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IPE special report May 2018

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Ahead of the Curve: The deflationary impacts of web 2.0

Edward Shing examines the deflationary effects of the emerging ‘sharing economy’ on traditional companies 

Years of overinvestment have led to overcapacity in many areas of global manufacturing. Coupled with slowing global growth momentum, this has driven down exported goods prices globally. Now we are witnessing the emergence of further deflationary forces unleashed by web 2.0.

Web 2.0, or ‘the sharing economy’, includes fast-growing cloud computing and e-commerce businesses that enable individuals to rent or borrow goods rather than buy them. The sector is forecast to record explosive revenue growth from just $15bn (€11bn) in 2013 to as much as $335bn by 2025, according to PwC.

We have already seen the profound deflationary effects of online shopping, the growth of which is continuing to take market share from traditional bricks-and-mortar retailing. In the US, online shopping represents about

13% of total retail sales (ex services, autos and gasoline sales). In the UK, a world leader in online shopping penetration, 15% of retail trade was over the internet in 2015; the most important motivating factor for online shoppers is price.

Online shopping is also driving high-street deflation. In the UK, online selling prices are falling at an annual rate of about 3%. Online retailers are far more efficient from a capital investment perspective, as they do not need physical shops.

Likewise, new sharing economy businesses, such as Airbnb, Uber and WhatsApp, are disrupting service industries such as taxis, hotels and telecommunications, just as internet business models such as Google, YouTube and Spotify have disrupted the traditional media business models in advertising, video and music steaming.

Web 2.0 business models are built on cutting prices, in some cases to zero, but they also represent step-change improvements in productivity, in terms of capital, not labour. 

AirBnB, for example, allows people to rent out their otherwise empty apartments to generate an income, thus improving the capital productivity of their properties.

However, web 2.0 companies are putting downward pressure on a whole swathe of goods and service-sector prices. 

Telephony and messaging have suffered from voice over IP capabilities offered by Facebook, Facetime, Skype and WhatsApp, which now provide free communication. Discounted online shopping has been further disrupted by the likes of Amazon, eBay and Zalando. AirBnB has changed the way people book hotels and short-stay accommodation, while the newspaper, music and video industries have undergone fundamental changes as a result of the emergence of free web models, peer-to-peer content sharing and streaming services.

One sector at great risk from the sharing economy is autos, with many predicting ‘peak car’ on the back of the emergence of Uber and fractional car ownership schemes offered by the likes of Zipcar. The peak car theory follows that motor vehicle distance travelled per head has peaked and will fall in a sustained manner. Uber and Lyft allow car owners to become part-time private hire drivers, improving the capital productivity of their cars.

For many people the combination of Uber and Zipcar represents a convenient and low-cost alternative to car ownership. This could potentially reduce investment in cars by households, thus putting increasing pressure on carmakers. 

So, web 2.0 business-models will continue to push inflation in developed markets lower, while negating the need for capital investment. Central banks are certainly playing a role through quantitative easing, but much of the leg-down in long-term bond yields since the start of 2014 has been the result of the compression in long-term inflation expectations, rather than central bank bond buying.

There must, therefore, be opportunities for equity investors to gain exposure to this ongoing deflationary theme by aligning with price makers – industries that can usually raise prices year-on-year, no matter how weak the macroeconomic environment is. These industries, such as food and beverage, media and personal goods, have seen a consistent rise in earnings forecasts since 2012. This is typically the result of stable demand, high barriers to entry and global brands or innovation from high research and development spending.

In contrast, price takers, which rely on the cyclical economic environment for price setting, including industries such as autos, basic resources, and oil and gas, are suffering, given tough pricing conditions. 

Price takers will again outperform the price makers, but only once the downgrades to global growth and inflation have abated. While this could take years to happen, the trend is here to stay.

Edmund Shing is the global head of equity derivatives strategy at BNP Paribas

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