Investing in Paradigm Shifts

In "The Structure of Scientific Revolutions", published in 1962, Thomas Kuhn argued that progress does not follow a linear trend but happens in revolutionary episodes that he called paradigms. These paradigms have the capacity to change perceptions and behaviours on a mass scale, resulting in what Kuhn called paradigm shifts. As an example of this concept, when Charles Darwin first published his theory of evolution in "On The Origin Of Species", a paradigm shift was set into motion. Though it took some adjusting as divine selection was not part of the equation, it ultimately changed science, society and religion forever.

A paradigm can be a new theory (Darwin's theory of evolution), a new product (the iPhone) or a new method (Ford's mass car manufacturing). Paradigm shifts happen because the old world order no longer makes sense to a large part of the population, creating a new more progressive world order. To take hold, these paradigms have to add some greater value to society compared to what came before it, which is what gradually shifts society. As Jared Diamond wrote in 'Guns, Germs, and Steel': "Opportunity, not necessity, is the mother of invention".

In today's capitalist society, such innovations tend to happen in the realm of the corporation and once they this sets a paradigm shift underway, it usually has a long tailwind. However, every innovation tends to have sceptics at first. Take, for example, the release of the iPhone in 2007. An event that single-handily started the mobile computing paradigm shift but was difficult to spot even by "experts" and "insiders" at the time.

Amazon also made for some good headlines and it would have been easy to believe them at the time.

As it turns out, we are all gadget freaks and direct-to-consumer businesses should have been very worried. Companies that fail to acknowledge such paradigm shifts, tend to get left behind. Joseph Schumpeter called this process Creative Destruction, whereby one way of doing things is progressively but inevitably replaced with a new way of doing things, which eventually leads to an entirely different economic structure. This process repeats itself time and time again throughout time and history. Paradigm shifts are part and parcel of this economic cycle and necessary to produce what Jeremy Rifkin calls "aggregate efficiency in the economy", which can only be achieved by clearing out the old ineffciencies and replacing it with newer more efficient systems. That is the secret to economic growth and part of the reason why countries like Japan, whose economic structure has not been allowed to be fundamentally overhauled in decades, has had little economic growth in those three decades.

As an investor, it helps to acknowledge this principle behind economic growth and to make sure that you are invested in companies than can lead or adapt to new paradigm shifts. Companies that are unable to effectively compete in this new economic structure may eventually face existential threats. They have been disrupted. Arguably, this is happening right now in the auto industry as many of the traditional automaker companies have failed to recognise the electric vehicle as a paradigm shift. This complacency in failing to direct their resources towards innovation (instead paying out dividends to shareholders), may reasonably put many of these companies out of business down the road (pun intended). The same may be true about retailers failing to digitise.

Seeing how the world ahead is unfolding and what paradigm shifts are happening, requires research but also some intuition about human behaviour and psychology. This may be the most exciting part about investing in individual companies but also the fact that really you can invest into the future you want to see. And even when investing into a basket of companies inside an ETF, which constantly gets re-shuffled as the old is replaced with the new, you do want to make sure that future is represented.

We may well be in the middle of the third industrial revolution where digitisation is of the essence and any company failing to adapt are casualties of it. For example, decisions and value chains increasingly rely on data analysis and automation, software is increasingly accessed online (the cloud) as a subscription service (SaaS), and renewable energy is fast replacing oil-powered machines through sheer cost efficiency. We may well be in the middle of this third industrial revolution where digitisation is of the essence and any company failing to adapt are casualties of it.

Therefore, as an investor, make sure you remain invested in innovative businesses that continue to grow by out-innovating the competition in a way that adds value to the world.