Wealth destruction is evolution for capitalists

Eastman Kodak’s slide into bankruptcy was lamented by everyone whose childhood is recorded in blotchy shades of faded yellow and sepia. But investors should quickly overcome their sadness to think of its demise as a fine example of creative destruction, or what can be thought of as evolution for capitalists.

Creative destruction as a market concept stretches back to the mid 19th century and Marxist economic theory. It refers to the process of wealth creation and destruction that is characteristic of the capitalist model. Today, its results are recognisable as the economic cycle of boom and bust. The theory suggests that wealth creation and destruction go hand-in-hand; that one cannot occur without the other.

It is easy enough to visualise one side of this equation because you cannot destroy something that has not yet been created. But of more interest to investors is the idea that wealth creation is dependent upon destruction. The 63 straight quarters of GDP growth that the UK economy enjoyed between 1992 and 2009 gave Gordon Brown reason to believe he might have overcome boom and bust, but we have since learned that he fell somewhat short of defeating the natural progression of the economic cycle.

A theory that implies that periods of contraction and pain are an inevitable consequence of expansion and progress might seem like the sort of thing that makes growth investors a little queasy, but it is the creative side of the equation that we should focus on. Which brings me back to Eastman Kodak, a firm that once defined its industry but is now fighting for its survival.

Kodak’s problem was not that technology overtook it; that it was stuck making films when everyone wanted digital cameras. Take a look at the company’s website and you will see a vast range of digital cameras for sale. What tripped the company up were management errors and bad decisions. For example, in the early days of digital cameras it was an innovator, producing hardware that was as good as any of its ultimately more successful competitors. But it was more concerned about its digital business cannibalising its film business than it was establishing a strong position in the new technology.

It failed to overcome that error and has suffered for it ever since. But its self-destruction might be the catalyst for its rebirth. That is what happened with General Motors which, after a similar near death experience, has re-emerged as a leaner and more confident company with a streamlined product line up and ambitious plans.

More generally, creative destruction can be thought of as the process of company and market evolution. There will always be winners and losers in a competitive, unregulated market and it is rare for a dominant company to remain at the top of its game for a long period of time.

Research in Motion, the company that makes the BlackBerry, is struggling to maintain what seemed like an unassailable share of the smartphone market because it has failed to keep up with Samsung, Apple and Google in the development of its hardware and software. It retains an enviable share of the corporate market and thanks to its instant messaging service, the BlackBerry is the cool-kids handset of choice. But unless its new management team is able to capture new sales and innovate with new products, Research in Motion could be vulnerable on both fronts.