NEW YORK (Dow Jones)With Silicon Valley still in a state of postNasdaq bubble trauma, Valley figurehead Andy Grove's famous maxim "only the paranoid survive" is being put to the test.
During the current economic slump, the Intel Corp. (INTC) Chairman's words taken from the title of his 1999 book have broad implications, not only for his company's own audacious plans to go after new markets, but also for the prospects of the U.S. economy as a whole.
When the economy was zipping along at breakneck pace in the latter half of the 1990s, this concept of paranoia in the high tech sector the belief IN THE permanent risk of having your competitors' new technology render your products obsolete was one of the conceptual pillars of the so called New Economy. In trying to explain the U.S. economy's newfound ability to sustain high, noninflationary growth, many economists identified its role in creating a virtuous, self repeating growth cycle in which investment, innovation and relentless competitive pressure fed off each other.
It was a compelling theory, at least when U.S. growth was consistently topping 4%. But now that the economy has experienced a painful slowdown, with the high tech sector going through what Grove himself has called a recession, New Economy ideas have been discredited. See, the skeptics now say, the business cycle is not dead after all, it was foolish to believe demand would continue to meet an ever increasing level of supply.
There is little doubt that many lost sight of these basic rules last year: the Nasdaq index's precipitous slide is evidence of investors' failure to consider where the demand needed to justify last year's lofty valuations would come from. But perhaps the more important question is whether the virtuous cycle of investment, innovation and growth is itself dead.
Grove, for one, seems to believe strongly in the continuation of the cycle, regardless of his pessimistic reading of the current short term environment. The biggest evidence of that is that Intel, despite facing a thin revenue year, has set a 2001 capital spending budget of $7.5 billion, up from $6.7 billion last year, and is dedicating $4.2 billion to research and development, all to revolutionize its chip making process and develop new microprocessor products for wireless devices and high end servers.
Hearing Grove justify these expenditures in recent media appearances it seems that fear of being beaten to new technology by the competition and not euphoria, is at work. Remember, though, in Andy Grove's lexicon, paranoia is not a dirty word.
If other companies like Intel are sufficiently scared of being beaten by their competitors to make what writer Michael Lewis calls the New New Thing, then the virtuous investment cycle could soon get a nice booster shot.
In fact, other high tech heavyweights are turning a blind eye to the slowdown in demand for technology that has sent lesser Silicon Valley companies to the grave this year. Witness Microsoft Corp.'s (MSFT) bold move into computer game technology and its planned October rollout the new XP operating system. International Business Machines Corp. (IBM) executives are also talking big, making projections for $80 billion in revenue from wireless technology by 2003 and boasting of a breakthrough in disk drive technology that will quadruple the data density of computer hard drives.
"I think (this investment wave) reignites the cycle," said Jim Glassman, senior economist at JPMorgan Chase. "It tells me there is a whole new wave of innovation coming that is going to be driving down costs." Creating Demand?
What excites Glassman and other New Economy enthusiasts is the chain reaction effect of these investments. New, faster processors from Intel (and from "paranoid" competitors) could inspire the development of new wireless devices, for example, while the more advanced features incorporated into Microsoft's new operating system could spearhead the development of new software.
The problem in fact, the fundamental lesson of the high tech sector's recent fall from grace is that the success of all this investment depends on there being sufficient underlying demand for the new products. And, while it is often said that necessity is the mother of invention, Silicon Valley often operates as if the exact opposite is true. And it's not hard to imagine situations in which they are right: when a businessman is confronted with a new high tech product he may recognize a hitherto unknown newly efficient way of doing things that makes the product a must have. He'll need it for the simple reason that his competitors will also have access to this technology the same paranoid cycle is at work.
But none of that offers a guarantee that demand will be there in the end. Investors learned quickly of the dangers of making such assumptions during the Nasdaq bubble.
Ultimately, it all gets down to the end users: the consumers. These are the folks who keep the companies that buy high tech products and services afloat. And while household spending data appears to be holding up reasonably well despite the sharp slowdown in manufacturing, there remains a big risk that sluggish stock markets and layoffs will yet lead consumers to rein in spending.
If the underlying demand doesn't materialize, the virtuous cycle of invention, obsolescence and competitive investment could finally come to a halt. The problem and it is a big one for the U.S. in general is that the cycle could then be very difficult to get going again.
"Inventive activity is what economists call a long-time-to-build investment,' says Leonard Nakamura, an economic advisor at the Federal Reserve Bank of Philadelphia who has written extensively on New Economy trends. "You are very reluctant to cut it back, but if you do cut it back you tend to stay out of the business for quite a while."
In other words, if you want the good times to continue, you've got to hope that the Intels, Microsofts and IBMs of this world have good reason to stay paranoid.
By Michael Casey, Dow Jones Newswires; michael.j.casey@dowjones.com; 2019382009
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