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Why authentic leadership matters

When analysing a potential holding, Artemis’ impact equities team ask six key questions. Here they examine the third and fourth of those questions – and why they need a clear ‘yes’ to them before investing.

Being able to provide a clear ‘yes’ in answer to each of the below questions helps us to define a successful, transformative, positive-impact investment. Questions one and two are answered in this article; questions five and six will be answered in a future article.

  1. Does it have a positive impact?
  2. Is it radical enough?
  3. Is its leadership authentic?
  4. Will it capture value?
  5. Can we earn a return?
  6. Are we prepared to be wrong?

Question 3

Question 3:
Is its leadership authentic?

The chief executive of Shopify, Tobias Lütke – Tobi – doesn’t look or sound like most chief executives. Rarely photographed without his trademark flat cap, he is as happy talking or Tweeting about videogames, coding and the music on his Spotify playlists as he is in discussing the achievements of Shopify, the company he founded.

These are all, of course, cosmetic matters. But they are suggestive of something broader… We want to invest in companies that can help transform the world – and to benefit from the economic value they create while doing so. Transforming the world, however, takes patience and a willingness to do things differently. That, in turn, requires leaders with vision, integrity and a commitment to the long term, characteristics that add up to something we could call ‘authenticity’.

Looking for unorthodox wisdom

It would be undiplomatic to list the companies whose leaders lack some (or all) of the qualities we demand – and it would not be fair. Most chief execs are simply doing what their boards of directors have hired and incentivised them to do: hitting short-term earnings targets, finding the most efficient capital structures or ensuring that share options are triggered.

Milton Friedman believed that “the only social responsibility of business is to maximize profits”. Orthodox managers (fund managers and senior executives) often tend to frame problems in a zero-sum context: that their responsibility is to grab as large a slice of a finite pie as they can.

We disagree. Our conception of a company’s ‘stakeholders’ extends beyond its directors, shareholders and employees to include the environment and society. And we also believe the best investments are a ‘positive sum’ activity by supplying capital to projects that help to create abundance where there was scarcity. Unorthodox leaders like Tobi understand that too: positive-sum ‘value creation’ (making a bigger pie for everyone) can go hand-in-hand with economic ‘value capture’.

We don’t want to invest in companies whose managers’ priorities lie in implementing the orthodox ‘playbook’ taught at business schools. We’re looking for companies whose leaders approach things differently.

Authenticity exemplified: Shopify

The leadership of Shopify, which provides software and payment tools to allow firms to set up their own online stores, exemplifies many of the things that we are looking for. We need to be convinced that impact factors are material to the running of the companies we invest in. In Shopify’s case, its long-term focus is clearly stated – and proven.

Not only is Tobi Shopify’s chief executive, he is also its founder. (Albeit not exclusively, many of the things we’re looking for tend to be most evident in founder CEOs) A coder, he set up the business in 2006 with two friends when it became clear the software he had designed to sell snowboards online had far wider applications. The company’s current president, Harley Finkelstein, joined just three years later.

In his latest entry on the company’s blog, ‘Tobi’ reminds readers that “Shopify is playing the infinite game. We are building a company that will likely outlive all of us.” That long-term thinking is reflected in its stated belief that “commerce and entrepreneurship can only thrive in the long term if our planet thrives too”.

The rhetoric is backed by action. For example, to help reverse climate change, Shopify’s Sustainability Fund invests at least $5 million annually in emerging technologies for removing carbon dioxide from the atmosphere.

To be clear, we are not investing in Tobias Lütke. Along with Harley and the rest of the company’s excellent management team, he is only one part of the much larger puzzle. But it is a vital one. In our experience, authentic leadership is a prerequisite for a truly disruptive company. So for this reason – along with many others – Shopify makes it into our portfolio.

Question 4

Question 4:
Will it capture value?

The fashion industry needs to change. This is a statement based on the simple recognition that its current model of production has enormous negative environmental and social impacts.

Somewhere between 10% and 30% of items produced by the industry remain unsold, so are given away, recycled or even buried in landfill., estimates that the fashion industry is responsible for 10% of global CO2 emissions and consumes 1.5 trillion litres of water annually

This is unsustainable – and that lack of sustainability interests us. We believe the best long-term growth opportunities come through investing in innovative companies that are addressing the most significant sustainability challenges. Clearly, fashion qualifies.

