarkets.

A version of this article was published on Trustnet on 3 October 2018