Breakthrough Ideas (Continued)
Qualcomm’s Strategic Dynamic Path
The Threshold of Significance. In network markets, the principle of increasing returns promises exponential profits to any company that becomes a de facto standard because its proprietary, but open, architecture controls a crucial technology interface. Because ideas create wealth, my intention in formulating the theory of dynamic paths is: (a) to help investors identify key significant events in the unfolding process of developing strategic architectural control, and (b) while keeping in mind the inevitable tradeoff between risk and reward, to identify as early as possible, but no sooner, a threshold of significant strategic advantage.
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In New Rules for the New Economy, Kevin Kelly (1998, pp. 23-38 and p. 161) discussed Brian Arthur’s idea of increasing returns, which implies, “as the number of connections between people and things add up, the consequences of those connections multiply out even faster, so that initial successes aren’t self-limiting, but self-feeding.” In discussing the successes of Microsoft, Fed Ex, and the Internet, Kelly offered a biological insight. Their successes became runaway events, each with a tipping point like that of a raging epidemic that suddenly becomes wildly out of control. After indicating there had always been a tipping point in any business, industrial or network, after which success feeds upon itself, Kelly argued that the network economy depressed tipping points to a lower threshold than in industrial economies. This lower threshold for tipping occurs as a function of network economics¾after the initial expensive copy, a knowledge company has low marginal cost to replicate copies and low transaction costs to distribute copies, profiting from increasing returns to scale on both the supply and demand sides.
Kelly (p. 55) cited the MIT economist Paul Krugman as saying that you can reduce the idea of the network economy to this observation, “in the Network Economy, supply curves slope down instead of up and demand curves slope up instead of down.” The traditional model of supply and demand taught that as a resource is consumed, it becomes more expensive to produce, and thus, prices go up, driving demand down. In contrast, because knowledge is a resource that can be used simultaneously by many people without ever using it up, the more an idea is used, the more demand to use this increasingly popular idea increases. And, as demand increases, supply, rather than diminishing, increases still further. This is so because of the learning effect, the more “spread spectrum chips” QCT supplies, then the easier it becomes for them to create an ever-larger supply more cheaply. Each doubling of the cumulative amount of supply-produced yields about a 20%, more like 30% for semiconductors, increase in the amount produced at a constant cost.
The increasing returns from combining demand- and supply-side scaling exponentially explode Moore’s already exponential law, which is already periodically producing ever-doubling functionality at ever-lower prices. Thus, the classic supply and demand curves become inverted because each follows the Principle of Increasing Returns. In the network knowledge economy, products become more valuable as demand increases, and products becomes ever cheaper as supply increases. If you will, the synergy of Moore’s Law and the Principle of Increasing Returns creates a double-doubling set of dynamic forces that explode these runaway markets, detonating both ever-increasing demand and ever-increasing supply at ever-lower prices. The winners are consumers, a society’s standard of living, and the company controlling the architectural standard, which gains a temporary winner-take-all monopoly.
According to Kelley (1998. p.34, emphasis added), “Lower tipping points also mean that the threshold of significance¾the period before the tipping point during which a movement, growth, or innovation must be taken seriously¾is also dramatically lower that it was in the industrial age. Detecting developments while they are beneath this threshold of significance is essential.” He (p. 35, his boldface) concluded, “In the past, an innovation’s momentum indicated significance. Now, in the network environment, where biological behavior reigns, significance precedes momentum.”
The investing idea behind the idea of strategic dynamic paths is the promise of unusual reward for discovering a threshold of significance before the momentum that follows from the tipping point has been widely perceived and discounted in the marketplace. If this approach proves successful, it would mean that its analytic strategy might succeed in reducing an investor’s residual uncertainty below that of the market as a whole.
Shannon’s principle was, “unexpected information reduces uncertainty.” Here, the unexpected information is to come from recognizing the emerging signs of significant strategic architectural control before others use the more obvious momentum of its business gains to recognize a winner. The wedge of theory produces an analytic edge that reduces uncertainty by early identification of a company’s future potential. Future potential is a joint function of an expectancy (a subjective or objective probability) that a company’s strategy for gaining strategic control will succeed and the value of that success. Thus, the concept of future potential is not necessarily incompatible with a view that a tradeoff exists between risk and return because it accepts that the future is difficult to predict, with only rare exceptions. Instead, it claims the level of residual uncertainty is a perceived value that hypothetically springs from the best available information and sound judgment, but, in reality, both information and judgment vary within normal limits in a population possessing bounded rationality.
