Wednesday, January 28, 2015

The Dance of the Disrupted: Observations from the front lines

Teaching is my passion, writing gives me joy and finance is my playground. While I am blessed in being able to immerse myself in all three, my activities put me in three businesses, education, publishing and financial services, that are begging to be disrupted. In fact, as disruption starts to challenge the status quo in all three businesses, I have a front row seat to observe how they react to these changes and perhaps add to their discomfort. 

The targets of disruption

As technology and globalization disrupt one business after another, it is useful to start with a simple question. Why do some businesses get targeted for disruption and others left alone? As I see it, there are three characteristics that businesses that get disrupted seem to share:
  1. Sizable economic footprint: The probability of a business being disrupted increases proportionately with the amount of money that is spent on that business. Using this template, it is easy to see why financial services (active money management, financial advisory services, corporate finance) and education are attracting so many disruptors and why publishing offers a smaller target.
  2. Inefficient production and delivery mechanisms: A common characteristic that disrupted businesses share is that they are inefficiently run, and neither producers nor consumers seem happy. Consumers are unhappy because producers are non-responsive to their needs and deliver sub-standard products at premium prices, but producers seem to have little to show in surplus. In education, for instance, students (especially under graduates at research universities) complain that they get a bad deal for the money they spend but colleges collectively seem to have trouble balancing their budgets, as is evidenced by their frequent and frantic attempts to raise money from alumni to cover their unmet needs. Publishers claim that their business models are being threatened by Amazon, while textbooks still cost outlandish amounts of money. Even in finance, where there are a few big winners every period, it is becoming increasingly difficult to find entities that win big consistently, and consumers of financial services are not exactly happy campers.
  3. Outdated competitive barriers and inertia: If these businesses are so big and inefficiently run, you may wonder what has allowed them to continue in existence for as long they have. The strongest force that they have going for them is inertia, where consumers have been programmed to accept the status quo: that it should take four years to get an undergraduate degree, that you need professional (paid) help to invest and that it makes sense to pay outlandish amounts for new editions of textbooks (on accounting, economics or mathematics) that are little changed from the old editions. Adding to the protections are regulatory or licensing requirements that have long outlived their original purpose and serve to protect incumbents from insurgencies. I have posted previously on how universities have bundled together screening, classes, networking and entertainment into packages that students have to take whole or leave and publishers and financial service companies have their own bundling variants.
The Dance of the Disrupted: The Five Stages
One of the enduring challenges that we face is explaining why disrupted businesses take so long to respond to disruption. Why did retailers not react faster to online retailing, in general, and Amazon, in particular? In a more updated version, what is it that is stopping traditional cab service companies from responding better to the car-sharing services like Uber and Lyft? I will let corporate strategists hash out the answers to those questions, but watching the education business respond to disruption has given me some perspective. With apologies to Elizabeth Kubler-Ross, I see disruption working its way through disrupted businesses in five stages, starting with denial and ending with acceptance.

Stage 1: Denial and Delusion
The first reaction to a disruptive challenge at most established businesses is delusion and denial, the delusion coming from the belief on the part of the existing players that the established way of doing business is the only (and best) way, notwithstanding widespread dissatisfaction on the part of both producers and consumers, followed by denial that others can do it better. I see this clearly in the education business, where I hear university overseers, administrators and faculty all express shock that anyone would question the Rube Goldberg contraption that forms the modern university education and conviction that no one outside the hierarchy understands education like they do.

Stage 2: Failure and False Hope
In most businesses, the initial wave of disruption usually fails, both because the disruptors do not understand the businesses that they are trying to disrupt and/or ran foul of the rules of the game (written by the establishment). Thus, Napster’s initial foray into the music business ended in it being shut down and the online retailing challenge was derailed (at least temporarily) by the tech market collapse in 2000. In the education business, the MOOC phenomenon was the shooting star that challenged the education establishment five years ago but it looks like it has fizzled out, partly because its providers mistook a university degree for a collection of courses. That initial failure was a moment of relief for the education establishment, since it reinforced its sense of superiority, and has created the hope among some in it that the disruption has passed.

