Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.
2020 in sightInnovation pulls the bits together
Special report June 2016
2020 innovation
2 ed.maguire@clsa.com 17 June 2016
Contents
Executive summary ...............................................
Executive summary 2020 innovation
17 June 2016 ed.maguire@clsa.com 3
2020 in sight
Technology-driven “creative destruction...
Section 1: Add the bits together and stir 2020 innovation
4 ed.maguire@clsa.com 17 June 2016
Add the bits together and sti...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 5
Signs of a new industrial rev...
Section 1: Add the bits together and stir 2020 innovation
6 ed.maguire@clsa.com 17 June 2016
robotics and automation is ex...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 7
The volatility in the markets...
Section 1: Add the bits together and stir 2020 innovation
8 ed.maguire@clsa.com 17 June 2016
While we do expect some pain ...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 9
among businesses and consumer...
Section 1: Add the bits together and stir 2020 innovation
10 ed.maguire@clsa.com 17 June 2016
Creating value: Platforms, a...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 11
Figure 3
Platform companies ...
Section 1: Add the bits together and stir 2020 innovation
12 ed.maguire@clsa.com 17 June 2016
businesses: eBay is an appli...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 13
The field of data analytics ...
Section 1: Add the bits together and stir 2020 innovation
14 ed.maguire@clsa.com 17 June 2016
to solve complex optimizatio...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 15
Figure 7
IT security - stron...
Section 1: Add the bits together and stir 2020 innovation
16 ed.maguire@clsa.com 17 June 2016
Wearable technology was at t...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 17
Of course, innovation does n...
Section 1: Add the bits together and stir 2020 innovation
18 ed.maguire@clsa.com 17 June 2016
Blockchain, the distributed ...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 19
Innovations in the physical ...
Section 1: Add the bits together and stir 2020 innovation
20 ed.maguire@clsa.com 17 June 2016
Figure 13
Innovations in the...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 21
One of the most significant ...
Section 1: Add the bits together and stir 2020 innovation
22 ed.maguire@clsa.com 17 June 2016
Figure 14
Adoption paradigms...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 23
An installation period typic...
Section 1: Add the bits together and stir 2020 innovation
24 ed.maguire@clsa.com 17 June 2016
productivity and growth from...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 25
sees more job redefinition i...
Section 1: Add the bits together and stir 2020 innovation
26 ed.maguire@clsa.com 17 June 2016
Figure 17
Tech leaders’ net ...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 27
Authors John Seely Brown and...
Section 1: Add the bits together and stir 2020 innovation
28 ed.maguire@clsa.com 17 June 2016
One of the challenges with t...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 29
Figure 20
ExO performance im...
Section 1: Add the bits together and stir 2020 innovation
30 ed.maguire@clsa.com 17 June 2016
Software - Value migrates up...
Section 1: Add the bits together and stir 2020 innovation
17 June 2016 ed.maguire@clsa.com 31
What the future economy will...
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire
Upcoming SlideShare
Loading in …5
×

2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire

6,147 views

Published on

Technology-driven “creative destruction” is impacting many different industries as information technology matures into the backplane of the global economy and society as a whole, and businesses undergo digital transformation. Following a frothy period, a funding slowdown for startups will provide established firms with attractive acquisition opportunities. Change is already accelerating within information-intensive industries like tech, media, retail, communications and financial services. Next up will be transport, manufacturing, agriculture, energy, materials and life sciences.

Published in: Technology
  • Earn real money online by working as a part time job easily, earn up to 2500$ dollars weekly guaranteed join link at http://earlypayjob.online/?money=27544
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here
  • Free Global Tenders global tender world tender notices International Competitive Bids. Business Opportunities trade leads tender notices bids. https://www.tendersglobal.com/
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here

2020 In Sight - Innovation Pulls the Bits Together - Ed Maguire

  1. 1. 2020 in sightInnovation pulls the bits together Special report June 2016
  2. 2. 2020 innovation 2 ed.maguire@clsa.com 17 June 2016 Contents Executive summary .......................................................................... 3 Add the bits together and stir ........................................................... 4 The Unicorn Era winds down............................................................34 Bits flow into currents .....................................................................53 10 themes from digital to physical ...................................................63 All prices quoted herein are as at close of business 14 June 2016, unless otherwise stated Follow our 2020 innovation series Ed Maguire ed.maguire@clsa.com +1 212 549 8200 Reagan Tangney +1 212 549 5028 Find CLSA research on Bloomberg, Thomson Reuters, FactSet and CapitalIQ - and profit from our evalu@tor proprietary database at clsa.com Produced by CLSA Americas LLC. For important disclosures please refer to page 136. Visit our 2020 mini-site at clsa.com
  3. 3. Executive summary 2020 innovation 17 June 2016 ed.maguire@clsa.com 3 2020 in sight Technology-driven “creative destruction” is impacting many different industries as information technology matures into the backplane of the global economy and society as a whole, and businesses undergo digital transformation. Following a frothy period, a funding slowdown for startups will provide established firms with attractive acquisition opportunities. Change is already accelerating within information-intensive industries like tech, media, retail, communications and financial services. Next up will be transport, manufacturing, agriculture, energy, materials and life sciences. We explore 10 innovation themes with disruptive potential and highlight Microsoft, Red Hat, Salesforce and Splunk as our top software picks. The information and communication technology (ICT) era is 40 years old. Cloud computing has industrialized IT, deflating costs and squeezing sector margins to the benefit of users and businesses pursuing digital strategies. Value has migrated from infrastructure to platforms, applications and applied analytics. The stage is set for a coming era of combinatorial innovation. Artificial intelligence, robotics, mobility and cloud will power new transformations at the intersection of digital, physical and biological domains. IT-driven deflation disrupts wages and economic “rents” from providers, as benefits accrue to consumers, innovators and transformational organizations. After years of growth in venture-capital (VC) funding and investment, sentiment is turning more cautious, as the era of Unicorns (privately funded companies valued over US$1bn) fades with “down-rounds” and IPO investors increasingly leery. The pace of new-business formation has rebounded however. Expect belt-tightening among startups to lead to favorable tech M&A opportunities for buyers from different industries. Structural headwinds in the US include slippage in science, technology, engineering and mathematics (STEM) education, broken immigration policies, costly patent litigation and over-regulation. We update our technology “meta-themes” - transparent IT, intelligent systems and convergence - highlighting the importance of platforms for innovation. Software remains at the top of the tech value chain as the driving force in innovation, gaining strategic importance for non-technology companies as well. A new generation of high-growth businesses builds on connectivity, massive data-processing power, near-ubiquitous reach and powerful analytics. We explore 10 themes with disruptive potential that bridge the digital and physical worlds: artificial intelligence, augmented/virtual reality, Blockchain, open source, security, clean disruption of energy and transportation, autonomous vehicles, robotics, 3D printing and the Internet of Things. Recommended innovation stocks Ticker Rating Target price Last close Currency Akamai AKAM-US BUY 69.00 52.66 US$ Alphabet GOOGL-US BUY 970.00 733.25 US$ Amazon AMZN-US O-PF 770.00 719.30 US$ Apple AAPL-US BUY 115.00 97.46 US$ Facebook FB-US BUY 161.00 114.94 US$ Microsoft MSFT-US O-PF 60.00 49.83 US$ Red Hat RHT-US BUY 94.00 77.17 US$ Salesforce.com CRM-US BUY 101.00 81.09 US$ Samsung Electronics¹ 005930-KR BUY 1,600,000.00 1,380,000.00 won Splunk SPLK-US BUY 86.00 56.64 US$ ¹ Covered by CLSA; all others by CLSA Americas. Source: CLSA The Unicorn Era winds down 10 themes frame innovations in the digital sphere and physical world Add the bits together and stir Bits flow into currents Change is accelerating in information-intensive industries Our top software picks are Microsoft, Red Hat, Salesforce and Splunk
  4. 4. Section 1: Add the bits together and stir 2020 innovation 4 ed.maguire@clsa.com 17 June 2016 Add the bits together and stir Since we published our 2020 forces converging: Crossing creative disruptions report in March 2015, US stock indexes have touched all-time highs with robust capital markets and M&A activity. In 2016, markets have shaken off early jitters, but there are signs that the sentiment that propelled the boom in privately funded tech firms is turning more cautious. As the “Bubble 2.0” cycle winds down, we see promising consolidation and expansion opportunities ahead for cash-rich firms. As software continues to “eat the world” we expect innovative cross-pollination across domains to accelerate, with the value-creation criteria inherent to technologies - platforms, applications and applied analytics - increasingly relevant across industries. Our subtitle for this report, Innovation pulls the bits together, alludes to a coming “Cambrian explosion” of innovation across disciplines. Information technology has become industrialized, and is becoming a substrate of the broader economy. We see less incremental value creation in technology itself than the increasing potential to apply technologies to an increasingly digitized physical world. The next era of innovations will be powered by cognitive software, robotics and ubiquitous computing applied in combinatorial ways to transform industries. The era of Unicorns (privately funded companies valued over US$1bn) is fading with “down-rounds” and IPO investors growing leery. Expect belt- tightening among startups to lead to favorable tech M&A opportunities for buyers from different industries. Innovation holds the key to sustainable value creation, with R&D estimated to drive 1.4% of GDP growth. Businesses continue to face headwinds including lagging science, technology, engineering and mathematics (STEM) education, broken immigration policies, costly patent litigation and over-regulation. With Moore’s Law and corollaries as a backdrop, software becomes the defining vector as businesses undertake digital transformation. Tech mastery will differentiate winners in every sector. Digitization of business creates deflation, disruption and dislocation. Cloud computing industrializes IT and accelerates deflation, impairing infrastructure hardware and software providers’ ability to charge economic “rents”. This causes the cost to field test a new idea or start a business to plummet. Startups can scale at unprecedented pace with a fraction of the resources previously required, increasingly disrupting powerful incumbents in media, transportation, hospitality and other industries. There are downsides too. Digitally enabled automation depresses wages for less skilled workers, exacerbating unemployment and social costs from income inequality. Economic dissatisfaction in the middle class is fueling a volatile political climate in 2016, though for the most part, proposed policy prescriptions do not address technology’s role in the underlying dynamics. We remain optimistic about potential for value creation from combinatorial innovation. Sustained progress in computing, storage and connectivity powers increasingly sophisticated ideation, design, prototyping, research, product development and business creation. Value creation migrates “up the stack” to platforms, applications and applied analytics. Red Hat, Salesforce, Microsoft and Splunk are our top thematic software picks, as they exhibit key value creating characteristics of platforms, applications and applied analytics A coming convergence between the digital and physical We highlight Salesforce, Red Hat, Microsoft and Splunk as our top thematic software picks There’s growing evidence that technology may be indirectly exacerbating economic anxiety Digitization of business allows rapid scale, but it creates deflation, disruption and dislocation The era of Unicorns (privately funded companies valued over US$1bn) is fading
