THINK DIFFERENT: THE ART OF DISRUPTION / by Adam Howard

I want to start this week's Update with a distinction.  It's an important one to make in the wake of our once-in-a-lifetime mining boom.

Most of the innovations and production improvements introduced by the resources sector over the past 12 years have been focussed on increasing output, what might best be described as improving productive capacity.

You know what I'm talking about...massive iron ore trains and new train lines, new ports to increase the amount we can ship and temporary camps that house thousands of workers dumped in the middle of nowhere.

But as the tide has turned, what is now being sought is a greater focus on getting the most out of available inputs.  I would call this a focus on productive efficiency.

So, when the price of what you are selling is sky high, who cares how much it costs to make it, dig it up or pump it out of the well.  But when the price drops through the floor all of a sudden you pay a lot more attention to how much everything costs.

One of the tools made popular by the church of the MBA (Masters of Business Administration) to measure the profitability of investments is Return on Investment (ROI).  It's useful to introduce that now, so here is a nice, easy calculation:

Any ROI of around 10% - 15% for small to medium size enterprise (SME) is reasonable.  Listed entities are less risky than SMEs and they tend to pay dividends of between 4% and 8%.  Enough of ROI analysis.  That's not what this is about this week.

A quick note.  The above calculation IS NOT definitive.  Google ROI.  You will find 5 different methods within 5 minutes.  I am using the above because it is simple and suits my purposes.

The variables are the profits from the investment, and the cost of the investment.  It's intuitive that if the gains are very high, the ROI will be high too.  As soon as the gains drop, people start thinking about the costs of the investment.

The question that is getting asked a lot these days is "Didn't these companies plan for a downturn?"  Answer: "No."

It's a version of The Innovator's Dilemma, where successful companies are in such a rush to meet customers' demands that they fail to pay attention to what might occur, or plan for future change.  Have a quick look at the link below for a summary of this idea:

The Innovator's Dilemma

Don't misunderstand what I am saying as an attack on the mid tier and junior miners, as they have definitely innovated to maximise output and get product to market as quickly as possible.  It's a remarkable achievement to go from zero to shipping 150 million tonnes of iron ore a year in a decade, as FMG has done.

But there has been an almost willful blindness to the likely possibility that iron ore prices would drop sharply.  After all, it was only late last year that the WA Treasury still had $125 per tonne as their price forecast. 

So the focus has been on innovative ways to maximise output but until recently, minimal focus on innovative methods to improve efficiency and productivity.  Which has left our mid tier and junior miners exposed to the damage a sharp drop in output price can cause.

As BHP and Rio have cheaper input costs due to better resources and larger capital bases, they have been able to oversupply an over supplied market and push the ore price lower and lower in an aggressive bid to clean out the market.

So, Atlas shut down because it is costing them more to ship than they are making on the sale, and BC and FMG aren't too far off being in the same boat.

Let's stop for a moment and look at FMG's debt, as the price of someone's debt and how easy they can get it is a good way to tell what "the market" thinks of them.  They have about $7.5 Billion in debt and have been trying to renegotiate about $2.5 Billion of that since the start of this year but haven't been able to due to concerns about the dropping iron ore price and FMG's high debt levels.

Not being able to renegotiate maturing debt is not a good sign.

But wait.  Good news! FMG just announced a deal today with US financiers to renegotiate that $2.5 Billion, at a headline rate of 10.25%, up from about 7.5%.  That's right...10.25%.  

Being able to renegotiate your debt at punitive rates is another bad sign.  Can mean your lenders are looking to make some money before you go bye-bye...

Anyway, enough about the miners for now.

I really wanted to talk about innovation this week: different types of innovation, how they get used and how Australia stacks up.

I had a chat last week with a couple of old mates from high school whom I will call The Scientists.  Now, I feel like it's a bit unfair giving two blokes the same name...but it works for my purposes here.

The Scientists are actually engineers and have both worked for a large, resource-based iconic West Australian company for a long while.  Despite this, they are both forward thinking guys who like a bit of flux and change.

How very unlike an engineer....but enough poking fun at engineers.  They are smarter than me.

This iconic WA business has just started a new division titled "Science." Staff numbers? 2; The Scientists.

The Scientists are now travelling wilburies, traipsing around the country talking to academics at lots of universities, trying to find interesting research and technology they could potentially help in developing.

Well, they wouldn't personally, but their employer would, with cash and support.  And this isn't altruistic work.  The purpose is to find things that will make their organisation more efficient and productive.

And I thought that was one of the coolest initiatives I had heard about in a long time.  Finally, a major company acknowledging that some of the smartest people in Australia, who are solely focused on finding new technology and new ways to use it, aren't being asked if they would like to help.

It made me think...and google...and read.  I found a report by the Federal Dept of Industry and Science that talked about how innovative we are as a nation and also listed some of the reasons why we aren't as innovative as we could be.  Here is the link if you want a read:

Innovation System Report

There are 6 big impediments to developing innovative new ideas and then implementing them.  I will list them below, but be warned, some of the following may be distressing to some readers.