Stage 3: Imitation and Institutional Inertia
The threat of disruption scares the establishment, though it moves in conventional ways to counter the disruption: by mapping out long-term plans and trying to borrow ideas from the disruptors. Those moves, while initiated with fanfare and backed up by resources, are generally undermined by an unwillingness on the part of those who benefit from the status quo to give up or compromise any of their existing privileges. In the education business, this “me too” phase is in full force, as universities create online course and some even offer online degrees, with a few faculty contributing willingly and a large majority going along either grudgingly, or not at all. If the only way that traditional colleges can compete with online education is by forcing professors to be accountable for the classes they teach (tying hiring, pay and tenure to teaching quality more than to research output) and firing those who do not measure up (no matter how productive they have been in their research), do you think that proposal has any chance of succeeding at a modern research university? I do not!

Stage 4: Regulation and Rule Rigging
The initial disruption may fail but it exposes both the weaknesses of the existing system and ways of getting around its defenses. Just as Napster softened up the music business for the assault of Apple’s iTunes store, the failure of MOOCs has offered valuable clues to disruptors as to what they need to do differently to beat universities at their game. In this post from September 2014, I laid out what I think will characterize the first successful online university: a combination of student screening, top-notch classes, discussion and interaction forums and networking opportunities , and I remain convinced that it will happen sooner rather than later. I predict that the education status quo will respond as other disrupted businesses have in the past, with a combination of complaints about unfairness and bad quality of the disruptors and a demand for protection from regulatory and licensing authorities from competition. Anecdotal evidence about the poor quality of education at some online education portals will be used to tar all online education, as if traditional colleges do not churn out their own share of substandard graduates.

Stage 5: Acceptance and Adjustment
The end game in disruption is painful. There will be jobs lost not only at the disrupted institutions and there will be ripple effects in the communities that serve them. With universities that have tenure-protected older faculty, the pain will be borne disproportionately by younger faculty and doctoral students entering the academic job market, and even tenure-protected faculty will find out that a guaranteed job does not come with guaranteed pay or research support. I am not predicting that universities will cease to exist, but there will be fewer of them, and the ones that survive will do so because they have carved out niches for themselves. IT is unfair, but it will be easier for a Harvard, MIT or Oxford to make it than lesser schools, with less illustrious histories, smaller endowments and less connected alumni.

My Disruption Plans
As I watch the businesses that I am in face the threat of disruption and respond badly, I plan to contribute to the disruption with small (and perhaps futile) acts of my own.
  1. In the publishing business, there is nothing more perverse and irrational than the textbook game, where books are obscenely over priced (even in their e-book versions) and old editions are made obsolete with a few selected edits. Of my ten books, four are textbooks and the way they are priced is the reason that I don’t require them in my own classes. The first editions of these books were written more than 15 years ago, and I had no choice but to use a publisher, but if I were writing these books today, I would do things differently. Then again, I am not done writing and will perhaps get a chance to make amends to those who have read my books.
  2. The finance business is too big for me to even cause a ripple, but I will continue to make the case that investors need to stop paying financial advisors for useless (and often counter productive) investment advice, that businesses should be able to make fundamental corporate finance decisions without calling in consultants and that the valuations that you get from bankers in IPOs and acquisitions are more pricing than value. One reason that Anant Sundaram and I co-developed uValue, a (free) valuation app for the iPhone/iPad is to make it easier for investors/companies to do valuations on their own.
  3. On the education front, anyone who has been reading my blog for a while knows that I put my regular classes online, class webcasts, lectures and exams included. I will be teaching corporate finance and valuation to MBAs at Stern in the spring, with classes starting on February 2, 2015 and continuing through May 11, 2015. The corporate finance class is the first one in the sequence, offered to first year MBAs, and valuation is an elective. You have four forums where you can take these classes:

Corporate Finance
My site (Stern NYU)
Apple iTunes U

Each option has its pluses and minuses. My site will include everything I offer my regular class, including emails and announcements but it is an online site without any bells and whistles. The iTunes U site is the most polished in terms of offerings, but there is no forum for interaction and requires more work if you don't have an Apple device. Yellowdig is a new add-on to my menu and it is a site where you will be able to access the classes and material and hopefully interact with others in the class. (You will have to register on Yellowdig and it is restrictive on what email addresses it will accept.) YouTube is the least broadband-intensive forum, since the file size adjusts to your device, but you will be able to get only the class videos (and not the material).

If you are wondering why I would disrupt businesses that I am part of, I have three responses. The first is that, with four children, I am a consumer of the products/services of these businesses and I am sick and tired of paying what I do for textbooks, college tuition and minor financial services. The second is that it is so much more fun being a disruptor than the disrupted and being in a defensive posture for the rest of my life does not appeal to me. The third is that with Asia's awakening, we face a challenge of huge numbers and the systems (education, public and financial services) as we know them don't measure up.


