Andy Kessler: Bandwidth, the Next Great Wealth Creator
By Andy Kessler
5/26/98
Get excited about deflation? You're kidding, right? Well, this
is hard to explain to investors who are used to simple math
-- rising prices good, declining prices bad -- but Silicon
Valley elasticity economics are this weird inversion, the
exact opposite of common sense. Wall Street can't model
them like the expected return of a derivative or the future
value of an option. Instead, consider this: Declining costs
create new applications that open up to take advantage of
the cheaper functionality. Repeat this to yourself again and
again. Make it your investing mantra.
A conceptual image, but not conceptual results! Casio
digital cameras are an overnight success because the
memory to store images cost $1,000 five years ago and now
costs just $10. Internet access at 56K cost $1,000 per
month five years ago, and now costs as much as a local
phone call. My network at home (you'll have one soon) cost
$75, a hundredth the cost of an identical Ethernet hub from
Bay Networks (BAY:NYSE) seven years ago. That, my
friend, is deflation!
Now, imagine it's 1981. IBM (IBM:NYSE) has just
introduced the IBM PC, an 8088-based system with 64K and
an amber screen. But you know that Moore's law is going to
work -- i.e. 30% per year comes out of chip costs -- that the
market is elastic, that over a trillion dollars of wealth is going
to be created by 1998. You are staring down this deflation
curve that you know is elastic and you know is going to
work. You can invest anywhere you want. It's pretty exciting,
right?
Well, it's 1998, and you can see an almost identical curve.
Over the next three decades, 30% or 50% or maybe 70%
per year will come out of the cost of telecommunications
bandwidth. Just like semiconductors (insert mantra here),
growth in this sector will fuel trillions more in wealth creation.
The price umbrellas that almost guarantee this growth are
everywhere. Start with the fat 90%-plus margins regional
Bells get on $1,000/month high-speed 1.5-megabit T-1
access. Cable modems are at $50/month. How about long
distance? The "dime lady" will soon be a bag lady, as
Qwest (QWST:Nasdaq) is charging 7.5 cents; soon it will be
a penny. The post office is contemplating raising first-class
stamps to 33 cents. Go right ahead, as this will only
accelerate the move to electronic bill presentment and bill
payment. Time for another Elvis stamp to make payroll. The
list goes on and on.
This elasticity curve works, but transitions are violent. I think
back to October 1989, when I was new to Morgan Stanley
as an equity analyst tracking technology. For months, I was
pounding the table recommending Intel (INTC:Nasdaq), but
the stock kept going down, and most everyone at Morgan
Stanley was convinced that I was a worthless buffoon. Then
the United Airlines LBO unravels, the junk bond market
collapses, the Dow is down 180 points, everyone, myself
included, is in a deep depression. Yet that day, my boss at
the time, Rod Berens, buys a case of champagne and
throws a party in the hallway to celebrate. When I get there,
he gives me a high five and whispers in my ear, "It's your
turn." Now almost nine years later, I finally understand what
he was talking about: Market transitions are always violent.
This current transition started with the Asian crisis, featuring
the U.S. dollar and the long bond as safe harbor for world
capital. But faced with sub-6% returns, capital will seek
growth. The second shock was the rate scare on April 27;
there will be more shocks. The only long-term safe harbor
will be in markets and companies with a process to leverage
lower costs. Telecommunications markets are deregulating
around the world, increasing competition and destroying old
price umbrellas.
As this unfolds, global companies must lower their costs of
doing business, not by chasing cheap labor, but by using
cheaper decentralized computer systems optimized for
service industries. They must harness cheaper bandwidth to
shatter time zones. They must carefully divide their business
between hard assets and process, between the book value
on a balance sheet and the value of intellectual property,
between pricing power and elasticity. These companies will
drive the next bull market. Internet companies? Sure, but the
Internet is like 800 numbers, a tool for business, not the end
game. The so-called Internet bubble of today is like the
DRAM and PC funding bubble of 1983 and '84. It came, it
went, and only the real companies survived.
Silicon Valley is ready, and thanks to this funding cycle in
1995-96 (er, add '97 and, oops, '98 too) is well-capitalized to
provide these tools to the world economy. These tools are
uniquely American, and hence currency-neutral. The IPO
boom, monster Internet valuations and the subsequent
access to capital over the last few years are not wrong --
they are just overdone. But hey, that's capitalism. It is now
time for many of these companies to execute on the dream
they were funded by. The winners will be companies that
benefit not only from chip-price declines, but also from
bandwidth-price declines.
Still don't get it? Get a super ball; throw it as hard as you
can on Wall Street; watch as it bounces higher than you
thought it would. That is the power of elasticity and deflation,
and that is the engine for the next 30 years of growth.
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