Tom Clancy: What Drones, Droids, and 3D Printing Mean for Your Investments
Lowering the costs of production may ultimately lead to a change in the way goods are delivered to lower-income buyers and emerging markets.
We are currently realizing the deflationary promise of the internet, which was anticipated 20 years ago, but we are still a long way from producing products at the price points necessary to appeal to customers in emerging markets. At the same time, many are speculating about the impact of 3D printing, drones, and robotics on the labor force. While technology will continue to make certain labor obsolete, there are two key implications related to these specific technologies:
1. Value will be captured by moving production closer to the point of consumption.
2. Removing labor, though massively deflationary, will preserve margins by enhancing the overall value proposition while lowering costs.
First, the reason Nike's (NYSE: NKE) Flyknit technology is so revolutionary is that it lowers the cost of production by eliminating most of the costs associated with manufacturing, shipping, and managing a disparate supply chain. The Flyknit potential rests in its ability to knit a shoe that's custom designed and fitted to your foot in the store. There is a human impact on the Bangladeshi workers, cargo pilots, and delivery personnel that will no longer be needed in the supply chain, but it results in a lightweight, high-quality product that is manufactured at a lower cost than the current product. We are not quite there yet with this technology, but you can see how moving production to the point of consumption has the potential to expand Nike's margins while lowering the price point of the product.
Second, the law of supply and demand holds that demand for products increases as the price declines. Lowering the cost of production also lowers the price point for certain technologies, allowing them to be deployed in new ways. These new applications increase the use of the technology, providing economies of scale and increasing overall productivity. Think of what Moore's Law, as applied to semiconductors, has meant for the cost of production and profit margins for any number of products and services across our economy. We saw this last week that personal income declined again last month, while the cost of living increased, putting more pressure on the middle-class consumer. Companies that manufacture products for these people have to find ways to lower price points, or cede market share to those that do.
Finally -- to bring this back to PPG -- a company called WorldHaus, started by Idealab, has designed a $1,500 house to meet the needs of the 1.5 billion people that live in hazardous makeshift houses. PPG makes paints, coatings, and sealants, much of which is sold into the construction market. I asked about the ability of these products for emerging markets to disrupt the companies built to serve the industry in developed markets. Its response was that, "as long as color is important, we will be competing for the business." One way PPG is preparing to compete in these markets is to reduce the amount of labor involved in the paint application process and including color at the point of production. As you eliminate labor, you lower overall costs and preserve margins. PPG's participation in automated color application markets provides a competitive advantage over companies that only focus on coatings applied with a brush/roller, like Sherwin-Williams (NYSE: SHW).
Last week I pointed out in a Buzz (on Minyanville's Buzz and Banter) that using recent sales comparisons is a terrible way to assess the long-term value of an asset. Specifically, while evaluating the market value of a rental property I own, I concluded that the market value exceeded the cost to build that house by about 20%-25%. Since rental rates increased at about the same rate as the market value, the capitalization rate remained at about 7.5%, which implied that market values were being supported, if not driven, by rental incomes. People investing in real estate often fail to realize the impact that construction costs have on both rental rates and home values, but Robert Shiller points out that construction costs tend to drive the long-term value of homes. Since market growth will be driven by penetrating underserved emerging markets, falling production costs -- while one of many factors impacting value -- present a long-term impediment to home price appreciation in developed markets. In addition, while I don't claim to know the tipping point at which replacement value erodes the market value of existing homes, the implication is that real estate may not be the inflation haven some expect. These investors must be aware of the risks associated with declining market values and production costs, but also that inflation could increase 25% without necessarily impacting the rental or market value of the property.
The point of all this is that there are still deflationary forces at work in the global economy, and we need lower prices for most products if they are going to be affordable to the vast majority of the world's population, but technology could mitigate the impact on margins. It is not easy to follow a long-term investment strategy in this environment, but if assets are ultimately valued by discounting future cash flows, we need to think about what the future may look like to keep asset values in proper perspective. Look at the assumptions used to justify the price targets on Tesla (NASDAQ: TSLA) and Bitcoin, and see if they coincide with your vision of the future. Some investments that many are purchasing have significant risks when inflation and deflationary forces are properly considered, and that risk is exacerbated when leverage (borrowed money) is involved.
While every market is different, do your homework and look forward to identify what the future may look like, because understanding risk means more than knowing history, and profitable investing is about running to where the ball is going, not where it is.
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