Ramdas said...

Disruptive plan No. 2 appeals to me the most. Investors who put their money into companies, should do so based on their own assessment, instead of depending on valuation given by consultants who have no stake!

Josh said...

Take a look at the Berklee School of Music. I study through them, and am hugely impressed. They've been running classes for years, have a phenomenal platform, and had thousands of applicants for the first degree program (300 student accepted).

Anonymous said...

Off the topic...Did you revise your valuation for VALE? If not, are you buying more? Just curious..

Anonymous said...

Thanks again Aswath for your insightful posts. I am a ceramic artist who follows your blog and lectures. I got a kick out of listening to one of your lectures where you stated you could be teaching pottery in place of your valuation class- and the NYU administration would not even know... and there I was throwing pots on a potter's wheel listening to your valuation class!
If possible I would also like to get your up-to-date opinion/valuation of Vale, considering the markets forecast for iron ore prices and whether you added to your position. Thanks!

Anonymous said...

Is there any revised valuation for Yahoo, Vale & Lukoil? Like the previous commentator are you buying more? Thanks

Aswath Damodaran said...

I have not updated my valuation of Vale but I have neither sold nor added to my position. It is unlikely that I will add to my position for a simple reason. I don't like doubling down on bets, even if I feel strongly, because I feel like I am tempting fate.

Anonymous said...

You are in education business, yet, you have plans to disrupt your employer. I find that noble.

However, my take is it is really difficult for the education sector to be disrupted.

Imagine someone who wants to be employed. Will an online course offered by an unknown entity (yet effective) be good enough to get the job? I am afraid not.

As long as current regulation prevails, as long as employers continue to seek degrees from regulation (not expertise), as long as the individual seeks job (rather than knowledge and entrepreneurship) and to be part of that rat race, nothing of what you write about disruption in education sector is likely to take place.

I wish it happens, but it wouldn't.

Anonymous said...

Is there any way to follow the class in yellowdig for someone who is not a student of NYU?

Aswath Damodaran said...

You can try registering on Yellowdig. It should accept non-NYU email addresses, but it has restrictions on some gmail or yahoo addresses. I am sorry if you have one of those!

Unknown said...

I'm a student from Singapore and my corporate finance class has been taught mainly through your work. Really brilliant. Personally, I've seen how Asia startups look towards the west for ideas and copy almost wholesale on how thing are being done (think Rocket Internet). I think generally, it's really difficult for Asians to accept new ideas till they see it succeed in the rest of the world. Thus, when something succeeds in the US or in Europe, the take-up rate in Asia becomes phenomenal. Personally, I see this as a huge opportunity for Asia but it's just a little sad that we're constantly following instead of innovating. Anyway, please keep writing as your writings are too awesome to keep to yourself!

Anonymous said...

I’ve been following your blog since late 2009 and I have always appreciated your candid insights. However, I have never asked a question. Since you mention financial services disruption I would like to know your thoughts on the financial services startups Wealthfront, Betterment and Robinhood? Full disclosure, I don’t work for any of these companies but Wealthfront manages my retirement accounts for 25 basis points and I enjoy trading for free with Robinhood. You’ll probably also notice “above the crowd” backs one of the companies. That doesn’t really matter too much but we all know how outspoken he can be.

Aswath Damodaran said...

I have no stake in any of these firms (or in any firm in this domain) but I like all three of these firms for what they are doing: Wealthfront for its sensible focus on index funds, Betterment for its advancement of diversification across asset classes and Robinhood for reducing trading costs. While I don't use any of them, I see all of them as a vast improvement on the status quo. If I were an investor in this space, though, my concern would be that it is going to get really crowded, really fast. It is easy to disrupt. It is difficult to make money off disruption in this space.

Damu said...

Hello Prof,

I am trying to valuate an option using the app that Prof Anant Sundaram and you developed and have a quick question on "Volatility of Asset"

What would be a good site to get this info ? Also, when you are trying to decide on the option of something that has very high volatility lately, do you have any recommendation ? Btw the Company that I am trying to valuate is RIG.

Appreciate all the help!

Anonymous said...

Prof, CF version 6 audio file cannot be downloaded. Can you please fix? Thanks.