Active investment commentary & analysis

Consumer values have changed, find the companies that can adapt

Consumer trends change with each generation, usually slowly. Brands disappear, but businesses can evolve and stay relevant. But now the pace of change has stepped up – can investors still rely on management to respond to consumer changes? Risks have risen, as rapid obsolescence hits services like travel, retailing and media. How can investors participate in new services, driven by changing tastes and technologies?

Key to managing risk in this area is first recognising that it is not simply about mobile, internet and cloud. Consumer values have changed, with younger customers having little respect for established brands. It points to a danger in some of the largest blue-chips, which are finding it particularly hard to adapt.

More of the emerging innovative businesses are to be found in small- and mid-cap companies, meaning that research stockpicking matters more than following stock market indices. Indeed, indices themselves are inherently backward-looking; market capitalisation is driven by past success, predicting little about the future. And, some of the most interesting opportunities are in business-to-business suppliers to these companies, many in new sub-sectors not yet widely recognised.

The next wave of consumers is bringing greater focus on ethics, authenticity, and means of delivery. This is not just millennials, but the younger consumers, Generation Z, that follow. Indeed, these newest consumers are even more focused on ethics. Generation Z is also more pragmatic and even less interested in product ownership. In aiming to serve these consumers, long-established businesses such as Thomas Cook and Marks & Spencer can take no comfort from more than a century of tradition.

This does open opportunity for new winners, such as online retailer, Ocado. Its efficient distribution has won major supermarket chains around the world as customers. Ocado’s core strength is service to other businesses - a pattern that seems likely to emerge in finance and other sectors. Investors should look for the core technologies underlying young, rapidly growing businesses. Mobile delivery, for example, is supported by companies like Boku, in mobile payments.

Accommodation and travel are areas where younger consumers are looking to new providers to meet their demands on flexibility and cost. Hostelworld, for example, has attracted younger customers with an online travel agency that focuses on hostels. As with a number of other successful new businesses, increasingly business value is embedded in a platform that offers low cost and a lot of data. Provided a business focuses on continued enhancement of the customer experience, there is often a network effect that favours a single winner.

A number of companies have developed to cater for university students, who demand accommodation that enhances their university experience. The specialisation involved has meant many universities opting to work in close partnership with specialist student accommodation providers. This offers the best opportunity to enhance the experience and operate efficiently. Unite and Watkin Jones are two of the listed companies in this sector. Watkin Jones has also noted the demand for a better rented accommodation experience as people leave university and enter work. It aims to use some of its skills to create a renting experience more tailored to the new consumers.

The platform effect is also evident in financial services, where activity can move to platforms offering liquidity and broadest range. AJ Bell and Integrafin are examples of platforms that floated in 2018; growth businesses that have attracted a premium rating.

Not all early stage would-be platforms will succeed. Many fintech businesses that are focused on attracting consumers – B2C – are likely to be forced to change their business model. Some of these will inevitably be swallowed up by banks and insurers that may lack fintech skills, but already have a customer base. In this way, some of the larger traditional finance businesses may have time to evolve to serve younger savers and investors, or can acquire to address the challenge.

Investors need to assess the drive and capability of company management to adapt. It is also worth looking for patterns in new businesses to spot emerging sub-sectors. A rapidly changing consumer market reduces the value of tradition and incumbency, and favours innovation and agility. Addressing new trends and building resilience in a portfolio should involve incorporating younger businesses.

A version of this article was published on on 27/05/2019.