Managing Externalities in a Digital Age
March 23, 2021
As digitalization continues to transform all aspects of the global economy and society, Sands Capital portfolio manager and research analyst Brian Christiansen discussed approaches to help companies navigate the societal challenges created by the rapid technological change.
At a recent conference The Governance of Big Tech hosted by ICGN (the International Corporate Governance Network) and Nasdaq, Christiansen and other panelists agreed that many of the existing environmental, social, and governance practices were created for an industrial society and need to evolve to meet new “externalities” that come with technological change. Such externalities, or the costs or side effects of commercial activities not fully captured by the traditional financial metrics of the services involved, include a variety of issues from data breaches, to carbon emission, to excessive or harmful use by minors. Companies that do not proactively and effectively manage externalities can suffer financial or reputational damage.
Digitalization Changes Everything
The digital age has changed the competitive landscape for companies in three key ways. First, it’s made the pace of innovation and change substantially faster. It took Coca-Cola 128 years to reach 1.8 billion consumers on a daily basis, but it took Facebook only 16 years to reach the same amount of users, and today it has a market capitalization nearly four times that of Coke.1
The second impact he noted is that it is easier to start a new digital business today and companies are staying private longer. Innovations like cloud computing, developer tools, and open-source software have lowered the cost of starting a new business and made it possible to quickly turn an idea into a full-fledged company. But, for start-ups to succeed and maintain any first-mover advantage, given how quickly white spaces can be closed in digital industries, companies need aggressive investments in customer acquisition in their early stages to fund their growth.
The third key trend is that technology is now impacting and disrupting every industry. In the early days, the transformation may have been led by consumer-facing sectors like ecommerce and social media, but now we’re seeing its impact on businesses in every industry, from education to transportation, and in areas like back-office workflows and employee productivity with the rise of enterprise software. The lines of the “technology” sector are blurring because technology has really become the name for something as ubiquitous and essential for every company as electricity.
While it is true that many sectors of tech have higher levels of industry consolidation than the offline world, he noted that it may be a mistake for investors, regulators, and other key stakeholders to assume that most large technology companies operate effective monopolies based on the assumption of a “winner-take-all environment.” Even a company like Amazon, which seems to dominate the ecommerce space in the United States, is facing formidable competition from Walmart’s ecommerce platform and from Shopify, a site that direct to consumer brands use as a deliberate alternative to selling on Amazon. Or in the case of China, companies such as Alibaba, JD.com, Pinduoduo, and Meituan are all competing heavily for wallet share in one of the largest categories of consumer spend in the online grocery market.2
Adapting Old Rules to a New Game
The speed of change means companies that better anticipate the potential externalities are better able to adapt whereas, if not, many otherwise successful businesses may find themselves unprepared for the increased scrutiny from regulators and other key stakeholders as they scale. The ubiquity of technology across industries and business models also means there is no one size fits all approach to solving externalities. Finally, the competitive intensity and dynamism of the technology sector means companies may need to balance a dual governance mandate of not only mitigating risks but also continuing to invest heavily in innovation, as to not lose out to the competition.
Given the magnitude of the transformation, Christiansen said it is very important that society and companies establish some rules of engagement around issues, such as data privacy and security, content moderation, protection of minors, and carbon emissions, to reduce some of the ambiguity.
Ultimately, companies must be able to build and maintain trust with their customers. So, if companies are not able to address new concerns that have arisen from digitalization, they will lose users, Christiansen said. “That is the major message we send to companies. While externalities may not be baked into their profit and loss statements, we think they are very baked into how sustainable their business model will be over the long term.“
To create these new rules of engagement, Christiansen said companies first need to acknowledge the side effects digitalization may be having on society. Companies are going to need help from investors, regulators, and other stakeholders to collaboratively come up with ideas to figure out a solution to externalities, which likely will not involve simply tweaking the policy and regulatory framework of the industrial age, but will require a third or different way.
1 Presented for illustrative purposes only to demonstrate differences in business models and achieving a scale of 1.8 billion daily units sold/daily active users. Coca-Cola is not a current Sands Capital holding. Facebook is a holding in the Select Growth, Global Growth, and Technology Innovators strategies.
2 Presented for illustrative purposes only. Walmart, Pinduoduo, Meituan, and JD.com are not current Sands Capital holdings. Amazon is held in the Select Growth, Global Growth, and Technology Innovators strategies. Alibaba is held in Global Growth, Emerging Market Growth, and International Growth strategies. Shopify is held in the Select Growth, Global Growth, Technology Innovators, and International Growth strategies.
The views expressed are the opinion of Sands Capital Management and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as of the date indicated and are subject to change. This material may contain forward-looking statements, which are subject to uncertainty and contingencies outside of Sands Capital’s control. Readers should not place undue reliance upon these forward-looking statements. There is no guarantee that Sands Capital will meet its stated goals. Past performance is not indicative of future results. The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. There is no assurance that any securities discussed will remain in the portfolio or that securities sold have not been repurchased. You should not assume that any investment is or will be profitable. You should not assume that any investment is or will be profitable. GIPS® reports and additional disclosures for the related composites may be found at Sands Capital Annual Disclosure Report.
This site may contain links to other websites, including links to the websites of companies that provide related information, products, and services. Such external internet addresses contain information created, published, maintained, or otherwise posted by institutions or organizations independent of Sands Capital. These links are solely for the convenience of visitors to this site, and the inclusion of such links does not imply an affiliation, sponsorship, or endorsement.