  5. 5. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 5 Signs of a new industrial revolution emerge In 2016, employment and a range of industries are navigating widespread disruption from an industrial revolution driven by ICT. It’s not exactly “bloodless”. Leaders have been dethroned, the status quo is fluid, massive wealth is being created with unprecedented velocity and there is bubbling discontent in the broader US economy as machines displace jobs and a disproportionate share of income accrues to an elite few. For investors, there are attractive opportunities and potential minefields as pace of innovations accelerates. Innovation (inextricably conjoined with technology) is key to sustainable value creation. With Moore’s Law and its corollaries as backdrop, software becomes the defining vector separating winners and losers. In this report, we characterize 2016 in a big-picture context, pulse-check the current state of funding and entrepreneurship, examine drivers and developments within frameworks and explore 10 critical innovative themes. Why is innovation so important? Innovation is critical to value creation in an economy increasingly shaped by advanced technology. The most innovative industries typically contribute outsized gains to GDP, create businesses that generate attractive returns for investors, and in the case of information technologies, enable productivity gains across a continuum of industries. R&D contributes directly to gains in productivity. Macroeconomist Charles Jones estimates that R&D accounts for around 1.38% of annual economic growth. If the US economy had invested only the same amount on R&D as a share of GDP today as in 1950, productivity would be 17 to 32% lower. The Brookings Institute’s 2015 study, America’s Advanced Industries, found that advanced industries (those with the top 20% of R&D spending per worker and a higher proportion of STEM workers) employed just 9% of the active workforce, but generate 17% of total US GDP. These advanced industries employ 80% of the country’s engineers, generate roughly 85% of US patents and account for 60% of US exports. Bits come together for a Cambrian innovation explosion We are on the brink of a veritable Cambrian explosion of combinatorial innovation, catalyzed by the confluence of cloud computing, mobile connectivity, automation and artificial intelligence. What has happened to the technology industry over the past decade is harbinger for disruption in other industries - with rapid, highly concentrated value creation on one hand, and deflationary forces that erode growth and employment on the other. Andrew McAfee and Erik Brynjolffsen’s 2014 book The Second Machine Age posits that the world is at an inflection point where digital technologies will manifest in full force through automation, resulting in the creation of an unprecedented range of “things”. Technology provides leverage for value creation, accelerating the ability for platforms to dominate and exacerbating the division between winners and losers in the economy. Starting a company is cheaper by a factor of 1,000x versus a decade ago. Just US$5,000 in funding can be enough for a new business to disrupt large incumbents. It’s not one single factor driving acceleration of innovative activity; it’s the combination of enabling technologies that creates powerful leverage to the economy. The convergence of Moore’s Law-enabled cloud and mobile computing, advanced analytics (artificial intelligence/machine learning/cognitive computing), Software becomes the defining vector that creates winners and losers 2016 sees continuing disruption from the digital industrial revolution R&D accounts for around 1.38% of annual economic growth Digital technologies will manifest in full force through automation Starting a company is cheaper by a factor of 1,000x versus a decade ago It’s the combination of enabling technologies that creates powerful leverage
  6. 6. Section 1: Add the bits together and stir 2020 innovation 6 ed.maguire@clsa.com 17 June 2016 robotics and automation is extraordinarily powerful. Gartner refers to a “Nexus of Forces”, IDC defines a “3rd Platform” comprised of cloud, mobile, big data analytics and social technologies. Boston Consulting Group describes a “software- driven digital metasystem” - a mobile-first environment of near-infinite compute power and connectivity with the capacity to scale massively sophisticated analytics in real time. However you define it, barriers to ideation, experimentation and true innovation are falling away, promising to empower billions of new minds coming online in the near future. Technology has become an embedded, foundational strata across the economy and society, representing a core infrastructure analogous to energy in the Industrial Age. Market boundaries are also shifting because of sharing and platform economy dynamics. Businesses that were previously based on the sale of products or assets are now being turned into renting, sharing or subscription businesses. We share an optimistic though tempered view. Cloud computing, mobile internet, non-traditional user interfaces, advances in programming science and artificial intelligence, and falling costs of compute and bandwidth place unprecedented power in the hands of everyone, from a child with a cellphone, to entrepreneurs, to researchers seeking to solve the challenges of medicine. For investors, it’s critical to time investments in disruptive technologies appropriately, as there are risks being too early or too late. Grownups don’t believe in unicorns Market sentiment in mid-2016 has apparently shaken off jitters over weakness in China and Brazil, but there are growing concerns of macro headwinds with US GDP in 1Q16 trudging along at a 0.5% rate. Figure 1 Official employment trends upward while stocks struggle for further gains Source: Research.stlouisfed.org, FactSet Sentiment is growing more cautious, judging by the dropoff in VC funding and decline of late-stage investments. GDP in the USA is plodding along at barely 1% growth despite the official unemployment rate in the 5% range. There are concerns that the post-recession recovery may be losing steam. There’s an ongoing debate regarding the future of US growth between the techno-optimists and those that view technology as ultimately contributing to slowing GDP growth. 4 5 6 7 8 9 10 11 12 6,000 8,000 10,000 12,000 14,000 16,000 18,000 20,000 May06 Sep06 Jan07 May07 Sep07 Jan08 May08 Sep08 Jan09 May09 Sep09 Jan10 May10 Sep10 Jan11 May11 Sep11 Jan12 May12 Sep12 Jan13 May13 Sep13 Jan14 May14 Sep14 Jan15 May15 Sep15 Jan16 DJIA (LHS) US unemployment rate (%) The challenge always remains a combination of timing and careful selection Technology has become an embedded, foundational strata across the economy and society Markets and employment recovered from the financial crisis Signs of trouble or a wall of worry ahead?
  7. 7. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 7 The volatility in the markets in early 2016 marked a shift in investors’ tolerance for high-growth software and internet companies with high perceived risks. “Internet Bubble 2.0” appears on its way to deflating not with a bang but with a whimper. Increasingly disciplined investors are focused on profitability and consistent execution. Top-line growth accompanied by losses is not commanding the valuation premiums previously. Skeptical sentiment among public company investors is impacting VC funding and M&A sentiment. Startups need to conserve cash and build sustainable, profitable businesses. Investors are increasingly cautious over venture-backed IPOs. On the IPO demand front, most recent tech IPOs are trading below issue price. When newly public companies have hiccups, investors are punishing the stocks. After a mis-step, there needs to be a sustained period of rebuilding a business before investors will award a premium valuation. According to an analysis by CB Insights, the average return of 90 US VC- backed tech IPOs since Facebook‘s May 2012 IPO through October 2015 was just 7.05%. For the same period, the S&P 500 return was 60.5% (over 8x higher than if an investor had purchased every VC-backed tech IPO during this period). For comparison, the Dow Jones Industrial Average gained 42.8% (6x higher) and equally weighted S&P 500 return (a better proxy for theoretical tech IPO investments) would have gained 67% (9x higher than IPOs). SecureWorks (SCWX) has been the only tech IPO in 2016, pricing lower than initially expected. According to the industry analyst firm 451 Group’s 1Q16 survey of tech bankers and corporate development execs, 58% expect the number of new offerings to decline, versus 43% expecting this in 3Q15 and 27% in 1Q15. Sentiment has also turned more bearish regarding M&A potential over the next year, although the flurry of software acquisition activity in late May and early June may help. Volatility in the capital markets is a contributing factor: in the first six weeks, stocks including Tableau (DATA), Hortonworks (HDP) and LinkedIn (LNKD) saw valuations cut in half. Public market sentiment impacts willingness to do deals. With economic uncertainty from Europe, the impact of lower energy prices and equity price volatility, participants are finding it more difficult to get deals done. Valuations in the M&A markets are polarized as well, with high multiple and low multiple deals and little in between - not a healthy indicator for M&A prospects. In 2015, investors were also rewarding acquirers, but this is not happening this year. Private equity is the only hope for many aspiring tech Unicorns, but the debt markets are also impacted by stock volatility, macroeconomic and some political uncertainty. There’s not an obvious investment cycle playing out in tech like the PC or internet wave either, so M&A focus is moving to life sciences and biotech. By 1Q16, the late-stage VC financing environment has become more challenging and more discerning. There has been an increase in failures among high-profile startups including Quirky, Secret, Fab.com and others. Mutual funds have also begun to mark down valuations from private investment rounds, and the pace of private investments by large mutual fund firms is slowing as firms find it more difficult to agree on acceptable valuations. “Internet Bubble 2.0” appears on its way to deflating not with a bang but with a whimper Investors are increasingly cautious over venture- backed IPOs M&A sentiment has turned negative and valuations are highly polarized Late-stage VC financing has become more challenging and more discerning Average return of 90 US VC-backed tech IPOs from May 2012 to October 2015 was just 7.05% Valuations in the M&A markets are polarized