The ‘7 Powers’

Like many investors, we want to invest in companies that can generate persistently superior returns on (y)our capital – to capture value for the long term. No matter how revolutionary a company’s product, service or idea, then the profits it should bring will vanish if a rival can provide it on the same terms. So any business we invest in must exhibit ‘power’, but how to define and identify it? To help structure our analysis, we use a framework set down by Hamilton Helmer in a book published in 2016: 7 Powers - The Foundations of Business Strategy.

The seven powers he proposes are:

  1. Counter positioning
  2. Cornered resource
  3. Network economies
  4. Scale economics
  5. Switching costs
  6. Branding
  1. Process power

Competitive advantage is often framed in static terms in the context of historic returns on capital of mature companies. But as investors in emerging growth companies, we are – by definition – trying to identify emerging power. Helmer explains the difference in this way: “Dynamic power (getting there) is completely different from static power (being there), but the two are often conflated. The key to strategy is identifying emerging scarcity. Scarcity is where innovation can create power.”

We are explicitly aiming to invest in unappreciated disruptive innovation, where power is emerging and where the potential future free cashflows of a business are misunderstood.

We need to see evidence that a business has at least one of Helmer’s powers before we invest. The importance of both branding and economies of scale are well known. The way network economies work – that the value of a service to each of its existing users increases as each new user joins – has been vividly demonstrated by the rapid and hugely profitable rise of social media platforms. But because we have a clear focus on disruptive innovation, our holdings frequently exhibit the power of ‘counter positioning’.

‘Counter positioning’ and fashion’s Kodak moment

History teaches us that incumbent industries resist change, with the result that it takes place reluctantly and incrementally – if at all. So we seek to invest in companies that can deliver transformational change and avoid those clinging to the past.

This has more than a little in common with the idea of ‘disruptive innovation’. To simplify, newcomers can adopt new, superior technologies or business models which incumbents can’t or won’t mimic due to the damage that they might do to their existing business.

Kodak is a lesson in the importance of dynamic power. It grew accustomed to gleaning profits from selling and processing analogue film, and although it could see the potential of digital cameras it couldn’t find a way to profit from the shift in the basis of competition.

Two decades later, the same digital transition may be happening in garment printing. The dominant, established technologies used today – rotary-screen or automated-carousel printing – involve multiple time-consuming forms of pre-treatment. This consumes energy, water and often results in hazardous chemicals being discharged into waterways. These technologies are both asset- and labour-intensive and so are traditionally offshored to developing countries where environmental and labour standards tend to be lower.

This old model is also inflexible: large print runs are needed to be cost-effective. In the fickle world of fast fashion, this leads to waste. Could apparel companies that currently garner their competitive advantage from manufacturing scale (i.e. dominating their overseas supply chains) be at risk of disruption from myriad small, local and sustainable clothing brands?

From t-shirts to your new curtains

Kornit Digital exemplifies the power of counter-positioning. From its beginnings providing machines to print cheap-and-cheerful designs on cotton T-shirts, it is now demonstrating the potential for the more sophisticated digital printing technology it has developed to supplant analogue technologies across a far wider range of fashions. It can now provide higher quality finishes and more complex patterns on a wider range of fabrics.

Each generation of Kornit machine brings new functionality and lower print costs per garment. But for each print run, the cost per garment remains essentially the same regardless of whether a single unit is being printed – or a thousand. That enables shorter print-runs, reduces the time lag between design and production and decreases the risk of excess inventory. Because digital printing needs less labour and physical space, it can take place closer to market (shorter lead times) and allows clothing production to be ‘onshored’ to areas where environmental and labour standards can be monitored.

The scale of the opportunity is potentially enormous. Its goal is to increase its share of the garment printing market from 1% today to 3% by 2026. By manufacturing in a less speculative fashion that is more closely aligned to real demand, they estimate that will save approximately 420,000 tonnes of waste and 560 billion litres of water.

Can Kornit’s technology alone eliminate the waste and impact of the fashion and fabric industry? Absolutely not. But we believe its technology can help make a bad situation much, much better.

Jonathan Parsons manages the Artemis Positive Future Fund alongside Craig Bonthron, Neil Goddin and Ryan Smith.

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