By Andy Kessler BANDWIDTH ARTICLE
Special to TheStreet.com
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. |
