The Generational Shift in Distribution That Will Define the Next Decade of Winners

There's a massive shift in consumer behavior happening in the world today. This change will lead to the erosion of legacy businesses while at the same time supercharging the growth of businesses founded in the new millennium.

The change I am talking about is around product distribution and how consumers choose to sign up for or acquire products and services.

In contemporary history, this has happened a few times. Take a look:

• Early 1900s - Local community-based distribution

• Post WW2 to 2000 - Interstate and phone distribution

• 2000 to 2012 - Online distribution

• 2013 to present - Smartphone and app distribution

Each of these new methods of product distribution represents a seismic shift in industry and how consumers engage with businesses.

This change is very notable, as it often brings a changing of the guard. Every business is founded and built around executing distribution according to the model prevalent when it was established.

For example: if you were a bank founded pre-2000, you have many physical locations. This means their entire business was built around the success of the strategy for legacy distribution, such as:

• Where to open them and why. What population size and demographic are necessary to do so?

• How to staff physical locations.

• Processes for handling paperwork at physical locations.

• Marketing a new location.

Whether you were a movie rental store, a bank, an insurance business, or a seller of consumer goods, the entire model was built around these physical locations.

The skill set and technology that make one an expert in these new models of distribution are entirely different from the old. Not only that, but every organization also has a power structure that is dependent on the old method of distribution. A bank, for instance, typically has executives competent in managing physical locations but with little to no experience in tech and development.

During this period of transition from an old distribution model to a new one, there are notable challenges that legacy businesses face:

• Management are experts in the old method of distribution and will naturally resist change, as this new method is not their core competency. Many will look for reasons to resist progress that erodes their position and the positions of those who report to them in the company.

• There is little sense of urgency.

• As new methods of distribution emerge, there is an adoption phase over time.

• People don’t use the new method 100% right away. Many people are most comfortable with the old method due to habit and the preferences of that generation. For instance, most Baby Boomers and the Silent Generation would prefer to make a transaction in person rather than online. Each generation tends to build habits around the predominant distribution channel of their time.

• Little expertise in the new distribution model.

• Those who are hired to execute on the new distribution method often have little skin in the game, so they are less incentivized to bring transformational change.

  • For example, Walmart initially hired local engineers in Bentonville, Arkansas, to try and compete with Amazon in online retail. If Walmart tripled in size from e-commerce, these engineers wouldn’t receive a windfall. Thus, it failed miserably. They did not take it seriously enough to not only compensate the team for massive success; they also didn’t even recruit top talent by building a team where top industry talent lived—in Silicon Valley. They treated it like hiring contractors.

• Overconfidence in their current position and balance sheet. Startups that challenge them have weak balance sheets and low market share at first. Even when legacy companies are presented with opportunities to buy these startups, they often pass, such as in the year 2000 when Netflix asked Blockbuster to buy them for $50 million and were laughed out of the boardroom for such a suggestion.

While these legacy businesses struggle or resist, or at best lack the expertise to adapt to the new normal in distribution, new businesses will be founded and developed to leverage this change. These businesses will be highly advantaged because:

• Their founders are laser-focused on the new method of distribution.

• They are not burdened or most incentivized by managing old methods. Their employees do not fight them to keep things as they were. They don't have to manage the unwinding of legacy distribution models.

• The teams are packed with expertise and energy tailored to this new distribution model.

• The company overall has skin in the game focused on the success of the new distribution model (e.g., stock options), making them highly motivated to succeed and attractive to top talent.

• The success or failure of the business is dependent on their execution of the new distribution channel.

  • i.e., If you're an online bank and build a bad app, the entire business fails. This is opposed to a traditional bank, which can take its time and fail for a long time at making a great app because it mostly makes money from branches.

While all of this might seem obvious, to the stock market, it often isn't. The stock market frequently does not think in terms of these fundamental challenges of legacy businesses and fundamental advantages to new businesses. Instead, this is how they generally interpret things during changes in distribution:

• Legacy distribution businesses currently have better profitability and more established customers, so they are better investments.

• Legacy distribution businesses have bigger balance sheets. They can simply spend their way out of it.

• New businesses have smaller balance sheets. There is more risk.

• New businesses aren’t very profitable right now. They are burning cash to scale.

This is often the narrative of Wall Street and investors. For instance, take a look at this news article from CNN Money in 2011. At the time, Netflix was valued at around $7 billion, barely breaking even, and only had a couple hundred million on its balance sheet:

“Netflix can’t afford a streaming war.” Perhaps. Yet, here we are today, and Netflix is valued at half a trillion dollars. Wall Street conventional wisdom was once again proven wrong. It’s not balance sheets that win a war; it’s highly motivated, focused teams with skin in the game and expertise around emerging distribution models.

So how do we apply this to investing today?

• For starters, we stop thinking in terms that “the big eat the small,” but rather, “the fast eat the slow.”

• The great balance sheets of today can’t compete with rapid product innovation. Businesses like Netflix and Amazon have proven that.

• We are currently in a transition phase where distribution is only now entering mainstream adoption for product and service acquisition via mobile devices.

The key to finding future Netflixes rests on two points:

1. Find businesses that are acquiring the most new cohorts. Avoid businesses that are losing market share among these cohorts.

2. Find businesses with strong product velocity and innovation. The fast will eat the slow.

Notice that those two traits are often the weaknesses of legacy businesses, while they are the strengths of new, highly focused startups.

In summary, now is a time of immense opportunity in investing.

We are in a historic shift in distribution, during the widespread adoption of this new method. While balance sheets are still young, and market share has not yet solidified for new rapid-velocity innovators, the chance to acquire innovative companies at a discount to their potential is here. Meanwhile, many legacy investors will miss this chance, as they are still comfortable with "old distribution” methods and focused on the wrong metrics and hefty profits of old cohorts.

Remember, the new cohorts will determine the future of businesses, not the old.

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