Briefing.com Stock Brief: Platforms, Tools, and Applications
21-Aug-01 08:40 ET
[BRIEFING.COM - Robert V. Green] The pyramid paradigm for thinking about technology stocks is particularly useful in times of a technology downturn, like we have now, because it tells you where to be when the upturn finally happens (if it happens).
How To Think About Technology
No wants a technology product.
They only want the solution that technology provides.
An old saying that illustrates this is:
If you could buy a box of holes, no one would buy a drill.
This is an important concept to remember, particularly in times of a technology spending downturn. Technology is an expense, which must show a return to the end user.
The Pyramid
There are three levels to the technology pyramid:
- Applications: the product that actually delivers the solution
- Tools and Components: pieces of technology that are used to build applications
- Platforms: the essential infrastructure necessary for running or using the application
Platforms are the best investment of all, because everyone must purchase them. From developers to end-users, the platform is required. During the mainframe era, IBM was the platform. During the PC era, Intel and Microsoft were the platform. Today the platform, going forward, is the database, on the software side, and networking hardware. I argued eight months ago, and still believe, that the database has become the platform of the internet era. It is no longer necessary to have a PC to make use of the internet infrastructure that has been built, and PCs will likely become less important, not more, in the future.
Tools companies and components have technology companies as customers. They are used to build applications, or other tools, that the technology company adds value to and sells. Tools and component vendors suffer the most when applications vendors suffer. Furthermore, it is extremely difficult to stay "on top" as a tools vendor. Technology changes so quickly that the power-tool of today quickly fades. Whatever happened to Powersoft and Intersolv? Tools companies ride short waves.
Applications are the reason that anyone buys technology in the first place. From desk-top applications to enterprise wide software solutions, the application solves the business problem that was of interest in the first place. Applications, particularly enterprise applications, can be the most profitable technology solutions of all, because the pricing, historically, can sometimes be based on the reduction in expense to the enterprise, and not on the cost of development.
Applications that are sold on the traditional software "upgrade" model, however, suffer in technology downturns. Their customers postpone upgrades. In addition, as a product gets more and more refined, upgrades become less useful. Best is the application that is sold incrementally as the customer's business expands. Portal Software is an example of this type of business model.
Microsoft is one of the few companies that dominates all three levels. They used their monopoly power in the operating system platform to develop strong tools products (and destroying Borland in the process), and then proceeded up the ladder to dominate desk-top applications (and destroying Lotus and Wordperfect in the process.) Microsoft would never have been able to do this without owning the platform first. They were also fortunate to be developing these businesses during the technology boom of the 80s and 90s.
Downturns
There is no question that we are in a technology downturn. Corporate spending for IT (information technology) products has declined across the board. Some companies, like GE, are still investing heavily in technology, as an expense reduction through efficiency. But, in general, IT spending hit a brick wall in the spring of 2001.
This has had a severe impact on technology stocks. It couldn't have happened at a worse time, since the market's return to traditional valuations after the bubble, means lower multiples on lower revenues, with lower growth expectations. It is no wonder that so many tech stock prices have been hammered.
So how do you play tech stocks, in a broad sense, in a downturn? This table summarizes each domain.
Applications
Opportunities in Downturn
Selective. Companies dependent on the the "upgrade" business model are hardest hit. Applications which reduce an existing expense can succeed.
Trends in Upturns
Companies with the largest customer base usually win. A new application must be radically different.
Tools and Components
Opportunities in Downturn
Few. Until the upturn starts, it is usually unclear what tools are essential.
Trends in Upturns
The tool de-jour can be a big winner, but it is difficult to stay on top.
Platform
Opportunities in Downturn
Buying opportunity. Downturns offer cheaper prices, but patience is required.
Trends in Upturns
Rapid expansion as all levels of the technology infrastructure begin buying.
Upturn Expectations
None of this thinking matters if you don't expect an upturn in technology spending by corporate America.
Corporate spending budgets are usually set in the fall. Major investment banks, like Goldman Sachs and Morgan Stanley, do annual surveys of corporate IT departments in January to attempt to gauge the overall spending levels of IT departments. What will next year bring? At the moment, your guess is as good as anyone's as the budgeting process hasn't even started at most major corporations.
But waiting until early February, when the survey results are published may be too late. By that time, early word of the survey results will be common talk on Wall Street. Certainly the overall mood in the technology sector is worsening, not strengthening, but that doesn't mean corporate America will abandon investment next year. We will have to wait and see.
If you want encouragement on the future of corporate spending on technology, listen to a Jack Welch speech. He has directed all of General Electric to invest heavily in technology. But Jack is retiring soon.
Summary
Here's the whole summary:
- We are in a technology spending recession.
- If (big if), if you believe an upturn is coming, then:
- Buy platform investments now.
- Avoid tools and components companies (at least until the upturn comes).
- Be selective about applications. Avoid business models dependent on upgrades.
When is the technology upturn coming? That's a completely different topic. Unfortunately, there isn't enough evidence for us to say it is right around the corner. (See the Stock Brief of 26-Jun-01, Where Have All The Growth Markets Gone? for more on the disappearance of the great growth markets Message 16000408.
But, if and when you feel that it isn't long before corporate America begins investing heavily in technology again, then the above grid may be a useful construct for beginning to make new investments.
Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com
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