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The Creative Destruction Process | What Is It and What It Means for Apple, Amazon, Facebook & Tesla?


 

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Joseph A. Schumpeter, the Austrian-American economist, in his 1942 work titled "Capitalism, Socialism, and Democracy," first described the creative destruction process. However, the fundamentals of his work still hold true today.


"Technical change in economics can occur in two ways, according to Schumpeter:

1. Innovation of Process: a new, more efficient method of producing an existing product or service.

2. Innovation of product: a completely new product or an improvement of an existing product.


Process innovation is linked to production processes. For example, instead of mixing cement by hand, electric mixers have been available since the electric engine's invention.


Product innovation is linked to the product itself. Smartphones, robotic surgery, and GPS vehicle tracking are all relatively new technologies. These are brand-new goods and services. While portable phones existed prior to the invention of the smartphone, no similar service existed prior to the invention of GPS tracking of personal cars and freight trucks.


In the short run, when a company develops a unique product or service, it is the only one to take advantage of this novelty; this, of course, brings high profits and propels the company to lead all competition due to its innovation. An example would be when Apple introduced the iPhone, or when Tesla introduced a reliable, functional, and practical electric car.


The second stage, according to Schumpeter, is the 'Swarming' (When a group of bees swarms, leaving the hive to follow the queen): As other entrepreneurs and companies notice the new product or service, and the substantial profits, they follow the first-mover or innovator through imitation, and while not all can be successful in following or imitating the innovator's success, some do manage to succeed, or even outperform the success of the innovating firm.


The third stage, according to Schumpeter, is when the technology is no longer new as imitation becomes widespread. Once this occurs, economic profits are unattainable, as the new product is no longer novel and the competitive advantage that the new product or service offered to the first-mover, the innovator firm, no longer exists. This causes the condition of perfect competition to prevail and persist until an innovation restarts the cycle".


So, what's the fundamental understanding we can glean from the creative destruction process theory?

All the big guys that are presently at the first or the second stage, in the long-run, would not be able to maintain their high-profit levels or competitive advantage.

Apple and Samsung, for example, have been losing the value to cost ratio to the Chinese manufacturers, most of which are selling at marginal cost. Their marginal cost of innovation and growth rate in terms of utility, for example, far exceeds the similar figures for Apple and Samsung. The third stage is closer than ever for the smartphone industry. If the big guys don't restart the cycle, it wouldn't be prudent to hold or maintain a substantial allocation of Apple or Samsung in the portfolio for long-term capital growth.


For Amazon, it appears the second stage is well underway. The bees are indeed swarming, and with that much effort being put by national and international competitors, using advance data mining and machine learning systems, the third stage seems nearing at a higher rate than before. Nonetheless, if Amazon accurately gauges this volatile, uncertain, complex, and ambiguous (VUCA) landscape and manages to out-innovate the rising competition, it can manage to prevent high-degree of competition in its primary business, for some time.


Thus, it is not in as unfavorable a position as Apple and Samsung in the smartphone space.

For Facebook and the social media space, arguably, the third stage has been underway for some time now, and there is a very strong case supporting the argument that platforms like TikTok have restarted that cycle in the social media space. Facebook needs radical innovation at this point; otherwise, the challenges seem insurmountable, this, of course, means that long-term growth is very likely to be stagnant or even negative, with Facebook unable to gain economic profits.

For Tesla, the current condition very much points to the swarming stage, the bees, almost all of them, have left the hive and are now proactively trying to improve on what Tesla created. The investment requirements in the automobile industry are very substantial, and that is why we have seen a delayed or prolonged swarming stage in the automobile industry in terms of shifting to the electric model; however, if Schumpeter was observing the condition of the industry, he would, arguably, allude to the inevitability of the third stage and perhaps argue that it is not very far.