5 Principles to Find Disruptive Companies, No. 4: Capabilities Define Disabilities

By Motley Fool Staff Markets Fool.com

Think about the number of people that have to clear a new project at a multi-billion dollar company -- lower level managers, company executives, the board members -- and it becomes much easier to understand why start-ups are often much more nimble.

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In this segment fromIndustry Focus: Tech, Motley Fool analystsDylan Lewis and Simon Erickson explain why smaller companies likeNetflix(in its early days) and SolarCityare better able to innovate than their larger and more established peers.

And check out all five of Simon's principles, based on Clayton Christensen'sThe 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.

Dylan Lewis:No. 4 on our five-point principle list here: Capabilities define disabilities. I think this plays into the idea ofsmaller companies maybe being ableto be a little bit more nimble, andthere being a certain stodginess with being a larger company, and being a little bit more fully formed.

Simon Erickson:Yeah, that's right. It'skind of an interesting way,how you can define culturein a bunch of different ways. But one way topossibly define culture is howdecisions get made at a company. There are typically certain metrics that, in the boardroom of a business, managers and bigwigs of the companies are using to base whether a decision is good or bad. Does this bring in a certain amount of cash flow? Is this a good return on our investment today? Do we havecustomers lined up that are ready to do this kind of stuff?

That's interesting because those capabilities, how a business is making decisions, its culture, and how it's deciding on things, can actually handicap it inlooking at all of the stuff we're talking about today. Anexample of this isthe large regulated utilities. When utilities spend billions of dollars to build a new power plant, they mandate a certain return on equity and a return for their investors that they can pass along to shareholders. It's heavily regulated by the states. That's how business is done. These are huge decisions.

Then, you have this small, scrappy company calledSolarCity.

Lewis:Oh,I think I've heard of them.

Erickson:Maybe a time or two before. One ofmy favorite companies -- apparently Teslaalso likes them, they're trying to acquire them right now.

Lewis:Yeah, Elon Musk seems to really like them.

Erickson:That's right. They said, "Itdoesn't have to be this way. If you can figure outhow much electricity one house needs, you can size a solar panel on the rooftop and have that produce all of theelectricity you need for that one house. You can size those accordingly." And if people payon a monthly basis for that power, you don't have to put up the $20,000 to $30,000 to build it yourself. Totally disruptive idea. Didn't have the same metrics they were using to make decisions,because they weren't building thesegiant power plants. Avery disruptive company to the energy industry.

Lewis:Yeah, and that is a little bit of an inside example, one that maybe needed to know the industry a bit better,understand how it works, to fully grasp. I think,to go back to Netflix, they'reanother example of a company that,even by name, shows thatthey weren't limited to the business structure that they hadwhen they first started.

I've heard David Gardner make this point before,and it's a very bright one -- they're called Netflix. They were not calledMoviesByMailFlix. That would have been redundant. But, they weren't tethered to this idea of being a by-mail company. They were a digital company that pivoted when they saw the opportunity. And their name suggested that. So, that's tougher to recognize,but something to keep in mind. I don't know how many exampleswill show themselves like that. There are different waysthat businesses indicate, I think, their flexibility and how nimble they are. Any indicator you can find there can behelpful in looking for some of these more disruptive companies.

Erickson:And David has many times calledReed Hastings the smartest guy in any roomthat he's in, which isa telling sign of exactly what you said,that he saw changes in the industry to take advantage of.

Dylan Lewis owns shares of Tesla Motors. Simon Erickson owns shares of Netflix, SolarCity, and Tesla Motors. Simon Erickson has the following options: long January 2017 $50 calls on SolarCity, short January 2017 $50 puts on SolarCity, and short January 2017 $40 puts on SolarCity. The Motley Fool owns shares of and recommends Netflix, SolarCity, and Tesla Motors. 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.