Stig Brodersen  07:09

Yeah, I think that there was like three or four that I’d like to highlight. But I think the first one is focus. And like when we study billionaires, and when we study successful companies,  everybody talks about focus. And what focus means here is that when you have a traditional technology, and then you have disruptive technology, you can’t keep the same type of focus. And that’s actually quite clear why you can’t do that because you will have another kind of branding, another type of customer, simply another market. And typically, you will build up your business to a certain business model, which is outlined from the products that you’re selling at the beginning. And the successful products that we get later on… It’s really, really hard to do that. 

Stig Brodersen  07:51

For instance, if you’re selling, say, cell phones then just switching to smartphones, because it’s just a complete another ball game. Clearly it is related but the customers are different and so on. So I definitely think that focus, that’s one thing. 

Stig Brodersen  08:07

Another thing that Clayton Christensen talked about a few times was the values. And I think that’s really important. So you might have like a really visionary leader, and that leader would be saying, “No, we should go in this direction.” But if the product, the new technology, is not true to the values of the existing business, and there might definitely be a discrepancy between the values of the existing business and the new business, because by definition, it’s new. Then those employees, perhaps even some of the managers, they will *inaudible they will stay and you know, keep doing what they’re doing because the products that they already have that’s more consistent with the values of the new products that might be inconsistent with that.

Preston Pysh  08:52

I really like this discussion and I thought this was laid out really good in the book where he’s talking about every organization has its own habits and it has its own values. And those habits and values are typically well suited for the existing business. And what argument he makes is this emerging disruptive technology typically needs a different culture or a different set of values in order to be successful. 

Preston Pysh  09:19

And what happens is a lot of these companies try to basically copy and paste their previous values and organizational habits into this new emerging technology role or organization that might be small and might need to have a lot of agility in the way that it’s being set up and being managed. And whenever they bring this architecture from the old to the new, it’s typically very debilitating for them to be successful. 

Preston Pysh  09:49

And s,  he’s basically promoting the idea that this disruptive technology that you’re investing in really needs to have a new foundational level established from the root and that it can’t really adopt the previous organizations architecture. And I think that that’s a fantastic point. And I think that that’s one of the reasons why, when you look at Warren Buffett, and the fact that he’s been adding all these *inaudible-on companies into his organization, and he’s never really pushed a Berkshire corporate mindset or fundamentals down to those companies that he’s purchasing is one of the reasons why he’s been so successful for so long. And that’s really important. 

Preston Pysh  10:26

I think you see the same thing happen with Amazon. And you see, the same thing happened with all these companies that are having these major acquisitions, and they do it successfully. They don’t try to come in and change the architecture of that pre-existing organization. They really kind of let them do their own thing and let them exist kind of as their own microcosm outside of their overall architecture or their headquarters. 

Preston Pysh  10:49

One other thing that I want to highlight and I think this was a great discussion in the book, was the idea that he says that a lot of these higher level managers, whenever they’re looking for growth within their company, they fail to recognize the power and the importance of investing in disruptive technologies, because at that present time, they don’t recognize the value of the return that it could potentially give. They’re only looking at the current return, and the current market cap of what that technology is. 

Preston Pysh  11:19

So let’s go back and use our cell phone example. So I’m sure if you went back to the point in time when smartphone technology or the smartphone market was emerging at that infancy stage, I’m sure the market size was like next to nothing. And so you had a lot of companies like call it Motorola or whoever that are looking at this market and saying, “Hey, there’s no market size here that’s going to add any type of percent gain to our bottom line, because the market is too small.” And let’s just say Motorola, I don’t know what their, what their revenue size is per year, but let’s just say that it’s $500 million. I don’t know what it is, I’m probably way off but let’s just say it’s $500 million. So whenever they look at that smartphone market, let’s say that at that time during the infancy stage, they might say that it might add, you know, $500 million of revenue to their top line, assuming they took the entire market. So that’s a big assumption. And that’s something that they probably said that that’s not even possible. And if they would do that, that’s only going to add 10% of revenue to their top line with a huge amount of risk potential. 

