The argument against computer service stocks as investments runs like this. The really enormous profits from technology comes from building once and selling a million times. Microsoft designs and builds one copy of WINDOWS 2000 and each succeeding copy costs the company about zero to "make". So they build it once and sell it a million times. It's tremendously profitable. In the service business, to increase your business x fold you have to multiply your employee count by a factor of x. One company can only find so many bright people. So as they expand they hire some employees who are not so talented. The profitability thus decreases.
The counter argument to this is: with experience in a certain kind of job, for example, inventory management, currency conversion, what not, smart companies doing these tasks acquire proprietary software. Even smart individuals acquire proprietary tools for doing certain tasks more quickly than most can do them. Ask any programmer with decades of experience. The proprietary software does not exist as complete standard packages which can be sold by the million in shrink wrapped form. Instead it exists as sections of code, partial programs, code libraries etc. These can be used in various specialty areas such that the service programming company knows it can bid low in these areas and get lots of business because it has proprietary short cuts in the form of code already built. So there is a long term tendency for the profit margin to increase, i.e. for profits to grow faster than sales. In other words we can increase profits faster than we increase the number of employees. We should look therefore for a low turnover of employees and repeat business in specialty areas. The strong attraction of this kind of company, when well managed, is that we attain a kind of immunity against technological change. Even the mighty windows O/S can in principle be replaced in the future, by UNIX(that won't happen soon) or by some invisible system up line on the web that the end user doesn't know or care about(this looks likely happen in the decade which begins next January 1). But the service business will always remain. The key to success is management's nimbleness in anticipating the future and shifting their people well in advance into areas which give promise of growth.
We hear, year after year, that the end user has no further need for computer speed. But each increase of computer speed increases the range of practicality for new technology, e.g. voice recognition, robotology, context sensitive language translation, highly complex problem solving etc. and increases the areas in which we need some software specialist with experience and cannot expect easily to hire a team for an in house development. Outsourcing reigns. Packaged software is per se the most profitable, there's no doubt about it. But rapidly changing technology creates the risk of replacement of the software whereas the service company can keep shifting its emphases. I conclude that one should own both kinds of investments. |
