stock bull,
I dont know if this has been posted:
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A Dell for every industry
Above the Crowd, by Bill Gurley
Mail to: atc@humwin.com
October 12, 1998
Economists love to argue about a phenomenon known as the productivity paradox.
The optimists aver that America is in the midst of a long boom cycle
resulting from increased productivity brought about by technology. In other
words, by replacing humans with software, companies win higher profits,
higher return on equity, and, as a result, higher stock prices.
The skeptics champion the notion of a paradox. They argue that return on
equity, margins, and profits have not improved markedly since the advent of
high-tech. Chief skeptic Paul Strassmann argues in his book Facts and
Fantasies about Productivity that computer technology in fact detracts from
productivity. He suggests that companies keep a tight lid on technology
spending unless they can specifically tie that spending to profits.
The problem with both the optimists and the skeptics is that they are
having the wrong argument. Tech spending needs to be considered in light of
the evolution of American and global business, because companies exist as
part of a competitive capitalist ecosystem. Technology extends the
capabilities of the members of this ecosystem. Playing out the evolution
metaphor, a good accounting system is equivalent to being able to walk
erect--add a Web site that's ready for e-commerce, and the corporation's
got the equivalent of an opposable thumb.
Companies, like species, are competitive beings, and while evolving on an
absolute basis is nice, relative evolution is the only thing that really
counts. If you only improve as much as your natural enemy, you've done
nothing to ensure your survival.
Considered from this evolutionary perspective, it's clear that arguing
about the productivity paradox is pointless. The optimists say that we
should all benefit somehow. But if one company uses technology to become
more fit, everyone else in the competitive landscape must do so as well.
Let's say the first mover goes after market share by lowering its price in
line with the efficiency gains it has won. Other companies will quickly
match its moves, to ensure that they don't lose too much market share. The
result? Profits and return on equity do not increase at all--in fact, the
only result is some temporary market-share shifts from the less efficient
to the more efficient.
As for the pessimists, well, choosing not to adopt technology is like
choosing not to evolve. As an example, consider the effect that the
oversized racket had on tennis. Old-timers scorned the new idea as somehow
improper, almost illicit. Now, however, every pro on the circuit uses such
a racket.
Are tennis players now more productive? Sure, they hit more aces--but so do
each of their competitors. The technology advantage is shared by both
sides. The game has absorbed the advantage, and the only person with a
demonstrable disadvantage is a fool who insists on using the small wooden
racquet of yesteryear.
Those still mired in the productivity paradox debate need to face facts. No
one can start a bank today with paper accounting ledgers. You wouldn't dare
try to build a competitive insurer, utility, manufacturer, or even retailer
without some form of information technology infrastructure. Imagine a
global company trying to manage its back office without technology--the
odds that big errors would occur are enormous, while the chance that this
company would effectively manage its balance sheet is next to zero.
In evolution-speak, the term "fitness" is often used to describe a species'
capacity for survival. From a corporate perspective, the best measure of
fitness is return on invested capital (ROIC), which measures a company's
true cash output relative to the total cash value of the assets deployed in
the business. The reason this measure matters most is that, over the long
haul, capital flows away from investment opportunities with a low ROIC, and
toward investment opportunities with a high ROIC. Inefficient companies are
eventually starved from the cash that they need to survive.
To truly understand just how indispensable technology has become, you have
to break down ROIC into its two key components: The numerator is its
cash-adjusted operating profit, while the denominator is the cash value of
the company's net capital investments. Divide both numbers by sales, and
you'll see that ROIC can be restated as operating margin multiples divided
by asset turnover.
In other words, the two critical components that define a company's fitness
are an ability to charge a higher spread between price and actual cost, and
the ability to generate more sales from a smaller base of invested capital.
Now let's take a look at how these two components are affected by
technology: A company can earn a higher profit margin if consumers think
its product is differentiated from others. That's why commodity products
have low margin and specialized products have high margins. Obviously, the
most differentiated product is something designed specifically for one
person. Technology is now helping companies do this efficiently.
The concept, known broadly as mass customization, is best exemplified by
Dell Computer, which builds millions of computers a year, each to the
specifications desired by the buyer. For one big customer, Ford, Dell has
established different PC configurations designed to suit different
employees in many different departments. When Dell receives an order for a
PC via the Ford intranet, it knows immediately what type of machine the
worker is ordering and what kind of machine he or she should get.
Ford pays a premium for such personalized service. Is the price worth it?
Consider the alternative. Ford could purchase its PCs from a local
distributor. The distributor would send boxes over to Ford. Those boxes
would need to be opened and configured by a systems worker. This process,
which is common at most companies, typically requires four to six hours of
a professional's time for each computer and often results in configuration
errors. Clearly, Dell's customization is worth the higher price.
The same is true for other custom products. Levi's is able to charge more,
not less, when it customizes a pair of jeans, and Mattel can be sure that
little girls will pay a higher price for a personalized Barbie doll. So
there's no doubt: companies are beginning to use technology to push margins
higher.