Preston Pysh  12:22

And that’s how a lot of these higher executives are looking at things in that perspective of, “Hey, this isn’t adding much to my top line, but I’m assuming a lot of risk because this technology isn’t even proven, the market size isn’t big.” And so they immediately turn off and then they’re late to the game. And that’s where Christensen is really saying that these companies are making big mistakes, because they’re not looking at, I guess the exponential growth of a possibility of a disruptive technology. 

Preston Pysh  12:50

So that’s the hard thing here that he’s really talking about as the innovator’s dilemma is, “Do I invest in this emerging technology that has has a huge upside but tons of risk? And is it going to be a disruptive technology?” And that’s really the struggle that a lot of these business leaders have. And I think that when we get into the third segment of this episode, we’ll talk about how you go about that in the most risk-averse way. That’s really thoughtful, but I want to throw it back over to Stig to the talk through some more of these issues that caused this dilemma.

Stig Brodersen  13:23

So basically, I think this is a leadership issue. And now, I can also hear that you’re talking about that Preston. But I think the key here is really to have the right leaders in place. And this is not the same as saying that top leaders, top executives aren’t doing the job the right way, because it’s, it’s very logical why they do what they’re doing. 

Stig Brodersen  13:43

For one thing, these disruptive technologies, they are new markets. And by definition, new markets are very, very hard to analyze. Perhaps because there is basically no market. Another thing, I also think that probably one of the things that you were aiming at Preston was that you need to get the managers excited. So like Christensen, he takes an example in the book, and he’s saying something like a billion dollar company, they won’t be happy about a $1 million order. But if you have a small $10 million company that will mean the world to them. And you need to have leaders in place that will get excited about new orders comeing from this new disruptive technology. They should be judged completely on the performance of that new technology, and not on the overall performance of the business. Otherwise, it will never thrive.

Preston Pysh  14:36

So he doesn’t say this exactly in the book but this is the way I took it. I think that the leaders that go about this, investing in this disruptive technology in a manner that they’re successful, really comes down to this kind of fundamental point. The guys that do it wrong are the leaders that are investing because they don’t want to be left behind and they don’t want to lose market cap. The guys that are doing it successfully, they’re doing it because they want to invest and shape the future for the good of their customers, and they really want to be at the forefront of that emerging movement, and they want to make a difference. 

Preston Pysh  15:10

I think that when you compare those two contrasting points of view, the guys that are just playing catch up, because they don’t wanna lose market share, versus the guys that are really trying to make a difference in the world, that’s what separates, and that’s what makes the difference. And that’s really hard to gauge, especially if you’re an investor from the outside and a non-controlling share of a company. It’s kind of hard to gauge that but I really think that that’s the difference of a company that is going to be really successful in the future with implementing disruptive technology versus one that’s not. And I think that that’s one of the reasons when you look at Apple and when you look at Amazon, this guys aren’t playing catch up. They’re shaping the future. And I think that they really have that mindset really bred into the culture of those companies. And I think that’s one of the reasons they’ve done so well.

Stig Brodersen  15:52

So let’s talk about the solution. So that would be the third and the last segment. And you know, Clayton came up with a few different suggestions of how to solve this problem. And I think probably the most important one that I took away from the book was to have the right sized company. So when we’re talking about a right sized company, it’s typically a very small company, because this is disruptive technology. It’s a very new market. There are very few customers. So you need to have a company that’s well suited for that segment. 

Stig Brodersen  16:27

And I think that, you know, to me, that made a lot of sense. So, for one thing, when you are acquiring new customers, that takes a lot of energy from you. I don’t know if you you guys are familiar with the *7-to-1 rule, but we have this rule that it takes seven times as much resources to get a new customers as you get one of the existing. And one of the problems by not spinning it off into a new company is that you will lose some of the original customers if you change focus. So what Clayton is saying as a solution is not to change the focus, but to have a brand new focus for a very small growing company that is completely aligned with the new audience for that company. 

Preston Pysh  17:11

And that’s really the heart of of his solution. So I mean, it’s a short book, and it could be shorter. But I think Stig and I are just going to summarize this. What he’s really suggesting is that these larger companies, if they want to invest in disruptive technology, they basically have to birth a new company, and set the right conditions with the right leader in charge, in order for that person to basically go at it alone and out on his basically own microcosm company. And that’s how he’s suggesting that they go about this correctly. He really, and he gives a lot of evidence and a lot of case studies on why companies that don’t take that approach typically fail at the venture and they give up, and they basically take their resources back and basically handicap the venture when they don’t have quick returns and quick progress in shaping that emerging technology. And, you know, from what I’ve seen with other businesses, I totally agree with that thesis that he has for the book is the company has to be basically started off on its own.