  8. 8. Section 1: Add the bits together and stir 2020 innovation 8 ed.maguire@clsa.com 17 June 2016 While we do expect some pain for underfunded startup companies and overly optimistic venture and private investors, we do think these dynamics set up favorably for established companies with plenty of cash on hand. The deflation of the Unicorn Era bubble will set up unique opportunities for cash- rich companies. Innovations shifts from atoms to bits . . . to atoms One of more prominent questions is whether technology driven innovation has run its course as IT has become industrialized. We’ve seen prior computing architecture cycles - mainframe, PC and first-generation web technology cycles have run their course. Now the mobile/cloud architecture is maturing and consolidating. For investors, there’s a change in opportunities to invest in technologies as market value creation shifts away from providers of the technology to applications of the technology. Taking a broader view of technology systems (beyond computing) Robert D. Atkinson of the Information Technology & Innovation Foundation lays out how major tech system adoption waves layer upon one another in the economy. In Think Like an Enterprise: Why Nations Need Comprehensive Productivity Strategies, Atkinson posits that one can model the evolution of technology in the US economy through S-curves. The post-World War II growth wave was powered by electro-mechanical technology systems (televisions, electric appliances, etc). This drove growth until the mid-1970s when improvements in performance and reductions in cost diminished. It was not until the next wave of digital technologies based on computing and the internet that growth resumed in the 1990s. The chart below outlines how the cycles of the adoption S-curves for electro-mechanical tech systems, digital-electronic tech system and the artificial-intelligence-robotics tech systems. Figure 2 Evolution of technology systems Source: Robert D. Atkinson, Think Like an Enterprise: Why Nations Need Comprehensive Productivity Strategies - Information Technology & Innovation Foundation 2016, licensed under Creative Commons In Atkinson’s view, there are good arguments that we may be closer to the end than the middle of the current digital-electronic technology S-curve, as the incremental improvements in broadband speed, storage capacity and computing speed have far less incremental impact than they did in the 1990s, when the introduction new microprocessors drove steady PC upgrade cycles Technology adoption cycles occur in nested “S-curves” Value creation shifts away from providers of technology to applications of technology We may be closer to the end of the current digital- electronic technology S-curve M&A dynamics are favorable for established companies with plenty of cash on hand Tech system adoption waves layer upon one another in the economy
  9. 9. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 9 among businesses and consumers, along with significant productivity gains from the adoption of business applications. In his view, advances such as cloud computing are more stepwise in nature compared to the launch of the Netscape browser in 1995 and client server computing. It’s clear to us that cloud computing has accelerated the deflationary characteristics of information technology, making it more difficult for providers of infrastructure hardware and software to charge economic “rents”. As such, value creation is migrating “up the stack” to platforms and applications. Newer technologies such as artificial intelligence (AI), autonomous vehicles, drones, robots and genomics are still in their nascent stages. Atkinson thinks that it could be a decade or more before there is a new growth wave powered by technologies like robotics and machine learning - but we think this may be conservative. However, we think this analysis overlooks the nature of accelerating change. A period of slow deceptive growth is characteristic of new technologies. The early deceptive phase occurs before growth goes exponential then matures - and the pace of new technology phases in a “Nested S-Curve” sequence may be accelerating. The coming “Fourth Industrial Revolution” as growth catalyst Dr Klaus Schwab’s book, The Fourth Industrial Revolution, posits a new wave of innovation that goes beyond smart and connected machines and systems. This analysis looks back further: the First Industrial Revolution began in the late 18th century with development of machinery and automation. The Second Industrial Revolution began around 1870 using electrical power to create mass production systems with division of labor. The Third Industrial Revolution began around 1969 using electronics and information technologies to automate production. The coming Fourth Industrial Revolution will be powered by exponential growth of information technologies, catalyzing broad disruption across nearly every industry. Building on information technology advances of the Third Industrial Revolution, the combination of artificial intelligence, robotics, the Internet of Things, autonomous vehicles, 3D printing, nanotechnology, materials science, energy storage and other technologies will to be catalysts for exponential innovation. The Fourth Industrial Revolution will be characterized by the fusion of technologies across physical, digital and biological spheres. The biological component (reflected in advances in nanotechnology and gene sequencing) makes it fundamentally different from prior revolutions. The Fourth Industrial Revolution is expected to drive massive supply-side gains of efficiency and productivity. The decline of costs and frictions involved with delivering, creating, and consuming products and services will be so significant that demand will increase, opening up new markets and driving economic growth. This view downplays concerns about technological unemployment and inequality resulting from labor market disruption. Both the view of an AI-robotics technology system S-curve and the Fourth Industrial Revolution anticipate value coming increasingly from applications of technology to the physical world - Internet of Things, automation, materials science, manufacturing, bioengineering, precision agriculture, distributed energy production. While the exact timing is under debate, we think the signs are clearly pointing to more innovation coming from applying digital technologies to the physical (and biological world) - and this is where the most promising investment opportunities like ahead. A period of slow deceptive growth is characteristic of new technologies Fourth Industrial Revolution is about the fusion of the physical, digital and biological Expect more innovations from applying digital technologies to the physical (and biological world) Exponential growth of information technologies will power the Fourth Industrial Revolution This biological component will be fundamentally different from prior revolutions
  10. 10. Section 1: Add the bits together and stir 2020 innovation 10 ed.maguire@clsa.com 17 June 2016 Creating value: Platforms, applications, applied analytics If one subscribes to the premise that “Software is eating the world” in Marc Andreessen’s words, that every company ultimately becomes a software company, then it follows that many of the operative investing principles for software companies are relevant more broadly. We’ve previously outlined our views that value in technology migrates upward, from infrastructure to platforms to applications. The adoption of cloud computing represents the industrialization of information technology, paralleling the adoption of electrification of industry beginning in the late 19th century. There are three characteristics of software and technology based businesses that are capable of generating sustainable value creation in our view: platforms, applications and applied analytics. We prefer businesses with dominant concentration in one or more of these areas because of the ability to sustain differentiated value and competitive advantage, which leads to higher margins.  Platform businesses harness innovation from an ecosystem of partners, which results in far greater creation of value than a single firm could create. (We cover platforms in greater detail in Section 2 of this report).  Application businesses (more broadly referring the application of various technologies - software, hardware, and services) create value by addressing general or specific needs to businesses and users.  Applied analytics businesses make better decisions, reduce risks, are more effective at sales and marketing and realize more operational efficiencies. Platform companies create value by engaging multiple stakeholders, creating value across multiple dimensions. They are able to benefit from third-party innovations and compete more effectively in industries outside their core domains. Amazon’s competition is not just e-commerce and retail, but publishing, grocery, media, IT and other firms. Apple’s competition is not just PCs and phones, but watches, music and movie streaming services. Google and Nest compete against companies like Honeywell, Phillips and Toshiba. Platform firms innovate faster because they harness the capabilities of partners. Leveraging technology, they are also are able to generate more value from fewer resources. Uber is the biggest taxi company, but the company owns no taxis; AirBnB is the biggest accommodations marketplace but it owns no inventory; Alibaba is the biggest merchant but it owns no inventory. Platform companies also generate value at a greater proportion than product companies. According to MIT Professor Marshall Van Alstyne, platforms represent over two-thirds of privately held companies valued over US$1bn; three of the top five companies in the US by market cap - Apple, Google and Microsoft - were platform companies. Platform firms are also becoming more important in the economy, with the platform companies among the top 20 firms by market cap representing a growing proportion of total market value: from 10% in 2001 to over 25% in 2014. Platform companies dominate the technology industry, and leading platform companies in other industries also tend to be technology intensive. Leading platform companies include Apple, Facebook, Google, Microsoft, Samsung Electronics, IBM, Intel, Cisco, Oracle, Amazon, American Express, SAP, eBay and Alibaba. Platforms, applications and applied analytics are relevant across industries. Many of the operative investing principles for software companies are relevant more broadly Platform companies create value by engaging multiple stakeholders Platform companies generate value at a greater proportion than product companies
  11. 11. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 11 Figure 3 Platform companies have outperformed the S&P 500 since 2006 Source: CLSA, Factset - Index components: Apple, Google, IBM, Microsoft, Samsung Electronics, Intel, Cisco, Oracle, Amazon, American Express, SAP, eBay In our software coverage, we favor Salesforce (CRM), Red Hat (RHT), Splunk (SPLK) and Microsoft (MSFT) as top platform picks. All four companies foster vibrant ecosystems of application developers and partners that create powerful network effects through engagement and innovation. Narrowly defined, applications are software programs that address a business or consumer need. We prefer an expanded definition: the “application” of technology, or technologies and services that provide distinct utility of value to users. Applications simply consume technology infrastructure in order to deliver value to the users. They are the raison d’etre for technology itself. Successive generations of IT architecture have decoupled compute, storage and networking infrastructure from the application logic itself, which is where business value resides. Enterprise applications have predominantly moved to a software as a service (SaaS) model over the past decade. We increasingly see applications that run on infrastructure as a service (IaaS) from Amazon Web Services, Microsoft Azure or Force.com. Because application value is measured by the perceived utility to the user, application vendors benefit from infrastructure technology cost deflation which is absorbed by hardware, infrastructure software or IaaS. As a result, application vendors can better sustain higher gross margins. Applications are not immune to deflation from feature expansion, bundling, competition, and the transition to cheaper subscription-based models, but the inherent value is not impacted directly by the dynamics of infrastructure commoditization. Applications can be horizontal in nature (customer relationship management/CRM, human capital management/HCM, supply chain management/SCM, financial, procurement, marketing etc) or specific to a particular industry (retail, financial services, health care, ecommerce etc). Applications can also be monetized in ways beyond licenses and subscriptions. Large internet and e-commerce companies are application 0 50 100 150 200 250 300 350 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Platforms S&P 500 (2006=100) Leading platform companies gained 173% vs the S&P 500’s 59% gain since 2006 Applications are software programs that address a business or consumer need Applications can be horizontal, vertical and monetized in different ways Applications are less exposed to deflationary characteristic of technology We favor Salesforce, Red Hat, Splunk and Microsoft as top platform picks
