The Red Queen Effect (RQE) is a metaphor derived from the Red Queen’s statement to Alice in Lewis Carroll’s “Through the Looking Glass”. The famous saying states that – to run hard to stay where you are or do nothing and fall behind. It takes place when the Red Queen sprints beside Alice in the novel at one point, calling out, “Faster, Faster!” However, Alice discovers during the race that despite sprinting as quickly as she can, neither she nor her neighbours have moved. According to the Red Queen Effect, organisms must continually adapt and evolve to continue surviving in their hostile environments.
RQE is a function of competition. Companies need to keep investing in themselves to keep evolving and changing with the times, else they always run a risk of being left behind by their rivals. We can understand this with the help of a few examples:
– Samsung is one of the market leaders in the mobile phone space, all over the world. Yet, it has committed to spend $15bn on a new semiconductor research hub, amid increasing competition and user demands
– Closer to home, Hindustan Aeronautics Limited (HAL) ended up spending ₹1967 Crs in R&D, to continuously bring technological superiority in a key sector for India’s success going forward – Defense.
“If you want to get somewhere else, you must run at least twice as fast as that!”
Mutual funds are another example of the RQE. Investors purchase funds that have provided the highest returns over the past few years without knowing the investment philosophy. The real kicker is that due to the law of diminishing returns, a fund that has previously achieved success has more difficulty to continue generating the same earnings. Therefore, you should look for a mutual fund with growth potential if you want to continue generating alpha.
Businesses continue to engage in the Red Queen Effect as they continually do things to remain relevant – sprinting and attempting to gain an advantage over their rivals or to simply stay alive. As opposed to five years ago, the necessity for constant development is now more critical than ever. It will only grow in importance over the coming years.