Granted, the future is necessarily uncertain and difficult to predict, but if you are unwilling to assume some risk, you are not a stock investor. Investing strategies are the human’s best effort to deal with company-specific risk. Any coherent, logical, data based analysis that reduces the level of residual uncertainty below its common mean increases the investor’s probability of success. Judging the future potential of Qualcomm must be grounded in an inductive analysis of strategic and economic competitive advantage by using some conceptual model. Thus, a strategic-dynamic-path analysis of a company’s future potential portrays a company’s present dynamic position and posits a scenario of increasingly probable significant and consequential events along its dynamic path to strategic architectural control that, in turn, drives market dominance. If the theory of dynamic paths is logically coherent and inductively corresponds to nature, then its inventive features may well reduce residual uncertainty below that of, say, the average sell-side analyst.
If architecture has competitive advantages, then evidence of who controls it counts. If a strategy is to succeed, it should be coherent and consistent with successful strategies in past standards wars. If a business design focuses on meeting the needs and priorities of its customers within a profit zone, then it is planned with an eye on success. If it is also well executed, then it leads to success. If investors are to succeed, they must know something the market has not already discounted. To meet these goals, nothing is as practical as a good theory of strategic investing. On behalf of the Theory of Dynamic Paths, I claim: technology matters; strategy matters; economics matter; information matters, expectations matter, future potential matters, and judgment matters.
A probable scenario of an enticingly significant future may or may not meet your investment needs. If not, continue to monitor the company’s journey along its dynamic path (and the price of the stock) until enough events unfold to meet your personal threshold of significance.
Bounding Qualcomm’s Threshold of Significance. The focus of analysis in the theory of dynamic paths broadens to include both the process of generation of innovations and the process of diffusion of innovations. When a knowledge company bets it future on its ability to shape the future, they are betting they know something extraordinary about developing a technology and a strategy for diffusing it.
About forty years elapsed between Claude Shannon’s ideas about the unexpected as informative that inspired a modulation theory of how to spread the spectrum and its commercialization by Qualcomm. What’s more, over 80 years passed before the technology necessary for direct conversion within a baseband integrated circuit became possible. This required advances in sold-state physics, the invention and development of integrated circuits, and rapid evolutionary progress in ICs to overcome the 100dB difference on the same die between analog signals and UHF circuit blocks. The ZIF architecture also had to overcome other limitations, for instance, necessary RF components were cost-effective only at certain operating frequencies.
This is not unusual in the history of science and technology. What is possible in theory is often difficult to realize in practice. Many years may pass before a scientist can move from theory to having the tools necessary for basic research. Past tracer studies analyzing the Innovation-Development Process revealed that the move from basic research to development and commercialization often takes twenty years or more.
A major technological advance requires not just one innovation but also a cluster of interrelated innovations, often a dozen or more. Technologies are often functionally interdependent, requiring convergent and conjoint operation, needing a union of separate but integrated resources to solve a problem. New recipes combine an ever-increasing set of hard-won building blocks into new unified systems. In this instance, the commercialization of CDMA required integrated circuits that had not been invented when the theory was devised. In fact, commercialization of spread spectrum required an advanced generation of DSPs that was not available even half a dozen years earlier when digital TDMA came along. However, leading-edge technology companies stay abreast of science and related technologies so they can strike when the iron is hot to commercialize a new process and set of products.
Ideas create wealth. Qualcomm understood the significance of the idea of universal frequency reuse in the modulation theory of spread spectrum, how to translate spread spectrum theory into tightly integrated CDMA practice (including the breakthrough idea of advanced power control to solve the near-far problem), how to translate its software algorithms into customized and hardwired spread spectrum ASICs, how to use the strategic competitive advantage of its architecture, which enabled next-generation advances in spectral efficiency and packet-data performance, how to become a standard by demonstrating its excellence to prove its excellence, how to continue to develop new architectures that optimized high data rates or simplified direct conversion that permitted single-chip integration of multi-mode functions across different band and networks, how to protect and profit from its intellectual property during a standards war, and how to develop and nurture a value web, how to grow its standard-based business into an expanding, integrated, stabilizing and standardizing platform, and how to continue shaping the future of its business landscape. The profits it reaps are a small price to pay for its advances in mobile communications that enable so much social and economic progress.