  12. 12. Section 1: Add the bits together and stir 2020 innovation 12 ed.maguire@clsa.com 17 June 2016 businesses: eBay is an application that makes money from transaction fees; Facebook and Google make money from user engagement by selling advertising. Although not typically regarded as such, IT security products are applications as well. There are dozens of pure-play publicly traded application companies. Leading companies include SAP, Oracle, Microsoft, Salesforce, Workday, NetSuite, ServiceNow, Guidewire Software, Autodesk, ANSYS, Cadence, PTC, Adobe, Intuit, Blackbaud, Ultimate Software Group, Cornerstone On Demand, Fleetmatics, Marketo, Real Page, and many others. We’d include security leaders like Palo Alto Networks, FireEye, CheckPoint, Imperva, Fortinet, Qualys, Trend Micro and others as well. Figure 4 Application companies have outperformed the S&P since 2006 Source: CLSA, Factset - Index components: SAP, Salesforce, Workday, NetSuite, ServiceNow, Guidewire Software, Autodesk, ANSYS, Adobe, Intuit, Blackbaud, Ultimate Software Group From our software coverage, we favor Salesforce (CRM), Akamai (AKAM) and Microsoft (MSFT) as top application picks. Salesforce has leveraged its leadership in Sales Force Automation to expand into service, marketing and commerce. Akamai’s performance and security businesses leverage its extensive content delivery network infrastructure to solve technically complex business problems. Microsoft Office dominates personal productivity software, and its Dynamics applications are strong in the mid-market. Applied analytics businesses use data and sophisticated mathematical, statistical and cognitive techniques to reduce risk, increase sales and optimize efficiencies. We distinguish applied analytics from traditional data warehousing and business intelligence tools, which are general purpose technologies used to build applications. Companies that use analytics strategically can realize significant financial and competitive advantages. The retail industry provides a great example: in the 1990s and 2000s Wal-Mart was able to capture enormous share gains by applying advanced analytics to its pricing and supply chain. In the 2010s we’ve seen Amazon gain share of e- commerce by applying analytics to recommendation engines, dynamic pricing and its own supply chain, arguably to Wal-Mart’s disadvantage. 0 50 100 150 200 250 300 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Applications S&P500 (2006=100) Leading platform companies gained 138% vs the S&P 500’s gains of 59% since 2006 Applied analytics techniques reduce risk, increase sales and optimize efficiencies We favor Salesforce, Akamai and Microsoft as top application picks
  13. 13. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 13 The field of data analytics itself is evolving beyond the data warehousing, statistical analysis, multi-dimensional analysis and simple reporting that originated in the 1980s to embrace artificial intelligence (also known as machine learning or cognitive computing). We cover AI/machine learning in greater detail in Section 4 of this report. The use of AI techniques by large internet companies like Google and Facebook is a significant contributing factor to their financial success. Applied analytics also provide the means for companies in maturing or declining industries to protect their competitive advantages and margins. Information-intensive industries have long used predictive analytics: in financial services to reduce risk through credit scores, in retail to improve yield form marketing campaigns, in mobile telecommunications to reduce churn, in logistics to optimize efficiencies. It’s not always obvious which companies are best at using applied analytics for competitive advantage, but the success of the Oakland A’s baseball team chronicled in Michael Lewis’ book Moneyball has charted course for companies in many industries. Figure 5 Applied analytics vs S&P 500 Source: CLSA, Factset - Index components: Amazon, Google, Facebook, FICO, Netflix, Microsoft, Verisk, IBM, Visa, American Express Companies that are leaders in applied analytics include Amazon, Google, Facebook, Fair Isaac/FICO, Netflix, Microsoft, Verisk, IBM, Visa and American Express. Firms that are leading investment into AI/machine learning include Google, Facebook, LinkedIn, Microsoft, Baidu, IBM and others. There are also companies outside of technology that use analytics to drive new business opportunities, for instance GE for connected products and IoT, and Tesla for tracking user experience to drive product improvement. The market for pure-play AI is nascent so there are few if any ways for investors to gain direct exposure to the components - rather those firms with the foresight and expertise to apply analytics most effectively are those that will continues to generate sustainable value over time. In our coverage universe, we favor Akamai (AKAM), which employs sophisticated algorithms 0 50 100 150 200 250 300 350 400 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 S&P 500 Applied Analytics (2006=100) Leading applied analytics companies gained 254% vs. the S&P 500 gains of 59% since 2006 Applied analytics help companies in mature industries protect competitive advantages We favor Akamai and Microsoft as top picks for Applied Analytics
  14. 14. Section 1: Add the bits together and stir 2020 innovation 14 ed.maguire@clsa.com 17 June 2016 to solve complex optimization problems, and Microsoft (MSFT), which has been aggressively investing in AI to embed predictive capabilities into its platforms and applications. These two are our top software picks for applied analytics. Playing secular trends can pay off, but watch the hype Cloud computing, the mobile internet, non-traditional user interfaces, advances in programming science and artificial intelligence, and falling costs of compute and bandwidth place unprecedented power in the hands of everyone, from a child with a cellphone to entrepreneurs to researchers seeking to solve the challenges of medicine. For investors, it’s critical to time investments in disruptive technologies appropriately, as there are risks being too early or too late. Cloud computing has proven a sustainable growth trend for the leading providers, particularly for applications. Newer generation SaaS and high- growth software stocks have rewarded investors over the past five years. There has been pronounced and sustained contrast between the high-growth SaaS and cloud names and on-premise “Big Tech” stocks. SaaS consistently outperformed the S&P500 over the past five years while big (on-premise) tech has underperformed since 2013. Figure 6 High-growth software versus big tech stock performance High growth index components include Salesforce.com, Workday, ServiceNow, NetSuite, FireEye, Palo Alto, Red Hat, Splunk, Tableau, Veeva. Big tech index components include Microsoft, IBM, Oracle, SAP, Cisco, Hewlett-Packard. Source: FactSet, CLSA Some secular themes provide a bit more consistency but which need constant vigilance. The IT security industry benefits from the need for constant innovation to protect data, systems and reputations from myriad evolving threats. IT security is highly dynamic with accelerated adoption (growth) and maturity cycles, making for periodic disconnections between investor sentiment and fundamentals. Over the past five years, the sector has both outperformed and underperformed the market at different times. In 2016, the group has struggled as companies from different generations like Symantec, FireEye and Imperva have disappointed investors. 50 100 150 200 250 300 May 11 May 12 May 13 May 14 May 15 May 16 High growth tech S&P 500 Top big tech companies 107% (May 2011=100) 54% 36% IT security benefits from constant innovation cycles, but investors need to monitor constantly High-growth software is more volatile, but has outperformed big tach and the S&P 500 Traditional big tech and SaaS/high-growth software performance have bifurcated The challenge always remains a combination of timing and careful selection
  15. 15. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 15 Figure 7 IT security - strong fundamentals but a crowded market IT Security index components: AVG, Check Point Software, Barracuda Networks, Cyber-Ark, FireEye, Fortinet, Imperva, Guidance Software, NICE Systems, Palo Alto Networks, Proofpoint, Symantec, Qualys, Varonis, Qihoo360, Finjan Software. Source: FactSet, CLSA We’ve highlighted the 3D printing sector as a key innovation trend since 2011, and since that time the sector has captured popular imagination and investor attention. Interest in and awareness of the potential for 3D printing, a technology that incorporates a range of techniques including additive manufacturing, peaked in 2014, and investors aggressively sought out the limited vehicles to gain exposure to the trend. This pushed valuations to a peak, followed by a crash, corporate restructurings and protracted period of underperformance. Despite being a transformative technology for manufacturing, investor expectations around the consumer opportunity may have been misplaced, and the expiration of key patents in 2013-2014 has led to a flood of new market entrants. Declining costs benefit end users, but put pressure on vendors of the technology. Figure 8 3D printing stock performance Index components include 3D Systems, Stratasys, ExOne, Proto Labs, VoxelJet, Materialise. Source: FactSet, CLSA 90 100 110 120 130 140 150 160 170 180 May 13 Nov 13 May 14 Nov 14 May 15 Nov 15 May 16 Nasdaq Composite IT Security (May 2013=100) 39% 21% 0 50 100 150 200 250 300 350 400 450 500 May 11 May 12 May 13 May 14 May 15 May 16 3D printing stocks Nasdaq Compsoite -5% 67.3% (May 2011=100) The 3D printing sector has ridden a cycle of hype and disillusionment IT security exhibits greater volatility than the market overall We’ve been highlighting the 3D printing sector as a key innovation trend since 2011
  16. 16. Section 1: Add the bits together and stir 2020 innovation 16 ed.maguire@clsa.com 17 June 2016 Wearable technology was at the peak of hype in July 2015 when FitBit went public, but the shares have disappointed investors since the initial enthusiasm. In our view, wearable tech has been a classic hype cycle story, but it’s yet uncertain whether the sector overall will be profitable enough to support further IPOs. Figure 9 Overly optimistic views on wearable growth caught up with Fitbit stock Source: FactSet, CLSA The declining cost of solar energy promises to disrupt the traditional energy industry for the next two decades as the cost curve undercuts utilities’ own generation costs. This chart from author and futurist Ramez Naam shows solar cost undercutting natural gas-generated electricity in the early 2020s. Figure 10 Solar cost projected to undercut natural gas by the early 2020s Source: Ramez Naam 20 40 60 80 100 120 140 160 180 Jun 15 Aug 15 Oct 15 Dec 15 Feb 16 Apr 16 Nasdaq Composite Fitbit (Jun 2015=100) -57% -7% FitBit was the first wearable tech pure-play IPO Wearable technology was at the peak of hype in July 2015 when FitBit came public
  17. 17. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 17 Of course, innovation does not insulate investors from the risks of globalization and competition. Declining cost curves do stimulate adoption and disrupt incumbents, but they also can prove challenging for direct participants as well. Despite being one of the most disruptive technologies longer term, solar stocks are still a difficult investment and have been an ongoing disappointment to investors over the past five years. Figure 11 Solar technology is real, but solar stocks have been a losing proposition Source: FactSet, CLSA If one assesses stocks according to the Gartner “Hype Cycle”, the 3D sector may be nearing the “Trough of Disillusionment” before reaching the “Plateau of Productivity”, while solar remains mired in the trough for some time. A brief survey of the rich landscape of innovation We explore 10 key innovation themes worthy of investors’ attention in Section 4. A key thread across each category is the essential role that software and data analytics plays enabling accelerating innovation. In our view, these are longer- term themes that could profoundly reshape markets, the economy and society at large. As is typical of long-term technology evolution, early stage activities are small, but with exponential progress, inflection points are likely to surprise. Innovations in the digital sphere Artificial intelligence (AI), machine learning and cognitive computing are different terms that all refer a similar range of technologies. AI powers everything from speech recognition to search software, airplane navigation and auto-pilot systems, video image recognition systems and intelligent assistants for smartphones. A new generation of self-learning computing algorithms will be integrated into applications of all kinds. Integration with advanced robotics will power a new generation of autonomous and semi- autonomous machines. Augmented-reality and virtual-reality technologies are coming to mass markets in 2016. The technologies have captured public imagination and the first generation of applications and viewing devices have made their debut. Virtual-reality is making its entrance first with Facebook’s Oculus VR, the Sony PlayStation VR and HTC Vive. Next up is augmented reality, with Microsoft HoloLens and offerings from Magic Leap and Meta paving the way for a new generation of applications and entertainment. 0 20 40 60 80 100 120 140 160 180 200 May 11 May 12 May 13 May 14 May 15 May 16 Nasdaq Composite Guggenheim Solar ETF (May 2011=100) -73% 67% A key thread across each category is the essential role of software and analytics Artificial intelligence is seeing another resurgence - this time as foundational technology Augmented reality and virtual reality devices are coming to mass markets in 2016 Solar technology stocks have been a risky investment Innovation does not insulate investors from the risks of globalization and competition