Stig Brodersen  18:12

And you know, if you look at the empirical evidence for is Claton Christensen right? Then I need to look at spin-off. So if you look at spin-off in the stock market, it’s very, very clear from empirical evidence that spin-offs are better for the existing company, but it’s also better for the spin-off company. You know, it’s it’s very clear, and just to be completely specific about what is a spin-off, that would be if Apple, they were spinning off the iPad division. So everything that has to do with iPad, that would just be in another business with the new leader and having their own accounting. That would be spin-off and it just turns out to be the spin-offs are doing really well because they can have this focus. And it’s really, really hard for big companies. And if you are going to do that as a big company, I think you need to look at companies like Johnson and Johnson or Berkshire Hathaway, either buying new companies and just leaving them alone or having *bolt on companies that is completely aligned with the existing business model.

Preston Pysh  19:17

So it’s decentralization for companies. And I think that’s the thing that’s really interesting, unique. I mean, when you see that happen on the internet, with the decentralization of like Wikipedia, different sites, I think you’re taking that same mindset, same approach with businesses where you’re pushing the responsibility and the power down to the lowest levels, and then letting those people run with it and having the trust that you’re putting the right people in charge in order to run with it. And it’s a pretty amazing idea, but you see very few people actually implementing it appropriately. 

Preston Pysh  19:51

One of the companies that we previously mentioned, which is Amazon led by Jeff Bezos, who’s the person the reason why we’re reading this book is because we know Jeff Bezos likes this book. But with Jeff Bezos and the way that he runs Amazon, he set up these teams, these competitive advantage, basically like a board, where this competitive advantage team would go out and look across the market and say, “Who’s kicking our butt? Who out there is beating us at whatever?” I learned this whenever we read the, The Everything Store. There was a story about this in The Everything Store where there was this company that I forget the name of the company, but they were basically taking Amazon to the cleaners on selling baby diapers. I can’t remember the name of the company. 

Preston Pysh  20:35

But anyway, this competitive advantage team saw that this company was taking them to the cleaners and they basically said, “Hey, this, this is our target, either they’re going to continue to beat us or we’ve got to beat them or we got to buy them.” And so that’s what they did. They basically went to war with this company because they knew that they were outperforming them. And so, Jeff Bezos, his company, Amazon basically cut all their prices on diapers to compete with them price wise, and they went toe to toe with them. 

Preston Pysh  21:04

And then what they actually figured out was that somewhere in their distribution, and it’s been a while since I read this, but somewhere in the distribution of this company that was kicking their butt, they were distributing their diapers in a much more efficient manner. And so, Bezos basically learned this, adopted their distribution technique, and then went toe to toe with him. I believe he ended up buying that company out and then basically bolted them on to his company, kept everything the way it was, let them continue to operate. And then he adopted the methods that they were using into his own organization to improve his own organization. 

Preston Pysh  21:40

So it’s really fascinating to see him almost take the exact opposite approach of what you see major corporate leadership typically do where, you know, most of these companies will buy them and then force the Amazon name down on them and hey, this is how you’re now doing business. He took the exact opposite approach. He purchased the company, he learned why they were better than him. He adopted those principles into the larger Amazon company, and then kept them operating in the way that they were. 

Preston Pysh  22:10

So truly taking what everyone else does, flipping it on its head, and improving his organization, becoming more efficient. And I really think that that’s a great example of really the power of this book, because I would argue that he learned those techniques and those ideas from this book. And I think that’s where it’s all coming from. 

Preston Pysh  22:29

Okay, so that’s all we’re going to really talk about for the rest of The Innovator’s Dilemma. Like we said, it’s a very short book, I think it could even be shorter. That’s really the essence of what he was talking about. Really, really good read, though. If you’re a business owner, or if you’re a person who’s interested in this idea of disruptive technology, I really think that you need to come and read this book, because this is probably the root of where all that discussion and all that thought is really kind of emerging from so if you’re that kind of person, you’ll probably eat this up. 

