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Heroic profits


aa18-oct-nov-2006-heroic-profits Microsoft. Amazon. Intel. Federal Express. Google. Due to economies of scale and network effects, these firms are likely to dominate – for decades – the global industries that they created. Australia desperately needs to create new industries as the USA has done and as all other first-world nations are struggling to do. Those nations that succeed will thrive, like the USA; those that fail will face economic ruin, like Argentina.

A new business theory – “disruptive innovation” – can improve Australia’s odds in this global struggle, by focusing its investment on small firms with the best chance of becoming tomorrow’s giants. The theory is described in books by Professor Clayton Christensen of the Harvard Business School, first published in 1997.

Understanding this theory has the potential to reduce the risk of early-stage investment and increase returns, because – as Christensen says – commercialising a truly disruptive innovation is “a license to print money, and lots of it.” The theory is now widely accepted overseas, especially in the USA.

However, the theory is almost unknown in Australia. A Google search for the phrase “disruptive innovation” finds only 0.25 percent as many hits in Australia as it does overseas. That’s about 20 times fewer than expected. Alternatively put, in any group of 20 Australians who ought to understand disruptive innovation, 19 don’t.

Without this knowledge, most of Australia’s early-stage Private Equity (PE) fund managers wouldn’t recognise “the next Google” if they saw it. They might as well choose their investments by flipping a coin.

Apparently, that’s what they’ve been doing. According to AVCAL (the Australian Private Equity & Venture Capital Association Limited), the median Internal Rate of Return (IRR) on Australia’s PE companies’ early-stage investments (i.e., those investments categorised by AVCAL as “seed, start-up, or other early stage”) has been zero. Even the top quartile has returned only 2.7 percent – less than inflation. Meanwhile, early-stage PE investments in the USA – where disruption theory is known and accepted – have delivered a staggering 41.4 percent IRR over the last decade. At this IRR, Australia’s early-stage investments would have delivered almost a billion dollars of profit instead of, well… nothing.

Over this period, the USA’s PE firms invested AU$391.33 per US citizen in early-stage deals, whereas Australian firms invested only AU$65.86 per Australian citizen in such deals. Do Australia’s PE firms really think that Aussies are only one-sixth as inventive as Americans? Or are Australia’s young firms, unable to get funding in Australia, moving to the Land of Opportunity, where their disruptive potential is recognised and rewarded?

The USA’s investment in disruptive firms such as Apple, Intel, Microsoft, Google, and Amazon turned its entire economy around, from a declining manufacturer to the world leader in high tech. As the recent Ajax Fastener fiasco shows, Australia’s manufacturing base is eroding, too. If Australia doesn’t fund its own future giants, then its future could look less like the USA and more like Argentina.

When Argentina’s boom went bust, it had no new industries to fall back on. Its economic collapse of 2002 wiped out the jobs and pensions of millions of ordinary people.

Ultimately, Australia’s economic future depends on our ability to identify disruptive innovations (see picking winners). It’s the only way we can develop our future giants and share in the heroic profits.

Jim Plamondon helped establish Microsoft’s technologies as dominant industry standards, migrated to Australia and founded Thumtronics Ltd, which is now poised to disrupt the AU$40 billion global musical instrument and lesson industries.


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