  18. 18. Section 1: Add the bits together and stir 2020 innovation 18 ed.maguire@clsa.com 17 June 2016 Blockchain, the distributed ledger that powers Bitcoin and other cryptocurrencies, is emerging as a transformative technology for the financial services sector in particular. The combination of advanced mathematics, access to massive computing power through peer-sharing, the open-source ethos and powerful new software enables a new universe of applications for managing transfer of value. There is an explosion of new blockchain startups targeting healthcare, media, finance, insurance and other industries. Open-source principles inherently enable innovation, not just in software, hardware and services, but through derivative benefits to technology users in any endeavor. The open-source model has transformed software development and is increasingly being applied in hardware, networking, crowdsourcing, media and new business models. Trust is the basis for essential functions of commerce and society. With the explosive growth of connections, applications, communications, information and systems, threats become more pervasive, driven by technological advances and growing involvement of organized crime and governments. As such, there’s growing need for security to facilitate e-commerce, electronic money transfers and modern conveniences such as ATMs. The IT security market is a dynamic market, conducive to startups offering fertile ground for innovators and investors. Figure 12 Innovations in the digital sphere Innovation What it means Who could benefit Potentially at risk Related companies Artificial intelligence/ cognitive computing Artificial intelligence governs everything from speech recognition to search, airplane navigation and auto-pilot systems, motion- detection systems and intelligent assistants for smartphones Advertisers, businesses, consumers, government, society at large Jobs across a wide range of capacities from blue-collar drivers, security guards and others to knowledge workers like translators, paralegals, medical professionals, investment analysts Google (GOOG), Microsoft (MSFT), IBM (IBM), Baidu (BIDU), Facebook (FB), Amazon (AMZN), LinkedIn (LNKD),Salesforce (CRM), many startups Virtual reality/ Augmented reality Gaming, entertainment, commerce, travel Consumers, game developers, content creators na Facebook (FB), Microsoft (MSFT), Samsung, HTC, Sony (SNY), Google (GOOG), private firms Meta, Magic Leap Open-source everything The open-source model is transforming software development, crowdsourcing, prototyping, datacenters and the replacement of proprietary systems Entrepreneurs, operators of cloud datacenters, corporations and service providers, SaaS independent software vendors (ISVs), consumers, industrial designers, military, consultants Traditional proprietary hardware and software vendors including HP, Dell, Oracle, IBM, Microsoft, VMware, Cisco, EMC, Juniper, etcc Red Hat (RHT), Hortonworks (HDP), Microsoft (MSFT), Facebook (FB), Google (GOOG), Intel (INTC), AMD (AMD), many private firms including DataStax, MongoDB, Acquia Blockchain and cryptocurrencies Blockchain technologies are distributed ledgers that enable non- repudiable exchanges of value between unrelated parties without an intermediary Startup businesses, low- income workers, citizens in unstable countries, investors Banks and other financial services firms, credit card and money transfer firms Microsoft (MSFT), IBM (IBM), many private companies - Ripple, Ethereum, CoinDesk, Coinbase, BitPay, many others Security Trust is paramount in a connected world. Rising levels of increasingly complex IT security threats compel increasingly innovative defenses Consumers, businesses, government, society at large Everyone and everything connected to the internet, including consumers, businesses, utilities, governments AVG (AVG), Barracuda Networks (CUDA), Check Point (CHKP), CyberArk (CYBR), FireEye (FEYE), Fortinet (FTNT), Imperva (IMPV), Imprivata (IMPR), MobileIron (MOBL), NQ Mobile (NQ), Palo Alto Networks (PANW), Qihoo360 (QIHU), Rapid7 (RPD), SecureWorks (SCWX), Symantec (SYMC), Qualys (QLYS), Proofpoint (PFPT), Cisco (CSCO), IBM (IBM), CA (CA), EMC (EMC) and many others Source: CLSA Open-source everything Blockchain technologies have the potential to upend the financial services sector Security is an ongoing “arms race” between bad actors and security professionals
  19. 19. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 19 Innovations in the physical world The energy and transportation sectors are poised to undergo massive disruption as the combination of increasingly cheap solar, advances in energy storage and adoption of electric vehicles will disrupt the traditional oil, gas, utilities and automotive industries - without regulatory intervention. There are increasing signs that solar energy is on the verge of becoming the cheapest source of power, without any subsidies. Innovations and economies of scale in battery and other energy storage technologies pave the way for large-scale adoption of utility-scale solar and electric vehicles. The fundamental nature of transportation is changing as autonomous vehicles prove technological viability and sensor-based vehicle communications systems promise to ease traffic jams and improve safety. The first generation of self-driving prototypes is being tested on public roads, with all of the major automakers and several technology companies investing in research. The technology is also being extended to trucks, other commercial vehicles and unmanned aerial vehicles (UAVs). The bigger challenges to adoption lie ahead with laws, lawmakers and insurance companies. Advances in robotics are having a transformative effect on manufacturing and industry as a new wave of personal and collaborative robotics comes to market. The top three drivers of the market are increased processing, reduced cost and size of sensors and programming languages and interfaces. Beyond nanorobotics, drones and autonomous vehicles (covered robots are transforming industries like manufacturing, warehousing and distribution, healthcare, retail and other areas. Interest and hype around 3D printing peaked in 2014, leading to disillusionment among investors as stocks continued to come under pressure in 2015. The consumer market appears saturated with low-cost completion. Meanwhile, advances in industrial additive manufacturing continue to progress with adoption among manufacturers doubling between 2013 and 2015 and moving beyond prototyping toward full production. Hype around the Internet of Things reached fever pitch in the mainstream media in 2015, as technology and industrial raced to articulate their out IoT strategies. Our 2014 report Deep Field: Discovering the Internet of Things focused on growing relevance and opportunities across consumers and businesses in a full spectrum of industries. Interest in wearable computing and smart home also reached fever pitch in 2015 as a flood of new market entrants resulted in a highly fragmented market. In 2016, we are seeing industrial proof of concept projects chart paths to sustainable ROI, but some businesses are taking a wait-and-see approach. While the major inflection point is not expected until 2017-20, seeds for immense transformations are already being sowed. Autonomous vehicles and robotics will remake transportation and manufacturing A world connected - the Internet of Everything 3D printing - in a hangover from peak of hype, but technology is real The energy and transportation sectors are poised for disruption form solar and energy storage Advances in robotics are having a transformative effect on manufacturing and industry
  20. 20. Section 1: Add the bits together and stir 2020 innovation 20 ed.maguire@clsa.com 17 June 2016 Figure 13 Innovations in the physical world Innovation What it means Who could benefit Potentially at risk Related companies Clean disruption of energy and transportation The declining cost of solar, advances in energy storage lower the cost of energy and make electric vehicles the default choice by 2030 Consumers, businesses, entrepreneurs, cities, society at large. Carbon-based fuel businesses (oil, coal, gas), utilities, some automakers Tesla (TSLA-US); ADAS: Mobileye (MBLY- US); Battery: Panasonic (6752-JP); Sony (6758-JP) Smarter moving machines (autonomous vehicles, drones) Self-driving cars, trucks, buses, drone aircraft Consumers, businesses, automobile manufacturers, auto supply chain, military Transportation based employment (taxi, truck drivers, logistics) Google (GOOG), Toyota Motor (TM), Ford Motor (F), General Motors (GM),Mobileye (MOBL), Raytheon (RTN), AeroVironment (AVAV), Boeing (BA), Northrop Grumman (NOC), Textron (TXT), BAE Systems (BAESY), Adept Technology (ADEP), Amazon (AMZN), Lockheed Martin (LMT), AeroVironment (AVAV), General Dynamics (GD), SAIC (SAIC), GoPro (GPRO), Ambarella (AMBA), IXYS Corp, (IXYS), InvenSense (INVS) and others Robotics Automated manufacturing, surgical robots, trainable robotic assistants, domestic robots Manufacturers, healthcare, consumers, military Labor, especially employees doing repetitive tasks in manufacturing, service, etc Amazon (AMZN), iRobot (IRBT), Google (GOOG), Raytheon (RTN), Moog (MOG), Intuitive Surgical (ISRG), Cognex (CGNX), Accuray (ARAY), AeroVironment (AVAV), Northrop Grumman (NOC), Rockwell Automation (ROK), General Dynamics (GD), Boeing (BA), Teledyne (TDY), Textron (TXT) 3D printing Custom fabrication, prototyping, spare parts Consumers, designers, industrial designers, manufacturers, service providers, materials producers Spare parts, machine tooling, mass manufacturing 3D Systems (DDD), Stratasys (SSYS), ExOne (EXONE), Proto Labs (PRLB), VoxelJet (VJET), Arcam (Sweden), envisionTEC, EOS (Germany), Renishaw (UK), Organovo (ONVO), Autodesk (ADSK), Staples (SPLS), Adobe (ADBE), Microsoft (MSFT) Connected everything (IoT, eHealth, sharing economy) Myriad implications for both industrial and consumer Consumers, businesses, manufacturers, logistics, military, public safety, wireless sensor network providers, analytic software vendors Companies with high reliance on manual processes IBM (IBM), Cisco (CSCO), GE (GE), PTC (PTC), National Instruments (NI),Google (GOOG), Intel (INTC), AMD (AMD), Siemens (SI), Oracle (ORCL), Salesforce (CRM), Amazon (AMZN), Teradata (TDC), SAP (SAP), Splunk (SPLK), Broadcom (BCOM), Qualcomm (QCOM); Apple (AAPL), Samsung, Sony (SNY), Nike (NKE), Intel (INTC), Qualcomm (QCOM), Microsoft (MSFT), GoPro (GPRO), FitBit (FIT) , Buddy Platform (BUD - ASX) wireless network, sensor and analytics vendors Source: CLSA Biology, healthcare and new worlds We don’t cover advancements in biotech, genetics and healthcare in-depth in this report, but want to highlight the potential value creation opportunities at the intersection of information technology, biology and medicine. There has also been significant progress in the space race, with SpaceX achieving several key milestones toward viable reusable boosters in 2015 and 2016. The declining cost of computing, more powerful systems and the capacity to store and process massive quantities of data create conditions are conducive to accelerating innovation in the life sciences. With Illumina’s latest machines lowering the cost of a sequenced human genome below US$1,000, genomics is actively decoding elusive mysteries of DNA, the “source code” for the human body, with promise of proactive avoidance and better treatment for cancer, Alzheimer’s, multiple sclerosis and other chronic diseases. Computational genomics are decoding the software of nature
