The landscape of the technology industry has been dramatically reshaped since the onset of the coronavirus crisis, with big tech companies witnessing their operating profit margins leap from 24 to 29 percent. In stark contrast, other companies have seen a decline of two percentage points in the same period. This trend, far from fostering competition, is solidifying a ‘winner-takes-all’ economy.
Why aren’t these soaring margins breeding competition? It comes down to the nature of technology and innovation. The initial investment in artificial intelligence, cloud computing, and data resources has a snowball effect, further entrenching the dominance of existing winners. It’s not a new phenomenon. Many US and Western European firms have transformed into platform companies, outsourcing lower-margin, capital-intensive operations to Asia, focusing on product development, marketing, and sales - realms driven by ideas more than physical resources.
The beauty of knowledge-based business is that selling an idea again costs practically nothing. This zero marginal cost enables rapid growth without additional capital, a trend accelerated by global trade agreements and the internet’s omnipresence.
This shift, however, spells trouble for competition. When a company gains an edge, it doesn’t lead to a new equilibrium but rather a market imbalance that often ends in the extinction of its competitors. Accusations of monopolistic ambitions are common, but it’s a natural progression in this tech-driven market.
Take the evolution of computer operating systems as an example. The rise of DOS over Apple Macintosh and CP/M wasn’t necessarily about superiority; it was about market dynamics and network effects, now amplified by the internet.
One winner per sector
This scenario is intensifying with artificial intelligence, pushing industries towards a singular dominant player. Companies eyeing growth will inevitably have to venture into new industries, simplifying investment choices with a handful of tech giants dominating the market.
In our backyard, ASML is a textbook ‹winner-takes-all› case. Born from a joint venture between Philips and ASMI, ASML has cornered over 90 percent of the lithography machine market, thanks to its EUV technology. Yet, the company’s real asset is its knowledge, not its physical production.
For investors, identifying these potential winners early is key. Companies that effectively sell and develop knowledge – often cloaked in a physical product – are the ones to watch. An iPhone, for instance, is more than a phone; it’s a vessel of intricate, hard-to-replicate knowledge.
However, dominance in tech isn’t eternal. History is littered with leading companies that faded rapidly. It’s not just about having knowledge or patents; it’s about how companies utilize and evolve that knowledge.
We’re witnessing the final phase of the fourth industrial revolution, akin to the Cambrian explosion, marked by a burst of diversification in organisms. This era brought technological advancements like skeletons and eyes. In today’s terms, it’s about the convergence of different technologies and ideas. Those who can adeptly blend these elements are likely to emerge as the victors in this rapidly evolving tech landscape.
Han Dieperink is chief investment strategist at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co.