Let's now look at the other half of the equation: How can technology
improve asset utilization? Historically, most companies thought of costs as
the physical labor and raw materials that went into a product. However,
many leading-edge companies today are using technology to focus more on
another cost, the cost of capital.
This focus serves two purposes: First, a company that implements
build-to-order manufacturing or just-in-time inventory ends up with a much
tighter supply chain and much less capital tied up in inventory. Second, as
these companies are no longer building to potentially inaccurate forecasts,
they significantly reduce the risk of inventory waste. They can use their
cash in more efficient ways.
The lesson is clear: Companies with information infrastructures that allow
them to custom-build products are beginning to enjoy higher margins and
improved asset-utilization. In the quintessential reference book on
business strategy, Competitive Strategy, Michael Porter argued that
companies must choose between a strategy of differentiation or one of low
cost. The idea seemed to make sense, since it seemed that the only way to
ensure low costs was to crank out many products from a single mold on an
assembly line. But now we know more about the real costs of extended supply
chains. We know that consumers will pay to have more choices, and we know
that technology can help solve these problems.
Porter was wrong; you can have your cake and eat it too.
There is, of course, a catch. To achieve nirvana, you must have perfect
information about every customer order (new and old) and every asset in
your business (both permanent physical assets and various inventory
components). And guess what? The only way to secure, maintain, and harvest
this information is through the aggressive use of information technology.
By now, my point should be crystal clear. There is a new competitive force
emerging in the corporate marketplace. It can deliver a highly valuable
personalized experience at a lower cost than any of its competitors, and
its key competitive weapon is mastery of information.
Over the next ten years, companies that lack a competitive information
technology department will be in serious trouble. They will resemble a
beaten-up 40-year-old trying to win Wimbledon with a small wooden racquet.
Their business models may no longer be economically sustainable. Companies
like Dell has overcome an interesting new hurdle in the evolution of
business: negative working capital.
Because the time between when these companies manufacture and when they
deliver is so tight, the balance sheet portion of their businesses generate
cash as they grow. This unprecedented phenomenon allows these companies to
execute and grow without raising capital, even if day-to-day profitably is
zero. This is similar to being able to hold your breath for a really long
time. These companies are highly evolved creatures.
Of course, not all technology investments result in unmitigated success. To
prove valuable, technology must either increase customer satisfaction or
increase asset utilization. This is much more important than using
technology to replace labor with capital. What good is a robotic controlled
manufacturing facility if post-production inventory sits in the channel for
120 days? Tomorrow's marginal competitive advantage will be obtained by
gathering perfect information about your customers, your distribution
partners, and your suppliers, and thus tightening the supply chain.
Information is what is powerful, not technology alone.
The venture capital community is pressing this opportunity. Rather than
trying to build companies that sell technology to companies already
established in the marketplace, many investors have decided to instead
attack those entrenched players by creating technology-enabled competitors.
Silicon Valley VCs are now investing in information technology-based
grocery stores, toy stores, insurance companies, and more, in the hopes
that entrenched competitors will continue to fail to understand the
powerful new forces at work.
My firm has invested in one such company, called HomeGrocer.com in Seattle.
This Net-based grocery store has just 54 employees, but it already has
deployed six major infotech systems: a call center application, an
accounting package, a purchasing system, a warehouse-management system, a
logistics routing system, and a package that produces personalized Web
sites for customers.
In the warehouse, grocery packers have computers on their wrists so they
can pack each order as quickly as possible. The technology helps increase
margins by allowing the company to save customers' shopping lists (which
lowers costs and reduces the time taken to place each order), target
promotions, and charge premiums for fresh fruit (orders are placed nightly
with the
wholesaler). The technology also helps increase margins by allowing the
company to maintain an inventory level dramatically lower than that of a
brick-and-mortar grocer.
Business managers in traditional industries that think of technology as
more of a nuisance than a benefit should be concerned. For years, they've
run the risk that a competitor might wake up and take advantage of this
emerging business model. But they now also run the risk that some start-up
could invade their business.
Despite all this, many executives continue to believe that they are "not in
the technology business" and that they might just as well outsource their
information technology needs. This is like an athlete saying that he is not
in the strength business or the coordination business. As the marketplace
continues to evolve, these naysayers might as well say that they are not in
the business of being in business.
J. William Gurley 1997-8. All rights reserved. The information contained
herein has been obtained from sources believed to be reliable but is not
necessarily complete, and its accuracy cannot be guaranteed. Any opinions
expressed herein are subject to change without notice. The author is a
general partner of Hummer Winblad Venture Partners (HWVP). HWVP and its
affiliated companies and/or individuals may, from time to time, have
positions in the securities discussed herein. Above the Crowd is a monthly
feature focusing on the evolution and economics of high technology business
and strategy
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Also, this is a great book on the current deflationary environment:
amazon.com
Article in this weeks Economist on deflation:
economist.com
stephen |