  21. 21. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 21 One of the most significant advances is a new technology, CRISPR, which enables scientists to edit genomes with unprecedented precision, efficiency, and flexibility. CRISPR (Clustered regularly interspaced short palindromic repeats) are segments of prokaryotic DNA containing short repetitions of base sequences followed by short segments of “spacer DNA” from previous exposures to a bacterial virus or plasmid. CRISPR interference technique has enormous potential applications, including altering the germline of humans, animals, and other organisms and modifying genes of food crops. While there is a lot of potential, there are also ethical considerations: Chinese scientists have applied the technique to nonviable human embryos, which hints at CRISPR’s potential to cure genetic diseases but also raises the prospect of genetically designed babies. Mobile healthcare technology is seeing robust innovations among consumers and professionals, though adoption is concentrated at the ends of the spectrum among the very healthy and very sick. There has been an explosion of FDA-approved apps for diagnostics and treatment as well as monitoring. Despite robust VC investment and high-profile media coverage, the market remains nascent and highly fragmented. We expect Apple, Google, IBM, Microsoft and Qualcomm to foster a robust ecosystem of startups and partnerships with care providers and pharmaceutical companies. A new generation of privately funded companies is pursuing a range of ventures including commercial space-cargo flights, low-Earth-orbit space tourism, asteroid exploration for resource extraction and longer-term plans for manned space ventures to the Moon and Mars. SpaceX has successfully landed its reusable booster rocket, potentially saving tens of millions of dollars per launch and opening up an opportunity for greater activity. Major aerospace firms Boeing, Lockheed Martin and Northrop Grumman are actively engaged, alongside leading private companies SpaceX, Virgin Galactic and Planetary Resources. Techno-optimists versus secular growth skeptics There’s an optimistic school of thought that convergence of information technologies, clean energy and connectivity bringing billions of new minds online will catalyze enormous gains in wealth, health and quality of life. The most passionate advocates like Ray Kurzweil and Peter Diamandis of Singularity University see the current technological disruptions to industry and employment as temporary, paralleling the dislocations seen in prior industrial revolutions. People have dealt with change in the past, ergo this time it’s just another cycle set to play out along historical lines. Technologists and investors tend to project the future in stepwise terms. Human beings naturally have linear intuitions about the future because linear thinking progresses logically from experience. However, innovations and paradigm shifts occur at an accelerating, often exponential pace. This creates a disconnect. The way the exponential progress in technology accelerates change can be illustrated by comparing mass adoption of inventions over the past 150 years. One only has to look at the rapid growth of Facebook and the explosive growth in tablet computing that the iPad catalyzed to appreciate accelerating paradigms. Tapping into accelerating change Techno-optimists see current disruptions to industry and employment as temporary The new space race Connected health poised for steady adoption CRISPR is a technology that allows unprecedented ability to edit genomes
  22. 22. Section 1: Add the bits together and stir 2020 innovation 22 ed.maguire@clsa.com 17 June 2016 Figure 14 Adoption paradigms are accelerating Source: Ray Kurzweil, KurzweilAI.net Working our way out of the trough of a “super cycle” Klaus Schwab’s view of a “Fourth Industrial Revolution” differs from economist Carlota Perez who views us in the middle of a multi-decade ICT supercycle. Perez draws from economists Nikolay Kondratieff and Joseph Schumpeter in framing multi-decade waves of technological change that occur in surges about once every 50 years. The current ICT revolution is the fifth upheaval experienced by the capitalist system since the first industrial revolution in the late 18th Century. Since we first encountered this thesis in 2011, we grow more convinced of its applicability to current conditions. Carlota Perez defines the “turning point” as the current phase of the grand ICT supercycle that commenced with the crash of the internet bubble in the early 2000s and persists today. Perez’ view is that this turning-point period may last a few more years, with structural changes to the economy working themselves out until we emerge into a new economic “golden age” in the decades ahead. Figure 15 The historical record: Bubble prosperities, recessions and golden ages Source: Carlota Perez Telephone Radio Televison PC Mobile Phone The Web Facebook ? 0.1 1 10 100 1860 1880 1900 1920 1940 1960 1980 2000 2020 (Years) Maturity 1771 The Industrial Revolution Britain 1829 Age of Steam and Railways Britain 1875 Age of Steel and heavy Engineering Britain/USA/Germany 1908 Age of Oil, Autos and Mass Production USA 1971 The ICT Revolution USA Internet mania, Telecoms, emerging markets, Financial casino & housing Sustainable global "golden age"? 5th London funded global market infrastructure build- up (Argentina, Australia, USA) Belle Epoque (Europe) "Progressive Era" (USA) 3rd The Roaring Twenties Autos, housing radio, aviation electricity Post-war Golden Age 4th 1st Canal mania Great British leap 2nd Railway mania The Victorian Boom INSTALLATION PERIOD Bubble collapse DEPLOYMENT PERIOD No., date, revolution, core country TURNING Bubble prosperity POINT Golden Age prosperity 1793-97 1848-50 1890-95 Europe 1929-33 USA 1929-43 2007/08 -???? The turning-point period may last a few more years The rate at which new inventions reach widespread adoption is accelerating Carlota Perez frames current problems as a consistent pattern seen in prior technology shifts
  23. 23. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 23 An installation period typically begins within a mature economy, with a great deal of experimentation in the free markets. What typically follows is a frenzy of investing, inflated asset prices and speculation followed by a crash (or crashes). This happened in the 1920s followed by the Great Depression, and again in the 2000s with the crashes of the first internet bubble and global financial crisis and Great Recession. This decade we are experiencing a protracted transition as the economy readjusts and the ICT revolution propagates through society and the economy. The coming “deployment” period (which Perez has estimated may commence before the end of the decade) will see expansion of both new and rejuvenated sectors, as the potential of new technologies comes to fruition. This is a period of creative construction, where benefits of wealth are spread more broadly and capital and finance decisions are directed towards production rather than speculation. Technology exacerbates economic imbalances Despite the promises of innovation, economist Robert Gordon and others are quantifying painful economic imbalances that are becoming more pronounced. The modern digital revolution has yet to deliver on the promise of better jobs and higher productivity. Instead, the new economy is creating immense wealth with far fewer workers, with income growth stagnating for the vast majority of employed. The stratification of income growth over the past decade has concentrated the majority of income gains in the top percentile while the median income in 2011 is 8% lower than in 2007, having peaked in 1998. These figures show earnings from labor are declining as a share of total economic output, but the share gains from highly skilled sectors have been growing. Figure 16 Median income and employment have diverged from GDP growth Source: Research.stlouisfed.org, FactSet Since the 1990s there has been a transition from an industrial-based to an information-based economy where big investments are being made in technology and technology industries and although innovations in technology are awe-inspiring some (like economist Tyler Cowen) believe they are having less transformative effects as inventions once did. Robert Gordon, professor of economics at Northwestern University, believes that after an initial boost in 50 100 150 200 250 300 350 400 450 500 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Private employment Labor productivity Real GDP Median household income (1967=100) Despite the promises of innovation, there are increasingly painful imbalances The “Great Decoupling” of income and employment from GDP growth accelerated in the 1980s Every major technology development surge has seen the same pattern play out The installation phase is a period where new firms are formed and older firms fail Some economists believe growth is over in the US
  24. 24. Section 1: Add the bits together and stir 2020 innovation 24 ed.maguire@clsa.com 17 June 2016 productivity and growth from 1994-2004, the potential impact from further technology innovations will be minimal. He predicts that for the next 25-40 years, real per-capita disposable income of the bottom 99% of the US income distribution will grow at an average annual rate of 0.2%, a tenth of the pace of the 2% per year for the century before 2007. Author Nicholas Carr writes in The Arc of Innovation “There has been no decline in innovation; there has just been a shift in focus. We’re as creative as ever, but we’ve funneled out creativity into areas that produce smaller-scale, less far-reaching, less visible breakthroughs”. From 1876-1886, we saw the development of the internal combustion engine, light bulb, steam turbine, railroad, car, phone, movie camera, and toilet among others. From this time until the 1950s life in America changed drastically. These were large-scale inventions that had a big impact on the way we live. Carr (as well as others like Tyler Cowen) believes that innovation is fundamentally less impactful today. There are other possible causes for declining growth such as a decline in education, lack of R&D investment, or short-sighted investors that pressure companies away from long-term investments. Cutting a broad swath through unskilled jobs The phenomenon of technology replacing jobs is not at all new. What’s different now is that it’s software and artificial intelligence replacing tasks and jobs at a dramatic pace. The downside for employment is that fewer people are required in many industries (eg, airlines, manufacturing and the supply chain). As service-sector tasks are increasingly automated, this reduces the need for cashiers, toll takers and potentially taxi drivers as we’ve previously seen technology replace stenographers, typists or bookkeeping people. Pessimists foresee a jobless future There’s been a lot of discussion of the impact of technological unemployment. Martin Ford’s Rise of the Robots - Technology and the Threat of a Jobless Future paints a dire scenario arguing that technological unemployment is inevitable, it will be pervasive, and societies will need to implement a universal basic income (UBI) to address citizen’s needs. A number of prominent economists including Lawrence Summers, Nouriel Roubini and Paul Krugman have publicly expressed concerns that successes in technology are eliminating jobs. Robert Reich has said that robots will “take away good jobs that are already dwindling. They will in short supplant the middle class.” Concerns over technological unemployment are not new, stretching back most prominently to the Luddites in the early 19th century. In the US, Congress has commissioned studies at the end of the 1897 recession and in the late 1930s to ascertain the impact of labor-saving devices on human labor, and in the 1961 recession, President John F. Kennedy created an Office of Automation and Manpower in the Department of Labor on the premise that the major challenge of the Sixties was “to maintain full employment at a time when automation, of course, is replacing men.” Robert Atkinson of the Information Technology & Innovation Institute argues that if technology-led productivity growth really has been the culprit behind America’s anemic job growth since 2009, one would expect that America’s productivity growth rate would be higher than normal. In fact, US productivity growth has tracked at about half the previous rate since the end of the Great Recession. One of most widely quoted studies on technological unemployment (by Osborne and Frey) estimates that 47% of US jobs could be eliminated by technology over the next 20 years. However, the McKinsey Global Institute Software and artificial intelligence are replacing tasks and jobs at a dramatic pace Concerns over technological unemployment are not new Some believe tech unemployment will lead to need for universal basic income (UBI) Digital innovation is not as significant to society as late 19th century inventions
