thestreet.com good article. Bandwidth, the Next Great Wealth Creator
thestreet.com
By Andy Kessler
Special to TheStreet.com
5/26/98 1:34 PM ET
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.
Andy Kessler is a partner at Velocity Capital, and runs a
technology and communications fund out of Palo Alto,
Calif. This column is not meant as a solicitation for
transactions; it is instead meant to provide insight into the
methods of venture capital, technology and investing.
Under no circumstances does the information in this
column represent a recommendation to buy or sell
stocks. Kessler appreciates your feedback. |
