Look for Paradigm Shifts

In every business landscape, the current predominant business model is always subject to being overturned by a new and more efficient business model that delivers new value over the old one.

If a company can find a way of completely changing the landscape in a particular field, that company can "outflank" its competition by shifting the entire paradigm.

A familiar example would be Apple's development of iTunes and the iPod players, which took a new delivery model for music (one that already existed, but was only used by a small number of consumers) and made it so practical and easy that it rapidly displaced the currently dominant means of obtaining music. Several companies that relied on the old model (buying music in a store) went out of business as a result. Apple's new developments completely changed the existing paradigm.

A paradigm shift is an important concept in the classic Growth Stock Theory of Investing. In his 1973 treatise on the subject (discussed in this previous post), T. Rowe Price stated:

"Most corporations, like people, pass through a life cycle of growth, maturity and decline. Common sense tells us that an investment in a business enterprise affords greatest gain possibilities and involves less risk while the long-term earnings trend is rising. [. . .] The risk factor increases after maturity is reached and decline begins."

In other words, although many people think that big, established companies are "safer" investments than average, it is important to realize that every established company must continue to deliver more value than the alternatives, and that other companies are always looking for ways to usurp their position of leadership. If a large company is not alert, it can be outflanked by a more effective new company, especially if that new company is able to change the entire paradigm with a new business model that is more efficient than the existing model.

This concept is closely analogous to the military concept of a "flanking maneuver." One of the clearest visual examples of this concept took place on May 2, 1863 in the famous flanking movement executed by the Confederate forces in the second day of Chancellorsville. In the illustration above, from the 1865 biography of Stonewall Jackson by his friend, chaplain and onetime Chief of Staff R. L. Dabney, we see one of the most famous flanking movements of the American Civil War.

On the second day of the battle, Lee sent 26,000 men -- well over half of his available forces -- under Stonewall Jackson on a flanking maneuver depicted on the map above by a large red arrow. The Union forces had been reacting to what they thought was the real threat posed by Lee's main body (see the small blue arrows in the map above) but were completely outflanked by Jackson's bold and deep flanking maneuver and were forced to withdraw to later positions which are sketched in the original map above but not colored in blue.

A flanking maneuver is particularly effective because your opponent is positioned with his fields of fire primarily in one direction, and your arrival on his flank or in his rear forces him to reorient rapidly to try to deal with the new threat. Often he is unable to turn effectively in time.

A paradigm shift "outflanks" the existing business model in exactly the same way. The existing business must rapidly try to catch up, but if they did not see it coming in time, they will often be unable to shift fast enough. All of their production systems and incentive structures are geared towards the old model, and they may be unable to effectively re-work those in time to prevent the new company from completely dominating the landscape.

It is also important to realize that a paradigm shift does not always take place because of new technology. New technology often does enable a paradigm shift, but a paradigm shift can take place from the creative application of almost any new and more efficient business model, whether it uses some new technology or not. A company with a clear vision and a more efficient way of providing greater value can outflank an entrenched leader and completely alter the landscape, and the history of business is replete with examples of this taking place.

Paradigm shifts are always taking place in one part of the business landscape or another. We believe that some important paradigm shifts are taking place right now, and others are being set up to take place in the next few years.

For later blog posts dealing with this same topic, see also:

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