  25. 25. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 25 sees more job redefinition instead of unemployment, foreseeing that very few occupations will be automated in their entirety in the near or medium term. A recent OECD report sees less risk of unemployment, rather certain activities will be automated, business processes will transformed, and jobs redefined. There is a “productivity paradox”, which refers to an observation made in that as more investments are made in information technology, worker productivity declines instead of increases. Part of the challenge is measuring value from ICT is the typical delay between the installation of new systems and realization of productivity benefits. MIT professor Erik Brynjolffson found a five- to seven-year lag between deployment of an enterprise-resource- planning (ERP) system and subsequent benefits. In a review of over 50 ICT and productivity studies between 1987 and 2002, Jason Dedrick, Vijay Gurbaxani and Kenneth L. Kraemer of the University of California, Irvine concluded that the productivity paradox had been effectively refuted, with greater investment in ICT associated with greater productivity growth. Living in a world of digital deflation Deflation is an inherent characteristic of information technologies, and nearly every business where technology dominates must reckon with deflation. Moore’s Law has continued unabated since 1958, and there are corollaries across storage and connectivity. Digitization and hyperconnectivity have served to eliminate frictions that allowed value to accrue to intermediaries, particularly in media businesses. So many businesses are built on a model of scarcity. Digitization typically brings significant deflationary pressure. This impacted newspapers and music, TV is coming next. The print newspaper industry increased from US$20bn in 1950 to US$60bn in 2000, then saw revenues drop in half by 2010 because of web advertising. The music industry saw revenues decline from US$16bn in 1998 to around US$6bn in 2008 as listeners access music through YouTube, Spotify, Pandora, iTunes and other sources. What’s increasingly clear is that there is less opportunity to extract economic rents from IT itself with adoption of cloud computing. Amazon’s founder Jeff Bezos charted the course for Amazon Web Services by targeting highly profitable business models of HP, Oracle, IBM and others: “Your margin is my opportunity”. With over 50 price cuts since 2006, Amazon Web Services has accelerated the deflationary trajectory characterized by Moore’s Law with economies of scale and highly aggressive pricing, leaving traditional enterprise server and storage hardware vendors hurting. Apple (and for a time Samsung) were the only vendors of smartphones able to sustain profits, while early industry leaders like Nokia, Ericsson and Blackberry have failed or struggled. Open source software has also eroded both revenue growth and profitability for infrastructure software providers as well. Highly automated companies need fewer people to generate more value. While tech employees (especially with specialized skills) tend to be well paid, by nature they are deflationary to employment; there are a lot fewer jobs required at tech firms to generate net profits than in other sector. A vivid example of the leverage that technology provides is illustrated by the difference in net income per employee across different industries. Tech leaders generated an average of US$250,029 of net income per employee, banking generated US$84,238, autos generated US$38,533, retail generated US$11,485, and fast food generated US$6,787. Technology will mean more job redefinition instead of unemployment Benefits from ICT investment could play out on a larger scale over time That there is less of an opportunity to extract economic rents from infrastructure IT The music industry saw revenue decline from US$16bn in 1998 to around US$6bn in 2008 Highly automated companies need fewer people to generate more value Nearly every business where technology dominates must reckon with deflation
  26. 26. Section 1: Add the bits together and stir 2020 innovation 26 ed.maguire@clsa.com 17 June 2016 Figure 17 Tech leaders’ net income per employee vastly outpaces other industries Source: CLSA, company filings, Brett King - Tech components: Apple, Microsoft, Google, Facebook, IBM and Oracle; Banking components: Bank of America, Wells Fargo, Citibank and JP Morgan Chase; Autos components: Ford and GM; Retail components: Walmart, The Home Depot, Target and Costco; Fast food components: McDonalds and Yum! Adoption of technology creates value by automating tasks and improving productivity, but also this has deflationary impact on wages. It’s our view that technological advances are also a key factor behind the growing divergence between rising corporate profits and labor’s declining fortunes. When technologies arise that reduce the need for human workers at lower costs, the cost of technologies also tends to decline over time. This allows productivity gains without impacting corporate profits, while reducing labor’s share of the pie. Andrew McAfee of MIT compared labor’s share of corporate expenses versus corporate profits as a share of GDP. 2015 data show ever-widening divergence since the last recession. Corporate profits, meanwhile, have never been higher in absolute terms or as a percentage of GDP. Figure 18 Labor’s share of corporate profits declining since 2002 Source: Research.stlouisfed.org, Andrew McAfee (MIT) Corporate profits calculated by profit per unit of real gross value added of nonfinancial corporate business. 0 50,000 100,000 150,000 200,000 250,000 300,000 Fast Food Retail Autos Banking Tech (US$) 84 86 88 90 92 94 96 98 100 102 104 60 80 100 120 140 160 180 200 220 240 260 280 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Corporate profits (LHS) Labor (RHS) (1947=100) (1947=100) Technology firms generate far greater profits per employee than other industries Increasing evidence that technology drives value creation but is deflationary to wages Technology reduces frictions that support wages
  27. 27. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 27 Authors John Seely Brown and John Hagel of the Deloitte Center for the Edge identified a fundamental paradox facing business that they dub “The Big Shift”. On the one hand, new technologies create vast possibilities for doing things better, faster, cheaper, more convenient and more personalized. Per- capita labor productivity has been steadily improving. However, returns on assets for businesses have declined over the past 50 years and businesses are not effectively capturing value from these new possibilities. Return on assets for US companies has fallen to almost a quarter of 1965 levels. Digitization and dematerialization turn everything into software The twin forces of digitization (of information and media) and dematerialization (reducing goods and services to software) have profound implications for the economy and for society on a global basis. Digitization has transformative and disruptive implications. Dematerialization (of personal electronics, recorded music, books, video, etc) alters the economics of many businesses based on physical goods. As more computers become connected, a fundamental shift occurs as business processes that were previously handled by human beings are now being executed electronically. Because these processes usually involve computers talking to one another, they are unseen. Rendering physical goods into digital bits and bytes impacts manufacturers, the supply chain, distribution, retailers and end users. A prominent example of the impact of digitization is tax-preparation software. Software that costs less than US$100 can replace many of the functions previously performed by a certified public accountant (CPA) or other tax-preparation professionals. Dematerialization refers to the transformation of physical products into software. Apps on a US$600 iPhone can replace pocket calculators, cameras, mobile telephone, video camera, clock radio, portable CD player, video cassette player and other items that historian Steve Cichon calculated would have cost over US$3,000 at Radio Shack in 1991. This is a 10:1 compression of value. The on-demand economy turns products into services On-demand or sharing business is a large and growing component of the economy. Online platforms where sellers can offer goods or services to customers are attracting more attention and spending. Data from the 2015 National Technology Readiness survey estimates that over 22 million consumers spend nearly US$58bn annually in the on-demand economy. According to Crowd Companies, which tracks on demand platform businesses, there are over 280 companies that provide on-demand goods and services in 16 industries. This is an increase from just 76 companies and six industries two years ago. The on-demand economy both creates and destroys jobs and businesses. In the case of Uber, there were investors that passed on investing in early rounds because they though the market was too small. Before Uber, the size of San Francisco’s taxi market was US$150m per year. In early 2015, Uber CEO Travis Kalanick disclosed that it had increased to US$650m with Uber accounting for US$500m. Uber expanded the market by delivering an experience to customers. However, this still came at the expense of incumbents - San Francisco’s Yellow Cab Co-Op filed for bankruptcy in January 2016. Digitization turns services into software; dematerialization turns gadgets into bits There are over 280 companies that provide on-demand goods and services in 16 industries A fundamental shift as human business processes become digital communications The on-demand economy both creates and destroys jobs and businesses
  28. 28. Section 1: Add the bits together and stir 2020 innovation 28 ed.maguire@clsa.com 17 June 2016 One of the challenges with the advent of digitization is that measuring digital goods and services as a proportion of GDP is difficult, if not impossible. Hours spent on the internet continue to climb (doubling from 2001 to 2011) and consumers access ever more free goods in the form of Facebook postings, blogs, online videos, games and other pursuits. As the volume of digital goods increases, this renders the traditional GDP measure less useful. Erik Brynjolfsson, professor of management at MIT, and Joo Hee Oh, assistant professor of management at the Erasmus University Rotterdam School of Management analyzed how much time people spent on the internet, and using that method they valued free internet services at about US$106bn a year. However, economist Tyler Cowen points that that this accounts for less than 1% of GDP. The nature of organizations changes with digitization There is a lot of change happening in the nature of organizations, as businesses no longer profit from the frictions of scarcity but find ways to tap into abundance. Examples include Zappos and Valve Software, which have no organizational hierarchies - teams self-direct their work. Haier makes 55 million refrigerators a year with 80,000 employees, and the company’s CEO created 2,000 independent teams that elect their own leaders and vote on features, with the resulting successes resulting in tripling the company’s market cap. For big business, transformation is difficult but disruptive changes are often best developed at the edge of the organizations. Apple is master of this approach: their real innovation is organizational - creating small teams that work in stealth to go after new industries. Singularity University’s Salim Ismail’s 2014 book Exponential Organizations highlights organizations with common characteristics - leveraging information technologies, massive transformational purpose and innovative organizations. Information-based industries are the best at leveraging technology to create value. Singularity University, in conjunction with the Hult School of Business, developed an ExO Score, and identified a correlation between stock market performance and the ExO score. The top five exponential organizations are GitHub, AirBnB, Uber, IndieGoGo and Google. Figure 19 ExO market-cap improvement Age (years) 2011 valuation 2014 valuation Increase (x) Haier 30 US$19bn US$60bn 3 Valve 18 US$1.5bn US$4.5bn 3 Google 17 US$150bn US$400bn 2.5 Uber 7 US$2bn US$17bn 8.5 Airbnb 6 US$2bn US$10bn 5 Github 6 US$500m (est.) US$7bn 14 Waze 6 US$25m US$1bn (in 2013) 50 Quirky 5 US$50m US$2bn 40 Snapchat 3 0 US$10bn 10,000+ Source: Salim Ismail, Yuri Van Geest, Michel S. Malone In the past only large organizations could drop their transaction costs, but now small firms can take advantage of forces of technology and innovation. Financial services firms lack scalability largely because of regulation, which perversely protects against startups. Software and information-based industries are the best adoptors of technology. There are no digitally scalable industries in healthcare - yet. The measure of performance improvement from using Exponential Organization principles is powerful: Despite disruption, traditional GDP measures may not capture change There is a lot of change happening in the nature of organizations Exponential organizations leverage IT, and innovative organizations to create massive value The Fortune 100 is disruptable with software for the first time