What were the key events in Qualcomm’s dynamic path to strategic architectural control? The answers have been repeatedly foreshadowed. Surely, you recognize that they include the original inspiration and engineering instantiation of the three breakthrough ideas. But, to make it more exciting, let me posit that two significant events, about fifteen months apart, bound Qualcomm’s threshold of significance¾a potential point of early investor entry because Qualcomm’s strategic competitive advantages must be taken seriously. An initial momentous event marked an early point of entry, given a theory that crystallized its meaning, and a second key event formed an upper bound where the case became more obvious, an event where residual uncertainty was further diminished, enabling more of us to see its investing implications.
Not only that, let me claim that these two consequential events, when placed in the context of all that was happening in the business landscape at that time¾a hard fought 3G standards war¾would be sufficient, given they were analyzed through the theory’s eyes using the informational resources available to readers of stock bulletin boards, to select Qualcomm as a World Ruler in 1998. I make the claim for its dramatic impact, but also to demonstrate that it is possible to analyze world-ruling companies before the stock’s price explodes and they become famous exemplars of exponential stock growth.
George Gilder (2000, p. 92) described the first momentous event, “The key breakthrough¾so little recognized that Qualcomm’s stock rose just 3% during that year¾came in January 1998 when the European Telecom Standards Institute (ETSI) endorsed CDMA as the next generation of GSM.”
The second consequential event occurred in March 1999 and confirmed the first: Ericsson dropped its legal action claiming “blocking” patents against Qualcomm, licensed CDMA, agreed to pay standard royalties, purchased Qualcomm’s infrastructure division, joined Qualcomm’s value chain, and jointly agreed to endorse three versions of a single 3G spread spectrum standard. After this event, it would be difficult to fail to understand that Qualcomm owned essential IPRs that were necessary for all versions of spread spectrum, the single 3G standard despite having three variations on the theme. The bottom line of Ericsson’s surrender read that Qualcomm was entitled to receive IPR royalties from every vendor of all 3G handsets. (However, note that the question of whose ASICs would be used in 3G still faced difficult-to-bound residual uncertainty.) After this event, the stock price began to increase significantly, even to runaway as its momentum increased throughout 1999, rising 26 times the year’s opening quote.
What did this first event mean? It meant Europe’s so-called telecom leaders were going to adopt CDMA instead of GSM for 3G. Why? If you filter out all of the vicious expectations’ management, like “CDMA violates the law of physics” and “Jacob’s patter is just blind faith, exaggeration, and mendacity,” and if you set aside Ericsson’s patent violation suit as a frivolous and unfair business practice, the meaning becomes a transparent deductive conclusion: Therefore, CDMA architecture must offer superior performance, so compelling that Europe’s “leaders” must eat crow and adopt it.
Simple conversion to the “true” architecture would be an extraordinary way to end a next generation “religious” war. Naturally, Europe claimed its “wideband” architecture represented the “true” 3G messiah. Thus, Europe could and did continue to call its crow “pheasant” by its “invention” of Wideband CDMA. Whether called expectations management or FUD, the intent of this spin was to generate fear, uncertainty, and doubt among the populous about who would achieve strategic architectural control.
The issue of the moment changes, but spin is always with us. If you cannot learn how to wade through the continuous FUD, your personal threshold of residual uncertainty remains too high to invest in Qualcomm. Simply put, the economic stakes are too high for competitors not to spin expectations. But, if you remember that Qualcomm demonstrates excellence to prove excellence, solid ground exists amidst the fog and FUD. This comforts investors who are committed to the values of science and logic.
However, before the Ericsson capitulation, given the ETSI decision alone, the conclusion that spread spectrum architecture was now judged to be superior to Europe’s GSM by ETSI itself was logically compelling. Why else would Europe adopt it for its third generation standard? |