1. Poor networking and collaboration;

2. Poor levels of Venture Capital and Private Equity interested in innovative technologies;

3. Fragmented and potentially obstructive government policies;

4. A small and fragmented domestic economy dominated by small minded business owners focused on local market domination, rather than global, game-changing innovations;

5. A risk averse and generally anti-innovation business culture; and

6. Relatively poor business management capability, leading to under investment in innovative technology.

Brutal, huh?  And that's a Federal Department assessing the job it has done.  According to the report, the two biggest problems are an inability to get access capital, and the lack of collaboration between business and research organisations.

We covered capital raising last week, so I will spend a little time talking about collaboration now.

What does it mean, this collaboration?  How would it work?  Who are these research organisations and what ideas or technology could they develop?

Well, to help understand this I have included a video below of a talk given by a bloke called Nicholas Negroponte at the first ever TED event in 1984.  He talks about 5 technologies he thought back then had legs.  They were:

- TVs as computers, or smart TVs;

- touch screen technology;

- CD-ROMS;

- Web pages on a global network; and

- web service kiosks.

They all ended up occurring as the technology had already been developed.  Negroponte was and still is head of the media lab at the Massachusetts Institute of Technology (MIT).

If you muck around on YouTube you can find another TED talk given by Negroponte recetnly where he lists more of the MIT media lab's inventions.  You will be stunned at how wide spread their uses are today.

Unfortunately our academics in Australia do not achieve the same rock star status as elsewhere because, for some reason, our business leaders don't go ask them questions.

So, like I said, the fact The Scientists are travelling around asking academics questions is a very cool thing indeed.

How would you measure a countries level of collaboration?  One way might be to look at how much investment business makes in innovative, research-based technology?

Once again, I thought...I googled...I read.

Surprise, surprise, there is an index already produced that measures this, called the National Academic Summit Innovation Index, that measures how many dollars per academic are being invested.  Here is a nice table I found that lists the top 30 countries.

15th...not bad.  But really, Asia is the big winner here with 5 countries in the top 10.  And those nations at the top appear to be investing 3 to 4 times as many dollars per academic as we are.

Not to worry, though!  I am certain the Federal Government will be taking steps to ensure investment in our universities is as high as possible...hang on a second.  I've got a bad feeling.  I think I remember reading something about that not happening....

What about by industry?  We have some very competitive industries who must be investing a lot of money in innovation.  Our mining industry has been going gang-busters so surely it is innovative.  What about financial services?  Makes up 50% of our share market and is safe as houses.  Must be innovative, right?  And we are a dry country but have a large agricultural sector.  Surely our farmers are innovative?

Have a look:

Yikes!!  That's a bit surprising.  Top of the pops is Arts and Recreation Services.  Agriculture; second bottom.  Mining and energy?  Middle of the pack or just below average.  Only financial services is above the line sandwiched between manufacturing and accommodation and food services.

So, maybe we aren't as innovative as we think?  Wrong.

We are really innovative.  Australians develop amazing technology and come up with solutions to global problems frequently.

Think about it.

Wifi?  CSIRO-developed idea.

Cochlear Ear Implant?  Australian invention and design.

Spray on skin?  Us again.

The Hills Hoist?  That's right.

Here is a definitive list of notable Australian inventions:

Aussie Inventions

The problem is we are conservative with our money.  Our business leaders tend to be overconfident and think they know it all.  We are not very good at celebrating success, particularly for anyone who isn't a sports star or war hero.

We need to get better at those things.  Because there is so much change coming.  Here is a list of some of the new stuff out there being dubbed "disruptive technologies":

- Mobile internet:  internet everywhere you go that can be used for pretty much everything. 

- Automation of Knowledge Work:  more and more jobs that are performed according to rules or processes can be done by computers.

- The Internet of Things:  real world objects having virtual icons and the ability to remotely control these real world objects.

- Advanced Robotics:  we already have the Roomba (seriously).  Check out the video below of a cool new robot that helps with you make videos.  But what about exoskeletons for the elderly or disabled?

- The Cloud:  we already accept the ability to save prodigious amounts of data to a nebulous area known as "the cloud."

- Autonomous or Near Autonomous Vehicles:  drones, remote operated vehicles, these exist.  But also check out Google's Chauffeur Program and of course, Rio Tinto's autonomous trucks program.

and the rest.

- Advanced Genomics.

- Next Generation Storage.

- 3D Printing.

- Advanced Materials.

- Advanced Oil and Gas Exploration and Recovery.

- Renewable Electricity 

Here is the link to read on at your leisure:

12 Disruptive Technologies

So, that's about it for this week, but I will leave you with a taste of next week's.  The banking industry is one of the modern world's largest and most critical.  But not really for all the credit it provides; more so for the service it provides by enabling the man on the street to move money around his local economy and the world.  This is called transactional banking.

Cash....

And cash is at the heart of the banking industry, because of something called capital adequacy.  The banks need to keep about $10 in cash for every $100 in lending.  This is constantly monitored by the powers that be, and one of the central reasons why Australian banks are so strong is there is almost no competition for that cash, hence they have strong capital bases.

What if there was new technology that threatened that oligopoly?  What would a loss of some of that cash mean for the amount of debt they provide?

Food for thought....