Preston Pysh  22:56

But what we’re going to do right now, this is the point in the show where we go to a question from a member of our audience and this week’s question comes from Daniel Reavis. 

Daniel Reavis  23:04

Hey, Stig and Preston, this is Daniel Reavis from Reno, Nevada. First and foremost, thank you guys for your podcast. It’s very valuable to me. And I know that you guys have given a lot of value to many people. So please keep up the good work and thank you. So my question is, I know that Warren Buffett has an average return on his investments of about 19%. And I was wondering, because I know that’s a lofty goal, but I was wondering if that can translate over to createing your own business. Should you want to, after your expenses, and at the end of the day, want to have a 20% return on your investment? Or is there a whole another part to creating a business that I don’t know about? Thank you.

Preston Pysh  23:48

Wow, so I really like this question. And I like the fact that you’re really talking about starting your own business, and that’s really where the question is stemming. So I’ll tell you a 19% return is a fat margin. That’s really good. And that’s pretty amazing over such a long period of time. And I think that’s the thing that makes Warren Buffett so successful. And it has really led to why he is such a famous person in the business world is because he sustained that over, you know, 50 years, which is just totally crazy. 

Preston Pysh  24:18

So, here’s what I’ll tell you. If you start a business, and you created a product, or you have some type of proprietary service that no one else has, you can fetch a higher margin, you can get 30-40% on whatever it is that you created, because you have something that’s very unique, and that no one else can compete with you on. But if you don’t have that intellectual property, of whatever that might be, you can’t get the larger margin, you got to settle for something a lot less.

Preston Pysh  24:47

So when we look at like the car industry, if you own a car dealership, the margins in that are like next to nothing. It’s like 5% to 10%, if you’re doing extremely well. And that’s because there’s so many competitors. If you buy a car on one street, you can go right across the street and probably buy the same car. So there’s so much competition and the margins go down. 

Preston Pysh  25:07

When you talk about something like Google, for example, how many people out there go and search off of Bing versus Google? Well, the numbers show you that it’s like something like 60% or 70% of people conduct all their searches on Google. That’s a competitive advantage. That’s a huge competitive advantage. And that will fetch you a very large margin. And so when you look at Google’s income statement, their margins are like 20% to 30%, from their revenues down to their net income. It’s really fat. 

Preston Pysh  25:37

So when you talk about a business, and you look at it from that context, that’s kind of where you need to start and really kind of understand what value do I have with my product or service? And then how much of a margin can I receive? I also want to throw out this idea when we were talking about Jeff Bezos in this whole episode. So Jeff Bezos has a quote. He says that, “Your margin is my opportunity and my competitive advantage,” which I love that quote, because it basically is his way of saying, if you’re charging a lot, I’m going to take you to the schoolhouse, which is a really kind of neat idea. And it’s the same thing, he really learned that from Sam Walton, he’s taken on the same approach as Sam Walton with Walmart. But Stig, I’m real curious to hear what you have to say about some of this stuff.

Stig Brodersen  26:17

Yeah. So I really liked, Preston, that you talked about margins. One thing I do want to also talk about is the return on investment. So when we’re talking about Warren Buffett, and we’re talking about his margins, we would typically be talking about the margin’s business, or we could also talk about his stock market returns, which is also perhaps closer to these. It’s called return on investment. So if you are considering and, you know, contemplating on starting a business with $1,000, you might be thinking, so will I get a 19% return on that? Or should I aim for like 50% return on that? And I think that’s a genuine concern. And I know, I have some students and they’re thinking about apps. I don’t know what’s happening about apps lately, but it seems like if you’re 20 years old, and you’re studying economics, you just want to do an app. You know, guys, that’s completely okay. So they would, you know, show me this spreadsheet. And then let’s say, so we invest $1,000, or $5,000 in the app, and we think we can get five X on that in two years. So they would be looking at me and saying, “Why do you think I should invest in the stock market and get 8% or 10%?” 

Stig Brodersen  27:28

Now, there are a few things I’m always saying to my student. And one thing is that you need to not only invest your money, but also you need to invest sweat equity. And that’s, I mean, that’s extremely valuable for you. And that’s really awesome. But, you know, you will be spending a lot of time developing this app. And if you can’t do it yourself, you will spend a lot of time designing it, speaking to a programmer, and marketing it. There’s all these different things that is not including those $1,000. So over $5,000 or whatever you’re paying. 

