When “Bits” Meet “Atoms”
Implications of the Second Machine Age for Corporate Profitability and Traditional Business Models
- Although the impact of the Second Machine (or Digital) Age was difficult to see for the first few decades, as even exponential growth from a small base is not visible for a long time, we believe technological innovation reached an inflection point around 2007.
- The Digital Age and the transition from “atoms” to “bits” implies a capital-light economy in which technology is being substituted for labor and physical assets. This points to higher ROE—in fact, all three components should rise (profit margins, asset utilization and leverage).
- Since progress in the Digital Age is exponential rather than linear, the business world has never seen disruption at this speed and scale before: witness the dramatic transformation in industries such as newspaper, film, music, telecommunications, retail, transportation, and accommodation.
- Additionally, platforms are arguably the best business models ever created, benefiting from low marginal costs, with their distinctive asset-light nature and powerful network effects. Winner-takes-all dynamics have resulted in neo-monopoly profits for dominant firms and increased concentration in most sectors.
- Moreover, the pace of technological change continues to accelerate, suggesting we are nowhere near the late stages of this transformation.
- The ability of companies to generate free cash flows is becoming increasingly dependent on how they adapt their business models to the Digital Age. We believe companies that can consistently generate free cash flow and allocate it competently will provide investors with the best returns.
Implications for Investors: Download the Full StoryUnderstanding how companies will adapt their business models in this environment is central to assessing their ability to produce free cash flow on a sustainable basis.
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