The Neuberger Berman Global Sustainable Equity (GSE) Team prefers to analyze the world using a “Value Chain Lens.” This means that, instead of analyzing companies according to their sector or location, we look at how they fit into the value chains that we believe are most tightly woven into the key long-term transitions in the modern economy. We believe this Value Chain Lens allows the GSE Team to view environmental, social and financial sustainability issues from different perspectives; to better understand technological development and disruption; to identify the competitive forces acting across a value chain; and to select the “Transition Winners” who occupy durable competitive positions, “do no harm” to the environment or society, and have the ability to adapt to change. The Value Chain Lens captures most of our daily economic lives: how the economy is powered and how enterprise evolves, how we stay healthy, and how we consume, pay for and finance our activities.
Sustainability issues are complex and the GSE Team’s Value Chain Lens provides the different perspectives that supports the holistic thinking needed to analyze them. Sustainability captures both environmental and social issues, and these are often interrelated, creating “meta-problems” and interlocking crises. As early as 1972, just before the world’s first oil crisis, the Club of Rome viewed the environmental and social problems facing mankind as interrelated meta-problems that constrained economic growth. In 1987, the World Commission on Environment and Development published the Brundtland Report, “Our Common Future,” which defined “sustainable development” as "development that meets the needs of the present generation without compromising the ability of future generations to meet their own needs." This definition underwrites that sustainability is about stewardship of resources between generations, which is complex and requires a long-term perspective in decision making by politicians, regulators, consumers and investors. We believe that the secondary market in listed equities can play a pivotal role in financing the transition towards a more sustainable society. In 2020, the constituents of the MSCI World Index generated an impressive $3.3 trillion of cash flow out of their operations. Via good governance and sound, long-term capital allocation decisions, these cash flows can be used to serve more sustainable objectives.
The GSE Team has defined five important value chains in the modern economy: Energy Transition, Access to Healthcare, Conscious Consumer, FinTech & Financial Inclusion, and Digital Enterprise. Within the Energy Transition value chain, we search for Transition Winners that are facilitating the electrification of the global economy, via infinite energy resources such as solar and wind, and enhanced energy efficiency, thereby contributing to the mitigation of climate change. Access to Healthcare is about identifying diseases, finding more customizable cures and offering more accessible and affordable quality care for everyone. The Conscious Consumer makes better informed purchase decisions based on social and environmental considerations as well as price: these might be the health impact of a product, or human and labor rights in its supply chain; or the carbon, resource and waste footprint of a product and its packaging. In the FinTech & Financial Inclusion value chain, traditional bank branches and cash withdrawals are being replaced by digital transactions in financial apps, and innovative products are increasingly designed around data, ratings and analytics, facilitating trade on virtual platforms or exchanges, and raising the importance of sustainable finance. And finally, the Digital Enterprise Value Chain Lens recognizes that tomorrow’s economy will be driven by connectivity, and by building both tangible and intangible capital via computing power that expands at the pace of Moore’s Law—enabling innovations such as efficient cloud hardware, algorithms, machine learning, artificial intelligence and virtual reality in the metaverse.
As the GSE Team searches for corporates with a durable competitive advantage, it warily acknowledges that technological development and related disruption are constant threats for established franchises. The Value Chain Lens helps here, by uncovering new developments, creating awareness of competitive forces active at the value chain system level, and identifying genuine sources of durable competitive advantage—or “moats.” In the Energy Transition value chain, for example, who would have thought that France’s brilliant nuclear engineers would one day face significant competition from a technology such as photovoltaic (PV) solar cells? That is the new reality, looking at today’s levelized cost of energy, a measure of the cost of electricity generation over an asset’s lifetime: the average cost of a new PV system is around $47 per MWh, while building a new nuclear reactor costs almost $460 per MWh—close to 10 times more expensive.
Unsubsidized Levelized Cost of Energy in France 1H2021 ($/MWh, nominal)
Source Bloomberg NEF as at 13 December 2021.
This transition to new, more sustainable power generation has additional, deeper consequences for a range of sectors. Traditional electricity generation assets are centralized, built by industrial companies and owned by utilities. By contrast, a lot of the new power generation assets are likely to be decentralized, owned directly by residential and commercial clients, and increasingly built by the semiconductor industry. Centralized power generation needed investment in heavy transmission infrastructure, while a decentralized system needs investment in local distribution or even on-premise micro-grids. This is a great example—and far from the only one—of how technological development and related disruption can have dramatic consequences for many parts of the economy and its participants.
The GSE Team’s Value Chain Lens also helps to get a better understanding of competitive forces acting on specific parts of a vale chain, or a particular company. The “Five Forces” model proposed by Michael E. Porter in the 1980s identifies them as (1) competition in a particular industry, (2) the potential for new entrants in that industry, (3) the power of suppliers, (4) the power of customers, and (5) the potential for product substitution. In this model, the number of players in a specific market is relevant as well as the respective concentration of market shares. Looking again at the power generation example, we prefer the market for solar inverters (which make the electricity output of solar panels suitable for residential usage) over the market for solar panels, because the former has only a few dominant players whereas the latter is divided up among numerous competing suppliers. Solar inverter manufacturers have built a high level of intellectual property, protected by patents, and are now building brand recognition for the quality of their products and warranties, raising high barriers to new entrants. Their suppliers have limited power, because most solar inverter components are commodities, while essential components are designed and built in-house; and their customers, who are mostly small, local solar system fitters, also struggle to achieve power through consolidation and concentration. The incentive for product substitution is also low, in our view, partly because solar is very competitive versus other sources of energy generation, but also because panels and installation costs are the largest spends within solar energy, with solar inverters being just a small part of the total investment.
We see a similar durable competitive position for solar inverter manufacturers when we look at our own criteria for “economic moats”: (1) A high level of intangible assets, which allow companies to price their products and services in line with their unique characteristics, such as patented technologies or brands; (2) Network effects, which increase the value of a particular good or service for both new and existing users as total usage increases; (3) Irreplicable process advantages, superior location or access to a unique asset that creates structural cost advantages; and (4) High switching costs, which exceed the expected value of switching, or would be disruptive to customers’ day-to-day operations. The solar inverter market has built valuable patents and is now building respected brands; we see that strong relations with fitters can create a network effect, as the sharing of system experience and warranty costs brings down total costs; patented technologies and economies of scale give the largest players production cost benefits; while fitters and residential and commercial clients will be less likely to switch if they have a good installation and product experience and can see the benefits of the integration of total system monitoring.
We think that this example shows how the Value Chain Lens allows the GSE Team to get a more comprehensive understanding of sustainability and competitive forces in the modern economy, which helps us to identify its most likely Transition Winners.
