Does innovation generate shareholder value?
Over the past decade, as demand for photographic film plummeted, Eastman Kodak Co went bankrupt, sold its intellectual property in a fire sale and is still struggling with the relevance of its legacy. In contrast, its great rival Fujifilm reported record profit of Y119 billion ($950 million) in 2014 and market analysts are positive for the future.
This turnaround was achieved because the (75-year-old) radical chairman of Fujifilm repurposed the company. He did this by identifying its core intellectual property and building a strategy of adjacent expansion, monetising core know-how organically and through acquisitions. For example, the layering technology used to create photographic film was applied to developing skincare business and film that holds LCD screens together.
Today Fujifilm describes itself as “a global technology company” that extracts “value from innovation”. The business mix is radically different to even a few years ago, as management is aggressively focused on sweating their intellectual assets. Now photocopier machines and printers are its largest source of revenue, while biotechnology and pharmaceutical operations are future drivers of growth. The market likes the story, with the stock up 70% in the last 12 months.
Other Japanese companies have got the message. Sony Corp has bitten the bullet on breaking up its inflexible structure to focus on its IP content (Sony Pictures), technology (where it has a quasi-monopoly with Playstation 4) and adjacent reinvention around core patents (image sensors for cameraphones). Meanwhile, Panasonic Corp, with more than 150,000 patents, has dropped consumer electronics and is rebuilding the business around smart home, avionics and famously its battery joint venture with Tesla Motors Inc.
In the private investment universe the most compelling evidence to support the notion that intellectual property creates shareholder value is provided by the valuation of the so-called 'unicorns' founded between 2009 and today. The aggregate private valuation of this tech-centric club now exceeds half a trillion dollars.
'Not invented here' turns out to be a great business strategy
Despite cries that the innovations of today are not as transformative as those of the past (eg, the railway was a greater innovation than the electric car and the telephone a more powerful game changer than the Internet), I believe that we are in a new golden age of innovation. As part of that, we are experiencing a paradigm shift away from Big R&D towards open-source creation and collaborative or virtual business models.
Just as military strategists talk about asymmetric warfare, so the capacity for thinly capitalised companies not only to innovate but also to execute has never been greater, attracting debt and market value as they gather momentum.
Iroko Pharmaceuticals is a case in point. Started in 2010 and funded by a family office, Iroko has a unique patented technology that significantly improves the performance of established drugs. With a core staff of just 50 people, Iroko has built a fully functional pharmaceutical company with sales in more than 80 countries and a pipeline of drugs. Sitting in Iroko’s office in Philadelphia’s Old Navy Yard, you can see Glaxo SmithKline across the street – making it crystal clear what 'punching above your weight' means in 2015.
The pharmaceutical industry, like the film industry, has always been active in collaborative R&D. This is partly due to the immense investment required to get a product to market and partly the result of the realities of innovation and inventors. More than 50% of drugs sold by major pharmaceutical companies are in-licensed from others. The same statistics apply to the role of independent producers in Hollywood films. What is interesting, however, is that today this model of innovation is becoming widespread across almost every industry. IBM, GE, Phillips, Eli Lilly, AstraZeneca, Qualcomm, Nestle, Panasonic, Fujifilm, Universal Music, Paramount Pictures, Nokia – the list of multinationals exploring new radical business models is mainstream Wall Street Journal fodder. It turns out that for these companies, 'not invented here' may be a great business strategy going forward.
The only growth is vertical
According to the Financial Times, the world now faces its third deflationary wave.
The first was the US-led housing and financial crisis of 2008-2009, the second was the Eurozone crisis of 2011-2012, and now the third is an emerging markets crisis. This third deflationary wave will mean that world gross domestic product will continue to operate at a level below potential output and a low growth and low interest rate investment climate will persist.
As the Financial Times states, negative real interest rates on bank deposits cannot be the road to prosperity, yet the promise of low nominal returns on traded securities looks risky.
The solution? Bet on innovation. Whatever you may read to the contrary, companies are investing and innovating in diverse ways that reflect the different realities of how innovation happens in 2015.
Investors who wish to follow the road from zero to one can profit from this knowledge in both public and private investments once they look under the hood and view potential from the perspective of intellectual property. It literally is the future.
This article first appeared in IAM magazine. For further information please visit www.iam-magazine.com.