By: Susan Smithfield, Columnist, International Director
Apple was the first company to reach $1 trillion in valuation recently. Shortly after, Amazon managed to reach the same record high valuation historically. Other technology companies are not far behind, with Microsoft Corp at $870 billion and Alphabet at $825 billion in market capitalization. Technology companies are earning more than entire countries and offering the highest salaries and best benefits packages to their people. They are also leading other sectors, given their fast pace of change. Their stocks represented by the Nasdaq index have been in a bullish trend for 10 years. Technology is the leading sector ona global scale—but for how long?
At a time when the US economy was growing at a nearly 1 percent rate, the prices of the stocks of major tech companies werereaching record highs. Productivity in digital industries has grown by 2.7 percent annually over the last 15 years. In other sectors, such as transportation, healthcare, education and manufacturing, productivity grew at a meager rate of 0.7 percent annually. Given their digital capabilities, the big tech players are establishing a presencein almost all other markets, such as music, movies, shipping, transportation, energy andeducation. Those sectors would have been mostly stagnant in their performances had it not been for the benefits of technological capabilities.
Lessons to be learned from the Japanese experience
Japanese companies have a strong reputation for being leaders in the technological arena. Or at least so in very recent history. Companies such as Panasonicand Sony are trademarks for quality. Yet, despite this strong reputation, Japanese tech companies have been failing to maintain a leadership position in the industry on a global scale. Those companies are highly reliant on their domestic demand—despite the global appetite—and have lagged during the years from 2000 to 2009 behind best performers in the industry, in terms of revenue and operating profit margin. They have failed to capture growth trends in emerging markets, which took a toll on their financial bottom lines. The case of Japanese tech companies can give us insight into what strategies work and what strategies do not in the industry. Moreover, this case can provide lessons about why high performers are high performers in the industry.
Critical success factors of tech companies
The high-performing tech companies have performed well because they have adopted one of manysuccessful models for growth. The factors behind their success can be classified intofour main categories: operational excellence, innovation, acquisition andprudent portfolio management.
Besides these factors, and given the explosive growth of the sector, these companies are undoubtedly delivering superior value to users, despite the privacy backlash, which is a cornerstone factor in their success. The high economies of scale that the companies in this sector can deliver have also contributed to growth.
Strong but not immune
Despite this performance, tech companies are not immune to declines. In March of this year, the stocks of tech companies declined by 10 percent, although they recovered later. The sector is currently dealing with tougher regulations following the Cambridge Analytica scandal, criticism regarding high valuations and tension as a result of the US’ trade war with China.
The progress those companies have been achieving through mergers and acquisitions (M&A) could be groundto a halt also by the protectionism originating from the United States. Take, for example, the aborted deal between Singapore-based Broadcom and US-based Qualcomm. The deal was canceled given Qualcomm’s access to sensitive information related to defense. Generally speaking, many other M&A deals could be canceleddue to similar concerns, putting a cap on growth potential.
Geographic concentration can change.
The growth of tech companies has been thus far concentrated in the US. But this may change. Chinese high-tech players are becoming increasingly on the offense. Companies such as Didi Chuxing (Uber’s Chinese rival) and Winsun(a world-leading company in 3D printing in the construction sector) are rising quickly ona global scale. We may see a shift in the gravity center soon from tech companies in the US to those in China, within a larger global shift in the economic gravity center to the East.
Trade-war threats are real for technology companies, considering that many companies perform their manufacturing processes offshore or even outsource them to other companies. The experience of Japanese tech companies clearly points out that serving the domestic market is not enough for exponential growth. With reduced access to global marketsand reduced revenue, companies will have a smaller incentive to invest in research and development, which could hinder the innovation that is partially behind the growth in this sector.
High but justified valuations
From a valuation perspective, the valuation of the big tech companies isjustified from a balance sheet and earnings point of view. There is no sign to indicate that those valuations are in the bubble territory, and thus the probability that they will see a steep decline soon is small.
Tech companies are still performing well and are likely to keep performing well in the near future. Nonetheless, they are facing many challenges. The effects of the trade war between the US and China may not have been felt yet, valuations may be a concern to some analysts, and stricter regulations may yet come. Different companies are affected differently by those relevant forces, and therefore the future of each tech company may need to be assessed individually. The potential of this sector remains strong, and investment in it remains justified. As long as those companies are offering immense value to a massive number of users, they are still in safe positions. Once this changes, though, there may be a need for reassessment.