  29. 29. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 29 Figure 20 ExO performance improvement Company Business Performance improvement Airbnb Hotels 90x more listings per employee GitHub Software 109x more repositories per employee Local Motors Automotive 1000x cheaper to produce new car model, 5-22x faster process for a car to produce (depending on vehicle) Quirky Consumer Goods 10x faster product development (29 days vs 300 days) Google Ventures Investments 2.5x more investments in early stage startups, 10x faster through design process Valve Gaming 30x more market cap per employee Tesla Automotive 30x more market cap per employee Tangerine (formerly ING Direct Canada) Banking 7x more customers per employee, 4x more deposits per customer Source: Salim Ismail, Yuri Van Geest, Michel S. Malone Because of technology, winners are winning bigger and faster Technology is accelerating value creation for new companies. Play Bigger Advisors’ study, Time to Market Cap: The New Metric that Matters, found that “category kings” (Facebook, Twitter and Uber, for example) that dominate their markets command over 70% of the total market value in their category, leaving everyone else to share the remaining 30%. While this dynamic is far from new, what’s different now is that winners are winning faster than ever. Companies headed for a US$1bn valuation will do so in a third of the time it took at the end of the first internet bubble. Companies founded in 2009-13 took 2.9 years on average to reach US$1bn valuation versus 8.5 years for those founded in 2000-03. Digitization exacerbates divide between “haves” and “have mores” The dynamics of the shift to a technology-driven economy favors developed markets. Emerging markets tend to have under-skilled workers and less flexibility to improve their skills. Developed economies are early adopters of new technologies and with them, new business models such as on-demand and platform businesses. There are also differences between industries. The McKinsey Global Institute’s study Digital America: A tale of the haves and have-mores finds that the US economy is digitizing unevenly. ICT is the most digitized sector, followed by media, professional services and financial services. The least digitized sectors include healthcare, hospitality, construction and agriculture. The McKinsey study finds that as the engine of digitization for the broader economy, the ICT sector accounts for about 5% of 2014 US GDP. Unlike prices for goods and services in most other industries, ICT prices have declined 63% from 1983 and 2010. Accounting for this price decline and impact on other sectors, McKinsey estimates the ICT sector represented roughly 10% of the 2014 US GDP. McKinsey devised an index that quantifies a growing gap between the most digitized sectors, “the have-mores” and the rest - “the haves”. The study found the gap between digital haves and have-mores is growing as the most advanced users pull away from everyone else. The less digitized sectors’ index accounted for just 14% of the most digitized sectors. McKinsey estimates that the US economy as a whole is realizing only 18% of its digital potential; digitization could increase 2015 GDP by over US$2tn based on its impact on labor markets, capital efficiency and multi factor productivity. The shift to a technology- driven economy favors developed markets McKinsey estimates the US economy is realizing only 18% of its digital potential Exponential Organization realizes enormous performance gains from tech-led innovation What’s different now is that winners are winning bigger and faster than ever
  30. 30. Section 1: Add the bits together and stir 2020 innovation 30 ed.maguire@clsa.com 17 June 2016 Software - Value migrates upward as it “eats the world” We’ve long expounded the view that value migrates upward in the technology “stack” from hardware to infrastructure software to software applications. The tech-sector business model is in transition from products to products plus services to services. The declining cost of compute and storage allows system architecture to evolve from optimized, tightly coupled systems (mainframe) to computationally “wasteful”, loosely coupled cloud-computing services. Hardware and services vendors are increasingly moving into software for technology and business reasons. Technology vendors that have a high concentration of revenues coming from infrastructure like IBM and Oracle are increasingly investing in and emphasizing SaaS platforms and applications. Manufacturers and retailers increasingly attach software and cloud services to their physical products. Non-technology companies are compelled to invest in applications and services to differentiate their products in a global market. It’s no longer tech and internet companies vying for the most promising startups in Silicon Valley; companies in other sectors are seeking out investment and acquisition opportunities. Ford announced in May 2016 it would invest US$182m in Pivotal, the software development company spun off from EMC. Companies in retail, agriculture, industrial equipment, automotive, consumer- packaged goods, energy, utilities, telecommunications, media and nearly every sector are compelled to embrace digitization, evolve or face disruption. There are numerous recent examples of non-technology companies making investments or acquisitions in software:  GE continues to invest aggressively in GE Digital, a separate business division to advance its vision for “software-defined machines”.  Under Armour has spent US$710m to acquire MyFitnessPal, MapMyFitness and Endomondo.  A German automotive consortium of Audi, BMW acquired Nokia’s HERE digital mapping business for US$2.7bn.  Conde Nast parent company Advance/Newhouse’s acquired big data analytics company 1010data for US$500m.  Defense contractor Raytheon acquired cyber-security firm Websense for US$1.9bn.  Audio and infotainment manufacturer Harmon International acquired software engineering and integration firm Symphony Teleca for US$548m and connected device software management provider Red Bend Software for US$170m.  Boeing acquired Peters Software, a provider of aviation training content for commercial and private pilots, as well as 2d3 Sensing, an imagery software company that processes intelligence and surveillance data. Companies in many industries are seeking to replicate the Silicon Valley innovation model by establishing their own startup incubators and venture funds. Hundreds of companies have established innovation outposts in Silicon Valley and other hotspots like Herzliya Israel. According to Global Corporate Venturing there are over 1,500 corporate venture units responsible for nearly 1,800 corporate venturing deals in 2015, double the amount of 2014 deal activity, with transactions worth US$75.4bn in 2015, five times the amount in 2012. If software is in fact transforming every industry, investors need to evaluate non-tech companies based on their command and embrace of these new technologies. There’s a transition from an economy of products to an economy of products plus services Non-tech corporations are investing to compete in a digitized, connected world Non-tech companies are establishing startup incubators and venture funds Non-technology companies are compelled to invest in applications and services
  31. 31. Section 1: Add the bits together and stir 2020 innovation 17 June 2016 ed.maguire@clsa.com 31 What the future economy will look like There’s always risk in trying to predict what the future economy will look like, but there are threads that will characterize the coming decade. Many of the changes will be generational, as the digitally native millennials increasingly exert impact on commerce, culture and innovation. Author Don Tapscott in Growing Up Digital identified 88 million offspring of 85 million Baby Boomers; this is a generation larger and more connected than their parents. This next generation has internalized their digital behaviors with implications for business models and industries across the board. The digital economy will continue to be defined by technology-driven business transformation. Over the past several years the rise of new sharing and public transportation models - exemplified by companies like Uber and Lyft has been accompanied by a declining rate of teenagers getting their first driver's licenses. Much of the value in the trade of traditional goods and services is the friction involved with connecting the asset with demand at the time and place of need. For companies that seek to compete more effectively, every company becomes a software company. With a world of users connected to the internet, this gives rise to services that intermediate and provide a trusted framework. We believe companies like Netflix, Uber and AirBnB offer a blueprint for what the next generation of high-growth businesses will look like. The nature of new businesses is less asset intensive with more sharing of resources.  Products become experiences - with more subscriptions. This also touches on a potentially more profound shift away from a consumerist culture based on ownership of physical products. Sharing-economy businesses like Uber, AirBnB and Lyft address needs through a shared- asset model. Futurist Paul Saffo sees the economy moving to subscription models, predicting that users will subscribe to - and not own - robotic cars among other goods.  Connected products transform development. In “How Smart, Connected Products Are Transforming Companies,” an October 2015 Harvard Business Review cover story, co-authors Michael Porter of Harvard Business School and Jim Heppelman, CEO of PTC, outline how an emerging generation of cloud-service-enhanced products will change how companies will increasingly integrate data from customers and the distribution chain to drive truly interdisciplinary product development.  Design drives differentiation. Companies like Apple, Chrysler, Oxo and others have embraced the premise that smartly designed computers, cars and kitchen tools can stand out in established categories. While engineering remains critically important, creative design is paramount for developed-market firms to prosper in an environment where production is global, choices are myriad and competition is omnidirectional.  More value from fewer resources. Businesses are finding ways to produce more with less energy and materials. Additive manufacturing (3D printing) reduces manufacturing waste; smart grids and intelligent thermostats optimize energy consumption; and cloud computing allows startups and enterprises to innovate faster with lower costs and overhead. The ability for startups like Instagram and WhatsApp to scale to hundreds of millions of users with only a few dozen employees is a harbinger of hyper-efficient organizations. There will be growing emphasis on the total experience rather than discrete products Creative design is paramount for developed- market firms to prosper Businesses are finding ways to produce more with less energy and materials There are threads that will characterize the coming decade The digital economy is defined by technology- driven business transformation

×