Preston Pysh  27:59

Yeah, I want to see what kind of app they’re developing for 1000 bucks. I’m jealous. I’m over here like dying and laughing. I know, people can’t see this. But your comments are really making me smile because this whole app thing is quite amazing to me. And I hear a lot of this as well, Stig. So most people don’t realize if you’re going to build probably a cheap app, you’re talking like $5,000 to $7,000. And then it’s like, well, what competitive advantage does your app have? And what value? Is it adding over the millions upon millions of apps that are already out there? And what’s your marketing strategy to distribute the app? But keep going I’m sorry to interrupt but I am over here dying.

Stig Brodersen  28:39

Yeah, I think it’s a great point for us and also, for these students. And  it’s not that I wanted to discourage students from ever going to start their own business because I think that’s probably the most important thing in the world, that we have students and they want to start their own business. But what they often don’t see is also the downside and I’m not talking about the downside about spending all this time because you know that’s amazing to learn a lot. 

Stig Brodersen  29:04

But the downside of you know, starting an app or starting an app company is typically that there is a really good risk that you will end up with zero dollars. I think this is actually very relevant to the next book that we’re talking about, the “Black Swan,” we should have next week, which is about things that are extremes because sometimes I hear something like, you know, I can get five-x or I can get zero. So that might be on average, I’m just making this simplistic, but I might say on average, you know, they were going to have 2.5x. But that’s not how this works. I mean, like 99% of all apps are not going to return any kind of profit for you. So you can’t do it like that. So there’s a there’s a huge downside if you invest $5,000 if, which is a lot of money for most students, there is a great risk that you end up with zero dollars. 

Stig Brodersen  29:51

Now compare that to stock investing. I say you invest in the index. Now you might lose 50%, which would be horrible, but I don’t think you will ever have zero dollars if you buy the S&P 500. Plus, if we’re talking about stocks, and people always know that I’m critical on stock, S&P stocks,  asset class. But you know, they are liquid, it’s truly passive. They’re all these different things, that it’s just very different when you have your own business. So really to answer your your question, Daniel, you can’t really compare like 19%. If we’re talking about general investment to Warren Buffett, that’s just another discipline.

Preston Pysh  30:31

Yeah, it’s a really hard discussion, especially when you’re talking about like a really small and immature business that you’re talking a couple thousand dollars. I mean, your returns could be 150% on your principal, when you’re talking those small numbers and it could be absolutely nothing. It’s typically very polarized at that level where you’re not talking about like the difference between a 10 to 30% margin. You’re typically talking about a zero to a 300% margin, when you’re talking about small numbers, but really fun discussion. Sorry to interrupt you a few times there, Stig, with the app discussio. I could play that up for a few hours. But that’s our two cents. 

Preston Pysh  31:09

So Daniel, that was a really fun conversation. We’re really glad that you asked that. We’re going to send you a free signed copy of our book, the Warren Buffett Accounting Book. And for anybody else out there, if you want to get your question played on the show like Daniel, go to asktheinvestors.com and you can record your question there. 

Preston Pysh  31:23

So we’ve really had a fun conversation this weekend. We’re really happy that you guys tuned in to The Innovator’s Dilemma discussion. So that’s all that we have for you. And we’ll see you next week. 

Preston Pysh  31:33

So one of the things that Stig and I are very strict about is not endorsing any kind of service or product that we don’t personally use ourselves. So with that said, we give our full endorsement of our sponsors content RealVisionTV.com. Real Vision is a site that Stig and I personally use ourselves and it has had a profound impact on the way that we view the financial markets. One of the most important things a person can do is seek the knowledge of highly successful investors and business leaders. And more importantly, understand their thought process and how they make decisions. And with Real Vision, you get exclusive and in-depth interviews and presentations from the world’s sharpest independent analysts, fund managers, geopolitical strategist, economists, and investors all in the same place. And right now, because you’re listening to this show, we have a special offer for everyone in the TIP community. If you go to realvisionTV.com and put in our special offer code, TIP, which stands for The Investor’s Podcast, you get 10% off your subscription in the Real Vision TV.

Preston Pysh  32:36

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Outro  33:27

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