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5 Principles to Find Disruptive Companies, No. 1: Resource Dependence

By Markets

Disruptive companies don't just churn out great results from quarter to quarter -- they change the ground on which their industries are built.

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In this segment from Industry Focus: Tech, Motley Fool analysts Simon Erickson and Dylan Lewis talk about how resource dependence (and independence) is one factor that investors can use to look for disruptive companies and the outsized returns that often accompany their stocks.

And learn more about Simon's five principles, based on Clayton Christensen's The Innovator's Dilemma:

No. 1: Resource Dependence

No. 2:Small Markets Don't Solve Growth Needs

No. 3: Markets That Don't Exist Can't Be Analyzed

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No. 4: Capabilities Define Disabilities

No. 5: Technology Supply Versus Market Demand

A full transcript follows the video.

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This podcast was recorded on Sep. 2, 2016.

Simon Erickson: There are five principles you could look for to predict when disruption is going to hit an industry or a certain company. We can walk through those, for this podcast, one at a time. The first is what Christensen calls the theory of resource dependence. He really says thatit's not companies, but it's their customers and their investors thatdictate how they're spending their money. Which is crazy, right?

You think about it,companies are always allocating capital: "We're going to do this and that." A lot of times, it's the investors saying, "We want you tomake this acquisition to juice your return on equity." Or,your customers might be saying,"We want aslightly better product, we'll pay a little bit more for it," and that guides yourallocation decisions. But the concept is, a disruptivecompany will look at where the market is headed, and is not as subject to its owncustomers orits existing investors telling them how to spend that money.

I have an example for it. Is it OK if I throw in an example?

Dylan Lewis:Drop an example, absolutely!

Erickson:One of the great examples -- we havea lot of these on our scorecardsfrom The Motley Fool -- it's Netflix (NASDAQ: NFLX). Netflix, as you and Idiscussed before the show, had a very profitableDVD-by-mail business.Reed Hastings, of course, went out and said, "Guys,I think the future is in online streaming. I'm going to get a lot more data aboutwhat shows people are watching and build this recommendation engine." Anda lot of people thought he was crazy for spending moneyon a market that really didn't exist yet. But he, in essence, disrupted his own business, and it's provedvery profitable in the long run for Netflix.

Lewis:Yeah,and you hear a lot of businesses talk abouthow you want to cater to the customer, and deliver what the customer wants. There are a lot of instances where the customer doesn't know that they want somethinguntil it's available. Then it's, "How do I live without this? What am I going to watch onSaturday night if I can't stream Netflix?" Andthat's something that wouldn't have even been a thought 10 years ago. Sometimes,companies have to be willing to anticipate what people want rather than respond directly to it.

Erickson:Very true, both of those. On top of that, what isavailable in the market at the time? Until people really had high-speed broadband internet, streaming movies over the internet was almost impossible. When that enabled digital streaming, Netflix really took off. It was in the right place at the right time.

Dylan Lewis has no position in any stocks mentioned. Simon Erickson owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.