Creative Destruction

Cre­ative Destruction

by Robert McConnaughey, Head of Equity, Colum­bia Man­age­ment Invest­ment Advis­ers, LLC

June 14, 2012 at 5:36 am

Cre­ative Destruc­tion is always at play in com­pet­i­tive mar­kets of all kinds. Given the meta­mor­phic pres­sures caused by today’s over-levered and struc­turally low– growth global econ­omy, the forces of Cre­ative Destruc­tion are per­haps far greater than nor­mal. Low over­all growth and his­tor­i­cally high profit mar­gins cre­ate a par­tic­u­larly potent envi­ron­ment in which cor­po­ra­tions com­pete for their share of a poten­tial profit pool. Rev­enue growth is increas­ingly hard to come by and cost-reduction oppor­tu­ni­ties may have been stretched to their outer lim­its. So growth strate­gies will increas­ingly be dri­ven by the quest for mar­ket share gains which inevitably come at the expense of others.

The same logic holds for the economies of nations. When there is less growth to go around, high unem­ploy­ment, and inter­est costs/ future enti­tle­ment lia­bil­i­ties weigh heav­ily on options, the forces of inter­na­tional com­pe­ti­tion ratchet up, with sig­nif­i­cant con­se­quences to be considered.

The mar­kets have focused largely of the “Destruc­tion” side of the ledger and rea­son­ably so. Profit growth will def­i­nitely be chal­leng­ing in this envi­ron­ment. But, as I noted last week in “Find­ing oppor­tu­nity in volatile mar­kets”, when the mar­ket dis­counts such chal­lenges some­what indis­crim­i­nately, oppor­tu­ni­ties arise.

While there’s plenty to be wor­ried about, we believe inno­v­a­tive com­pa­nies and busi­ness mod­els are still out there and will be able to regain the his­tor­i­cal pre­mi­ums asso­ci­ated with dif­fer­en­ti­ated organic growth as their strate­gies are proven out.

Exam­in­ing the chal­lenges of Cre­ative Destruc­tion as it relates to the health of nations is a slightly dif­fer­ent task. It is eas­ier to advo­cate for the fer­tile ground of growth that comes from allow­ing “Destruc­tion” among com­pa­nies than it is for nations. The human costs of pol­icy options rang­ing from severe aus­ter­ity to a money-printing dri­ven infla­tion and deval­u­a­tion of cur­ren­cies are not to be taken lightly. The ethics of these options weighs on deci­sion mak­ers, but we must also con­sider the polit­i­cal cal­cu­la­tions of elected offi­cials. Rarely do can­di­dates get elected of pre­scrip­tions of pain. Human nature is such that defer­ral of con­se­quences and selec­tively illog­i­cal opti­mism allows for “can-kicking” to usu­ally win out over “med­i­cine tak­ing.” In today’s world, most pro­posed solu­tions to exces­sive lever­age involve col­lec­tiviz­ing risks away from trou­bled pock­ets to be shared with broader societies.

That was the nature of the Trou­bled Asset Relief Pro­gram (TARP) res­cues in the U.S. as well as most actions taken and con­tem­plated in the Euro­pean Union (EU). The fail­ure of cer­tain con­stituents is delayed by spread­ing those costs over a broader base. A sound strat­egy if the dilu­tion across the broader base is mod­est enough such that the new col­lec­tive entity is not fatally infected with the dis­ease of the res­cued entity. This is my con­cern with the sit­u­a­tion in the EU.

With increas­ing weak­ness in larger nations, Ger­many is sim­ply not large enough to carry the weight of the weaker play­ers given the lack of pos­si­ble unity on fis­cal issues and appro­pri­ately com­pet­i­tive cost struc­tures. Even with Ger­man sup­port, the com­petive­ness of south­ern Europe is not improved under the com­mon cur­rency even with some of the cap­i­tal holes “band-aided” over. It may well take allow­ing selec­tive “Destruc­tion” and reval­u­a­tion to get to an actual cure for what ails the weaker play­ers in Europe. Scary though that may be, it might ulti­mately put Europe on a more sus­tain­able future ver­sus con­tin­ued “extend and pre­tend” tactics.

Read more in this week’s Per­spec­tives.

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