Imagine you are the head of a major business that has been very successful in the past. Your firm became a leader in the industry because it invented and commercialized a product that was new to the world. It became successful and your firm became a large enterprise with that success. Over time, the firm enhanced the product by adding many new features. You enjoy a dominant share of the market and are the leader in the industry. As a business manager of this successful business you are considered extremely successful too. Although your firm has other businesses, your business is the most important business as it accounts for over 65% of the firms revenues and profits.
Recently there has been a lot of talk about an emerging technology that will provide what you provide at half the price because it will remove most of the features you provide in your product. You have thought about this innovation and all research suggests that the innovation will succeed in the market whether you join the party or not.
After considerable thought, you understand that if you do not join the party this innovation will make your product out of line with the customer demand. This means you will lose most of the market share. On the other hand if you embrace it, you will voluntarily destroy your profits by over 35%. As you are rational manager, you believe the best thing to do is to embrace the innovation. This way at least you will continue to remain the leader albeit with much lower profits.
You make your case and go to your CEO and suggest that you embrace the new technology. He says “you know what. This is the worst recommendation of your entire career”. How would you feel?
If you feel horrible then you shouldn’t because you have company. This was the response that Gus Sauter got from the chief executive of Vanguard Jack Brennan. Sauter was suggesting that Vanguard enter exchange traded funds.
Next, I will write about how this is a common response and how ETFs were a rogue innovation. This is a key challenge for firms facing a rogue innovation. Stay tuned for more.