5 Principles to Find Disruptive Companies, No. 3: Markets That Dont Exist Cant Be Analyzed

By Motley Fool StaffMarketsFool.com

Could anyone have accurately predicted the impact the Internet would have in its earliest days? What about social media? Virtual reality?

And that is the challenge innovators have when trying to identify the "next big thing" before anyone else has come to recognize the opportunity. This becomes especially difficult when they find it but are met by a sea of skeptics, both inside and outside the company.

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In this segment from Industry Focus: Tech, Dylan Lewis and Simon Erickson discuss this challenge through the lens of Facebook (NASDAQ: FB)and more.

Check out Simon's five principles, based on Clayton Christensen'sThe Innovator's Dilemma:

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No. 1: Resource Dependence

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

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

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. 3, moving along: Markets thatdon't exist can't be analyzed. I think this might beone of the most interesting points that we'll raise during this show.

Simon Erickson:It'smy favorite of the five, actually. Can I ask you,how did he come up with the nameThe Innovator's Dilemma? Do you knowwhat that actually refers to?

Lewis:I don't.

Erickson:It's aninteresting thing.The Innovator's Dilemmais,if you want to get into something new,you don't have the data to support that decision,necessarily, because it's new. You don't know if it's going to work or not.

Lewis:So,the idea is, you're working on a hunch and not much more, in some cases.

Erickson:Yeah. It would be a no-brainer if all the data told you, "Hey, this new market that nobody's going into is going to be wildly successful." You don't get that. You have to jump out there ahead of the pack.

Lewis:And, in fairness, if the data suggested it,everyone would be doing it.

Erickson:Exactly. So, that's the beauty ofThe Innovator's Dilemma. It's always forward-looking, it's not looking at financial ratios. A lot of what Wall Street lives and dies by is things likemargins, return on equity, return on invested capital. This is always a framework looking forward.

Lewis:Evensomething like addressable market, which issomething that we like to look at when we can,but if you don't even know what a market is going to look like,or what the scale of a technology might be,it's kind of a fool's errand toeven put a number on it.

Erickson:Exactly. And let's go back in time to 2004, 2002 -- social media, social networks, Facebook is theexample for this one. This wassomething that most people didn't understand. You hadMySpaceand a couple otherstrying to figure this out out there. But Facebook was so far aheadof the game of the larger competitorsin the traditional space thatthey learned a lot more about what people wanted to doon social networks, then they collected that data and didtargeted advertising. Of course, now, it's a more than $300 billion market cap company.

Lewis:I will say, I saw aninterview that Zuckerberg did recentlywith the founder ofY Combinator. He asked him, "What wasone of the tougher things you experienced as CEO andin the development of Facebook?" And he said "People not seeing the vision that I see." These weren't external folks. These werepeople that were internal employees,members of the management team,that were disappointed when Facebook decided to shunearly buyout offers.

He saw this hugepotential to get beyond colleges, to become this huge platform that connects everybody, andthey didn't. And a lot of them actually leftwhen they decided to reject that buyout offer. So, this is not something that's limited to your average investor or mom and pop at home. This is something that even people in the space might not be 100% capable of grasping market size.

Erickson:Andjust like you said, it has to be the right person. You have to have the right vision,and not somebody that's leading youin the completely wrong path thatmaybe they think is the future of the business that really isn't. Good point on that.

Lewis:And even beyond the platform itself, we can look at the idea of,markets that don't exist can't be analyzed, orcan't be totally grasped -- withFacebook, in the context of its pivot to mobile. A lot ofpeople were pretty skepticalof Facebook's ability to monetize mobile audienceswhen they saw thatthat's where the majority of web traffic was going. Clearly, it'sworked out for Facebook. They, basically,quintupled in value as they've reallysuccessfully pivoted to mobile. Now, mobile makes up, I think 84% to 85% of their total revenue take. So, this is not evennecessarily something that is limited towhen a company is first starting out. It can be something that,similar to the idea of streaming video with Netflix, happens as a company sees opportunities, and maybe leaves some of the market behind because they don't.

Erickson:Yeah. It turns out,interesting as this might be, that predicting the future is actually pretty hard. It's not so easy to have a crystal ball and say, "We're going to put billions of dollars behind this new market that doesn't exist yet." A storyI love to tell when talking about this is back in the year 1980,AT&ThiredMcKinsey to do a study of how many U.S.-based cellphonesubscribers they thought there would be by the year 2000. Twenty years in the future. Put yourself back in 1980, say, "There's this new thing called a cellular phone. How many subscribers do you think it could possibly reach by the year 2000?" Any shot on what the estimate was?

Lewis:Do you haveany idea what the population was back then,so I can kind of anchor to it? You know,I'm going to say 40 million.

Erickson:Good guess. The actual estimate that McKinsey -- one of the bestconsultants in the world at the time, keep in mind -- they said it would be about 900,000 people.


Erickson:The actual number by the year 2000 was 109 million, just in the United States. It just shows how hard it is to lookeven five years in the future and predict where the market is going to head. But you do have to look, at some point, at smaller companies that are going in a path that everyone else is not going in.

Dylan Lewis has no position in any stocks mentioned. Simon Erickson owns shares of Facebook and Netflix. The Motley Fool owns shares of and recommends Facebook and 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.