Mad or Just Disruptive?

March 2nd, 2007 by under Uncategorized. No Comments.

Continuing along last week’s path I thought I’d share another general economic observation or two.

One of the key topics in my first few weeks of my Industry and Competitor Analysis class has been the idea of disruptive forces in markets. The idea is essentially that every so often a competitor will enter a market and provide a product or service that is so well responded to that it disrupts the market entirely.

The best example is napster. Music was going along fine as an industry until this college student in california launched peer-to-peer file sharing via napster. Now all of the music consumers used to have to buy by the album they could now own per song, by the second for free. This begs the question, given this new environment, why would anyone buy cds anymore? Or even more far-fetched, personify the market or simply the marginal consumer, it would have said for years, “Why can’t I just get the song I want and not the whole cd.”

That’s the idea, napster disrupted the music market by filling this need which had been present for years. As a business person you might ask, “Well how does one go about discovering the potential of disruptive market entrance and making it happen.” Good question. Well it turns out one of the best ways is to look at markets where there is quite a bit of demand at a lower price that cannot participate in the market because it is too expensive. This may seem overly simplistic, but the idea is not that they can seek some other similar good or service, it’s that they cannot be in the market at all despite their desire to be.

This conclusion led me to thinking of markets where this was the case. Markets that would ask questions like the music market did. Mutual funds came to mind immediately. Mutual funds have traditionally provided two major types of products: actively and passively traded funds.

Actively traded funds are more expensive products where you pay some person to choose your stocks, this person is super and they can do no wrong so that’s why they’re not cheap and you get a nice return. However, a lot of people came along in the mid-90’s who were a lot more super. And they ran Hedge Funds, so if you wanted super, you gave these guys a million or more and they gave you super.  

This brings me to the passively traded funds, which are not so super-unless you’re in the mutual fund industry. These funds simply give you a weighting of publlicly-traded securities that you hold like the S&P, which you pay fees to the mutual fund for buying and holding at a smaller fraction or a different weighting than if you purchased the securities individually. Wait a second, I think the market would like to chime in, “Why yes Mark I would. I want to know why this type of security isn’t traded on the exchanges along with stocks. Why can’t investors just buy the S&P in one security.” Great question market, why don’t you go into yahoo finance and search for SPY. Congratulations, you can buy that index on what’s called an Exchange Traded Fund or ETF. The market’s disruptive solution to non-sensical mutual fund fee structures.

Hedge funds took out all the high-end investors and the ones that were left didn’t want to pay the fees associated with passive funds, so the market’s response was to create Exchange Traded Funds that provided the same investment as the mutual funds, but with no fees. Works, right…

 More later…