As a target for disruption, Australia is also ripe for opportunity.
Australia’s major industries face increasing competition from outside disruptors. Could “self-disruption” be the key to mitigating risk and creating value for investors?
For years, Australia’s industries have lagged global peers on innovation, while corporate concentration and record levels of household leverage have positioned the region as an appealing prospect for outside disruptors.
Australia’s companies will need to embrace self-disruption as a strategy with two agendas: disrupt to protect and disrupt to grow.
Globally, disruption has been an ongoing theme as emerging technologies, big data, regulation and ever-changing consumer tastes force industry incumbents to either evolve or cede market leadership to fast-moving upstarts. But in a region such as Australia, where sector concentration is at twice the level of the U.S. market, is it possible for companies to “self-disrupt” to beat outside competition to the punch, grow earnings and innovate?
In a recent report, Morgan Stanley Research found that this notion of self-disruption - particularly for Australia's banks, insurers, supermarkets and telecoms - could help mitigate risk, develop new opportunities and create long-term value for investors.
“Since Australia is a target for disruption, many of the country’s companies will need to assess the risk of disruption to their competitive positioning, while also looking inwards to determine how best to transform to drive efficiency and position their businesses for growth,” said Chris Nicol, head of Morgan Stanley’s Australian Strategy & Economics team.
Australian Sectors Are Highly Concentrated
(Revenue Market Share %)
There are several factors which pressure Australia’s industries and companies to consider self-disruption. One obvious driver is financial.
Consolidated industries typically apply the benefits of scale and efficiency to drive return on equity, margin structures and market shares to levels well above the cost of capital. Excess returns don't last forever, however. Such industries eventually become targets for disruptive competition, putting pressure on both profits and cost competitiveness, propelling the need to use self-disruptive strategies.
The nature of industry is another key factor. Changes in positioning, consumer tastes and preferences - in tandem with the evolution of products and services - can accelerate disruptive risks. Technology and data are typically agents of such change, shaking up traditional business models and profit pools.
Changing policy and regulation can also open the door to disruption within an industry. Competitive landscapes can shift quickly because of environmental, social infrastructure, and policy agendas. Often, the only viable defence is to self-disrupt.
Finally, the most powerful driver of self-disruption is technology. To find growth, consolidated industries must keep up with - or stay ahead of – upstarts’ technology. Data technology can galvanize existing business models and fast-track response strategies. According to equity strategist Daniel Blake, “We are entering a new era of potentially more radical change. The influence of new technologies and their disruptive impact on existing business models will be a key component of the investment decision process.”
Australia Ranks 23rd of 127 Countries
on the Global Innovation Index
According to Nicol, companies will need to embrace self-disruption as a strategy with two overarching agendas: disrupt to protect and disrupt to grow.
Among the benefits are: improved market share; enhanced cost competitiveness and better positioning; extension into adjacent industries and products; geographical expansion; and optimisation of workers, along with an enhanced ability to attract talent.
In particular, three industries in Australia illustrate the conditions driving self-disruption:
Retail banking sector: Recent trends in digital and mobile banking, customer data and regulatory change are intensifying the threat of disruption in retail banking. Pressure from new fintechs and nonbanks, re-invigorated smaller incumbents, and global competitors are challenging major banks on residential mortgages, consumer unsecured finance, small business lending and transaction banking. In response, Australian incumbents are increasing investment in their own franchises and capabilities, partnering with fintechs, investing in new ventures, and highlighting potential risks to slow disrupters. These self-disrupters are also paying more attention to customer service, adding value on both sides.
Private health industry: A margin opportunity exists for challengers of Australia’s for-profit health-care sector, which will face the same risks seen across health systems in developed markets - growing health-care burdens and limited budgets. The bull case for insurers is to eliminate claims wastage and to permanently bend the cost inflation curve from its current unsustainable level of 4%-5% per year.
Supermarkets: Since Australia's supermarket industry is consolidated, opportunities to offset volume declines with price are limited. Like the nation’s other oligopolies, supermarkets have already exploited scale and efficiency to generate excess returns and premium valuations. To compete with tech-savvy rivals and self-disrupt, Australian supermarkets have invested in online delivery and click-to-collect capabilities to increase online sales. Digital assets could also add value and create opportunities for growth.
“The fight for revenue is a daily battle in any industry,” added Nicol. “But companies that engage in self-disrupting strategies, in our view, are often able to stay ahead of the trend, embrace change more effectively, pivot to opportunity and create value.”
For more Morgan Stanley Research, ask your Morgan Stanley representative or Financial Adviser for the full report.