Monday, April 04, 2005

Enjoy It Now, You 2000

Forbes magazine Editor Rich Karlgaard serves up a nice piece on Creative Destruction that resonates with the thesis laid out in my book, Quantum Investing.
Enjoy!
(steve)


Save this issue of the Forbes 2000 and buy up any strays. You'll make money. These are sure to become hot items on Ebay in a couple of decades. Business schools will bid up their prices as professors seek to learn more about companies that made the FORBES list in 2005--and had vanished by 2025.

During the next 20 years this year's FORBES 2000 companies will depart the list in droves. A recent McKinsey study looked at the "topple rate" at which firms lose their leadership positions. This rate doubled in the 20 years from 1975 to 1995. Example: the minicomputer industry. It began, grew up, grew big, grew profitable, grew smug, grew senile and died in just two decades. Digital Equipment Corp. slid from greatness to the grave in those years. It lives as a ghost with the Duryea Motor Wagon Co.

Why did the topple rate double in those years? Credit two factors: information technology and risk capital. In 1975 Sears thought IT was about payroll. Sam Walton held an expanded view: He saw that IT offered a smarter way to manage inventory and distribution. Thus did Wal-Mart leap ahead.

In 1978 the capital gains tax was 49%. What small morsels the government left on the table were eaten by inflation. Thus did risk capital attempt to hide in dead assets such as gold and collectibles for most of that rotten decade. But in 1979 the cap gains rate was cut to 28%. Then Paul Volcker killed inflation in 1982. Risk capital took notice and began a rush back into productive enterprises. The Dow went from 777 in August 1982 to 11,723 in January 2000. And a great storm of creative destruction was let loose.

You Ain't Seen Nothing

The topple rate could easily double again from 1995 to 2015. That's what a pair of McKinsey consultants suggest in a paper called "Extreme Competition." (You can find it at mckinseyquarterly.com.) I agree with them. Here's why.

• Just as 1975 was the dawn of the cheap computer age, 1995 was the dawn of the cheap network age. It was only ten years ago that the Netscape Web browser appeared. Even then most users got to it via a slow dial-up connection. What will the average connection speed be in 2015? Surely enough to allow for TV-quality video on your computer.

• The pace of technology is not slowing down. It's speeding up. You might miss this if you look solely at software performance on your PC. The revolution has jumped outside the box to BlackBerrys and iPods and to the Web and Web-applications.

• The back side of Moore's Law is more important today than the front side. The better-known front side says that chip performance doubles every 18 months. The back side says that prices drop 30% to 40% per year at a constant performance. The back side is the reason we have $290 handheld Treo 650 Web browsers and $249 Apple iPod minis with6-gigabyte hard drives.

• The back side of Moore's Law explains why there are350 million cell phone users in China now. A price tag of $100 for a cell phone or $300 for a basic PC seems to be the tipping point of digital affordability in countries such as China and India.

• Cheap tech greatly expands the supply of talented workers around the world.

The effect of the Cheap Revolution is anyone's guess.I would bet on another doubling of McKinsey's topple rate. McKinsey itself predicts "three broad consequences--the aggregation of formerly distinct markets; enhanced market clearing and efficiency; and greater specialization, particularly in supply chains."

McKinsey makes a good point about aggregation: "Competitors in one geography can compete in another because of falling shipping costs, lower search costs for consumers (as a result of the ability to find sellers on the Internet, for example), or both." Yep--this explains the success of Amazon.com, Ebay and countless smaller retailers.

But cheap tech and global labor pools will disaggregate many industries, too. This is already happening. Growth rates of "fabless" chip companies (that design in the U.S. and farm out manufacturing) have outdone giants such as Intel over the past ten years.

Remember, too, that talent is not a commodity. Given a choice, talent usually prefers to work in nimble companies with plenty of upside. In the old days the downside of small-and-nimble was limited access to resources and distribution. That's changed. Cheap tech and shrinking transaction costs within supplier networks are two trends that outpace any large company's ability to adapt. Size may come to matter less; talent will matter more. Some big vertically organized industries could be blown apart and rearranged into networks of talent.

Auto Industry Blowing Apart?

Here's a wild speculation. The auto industry will look far different in 20 years than it looks today. It's ripe for disaggregation. Imagine that you, as a consumer, want a car designed by J Mays, but you want it to come with some futuristic 400-horsepower Toyota-hybrid engine, a BMW rear-wheel-drive feel and a Jaguar-looking interior to be equipped with Qualcomm broadband. Will you be able to buy best-of-breed, à la carte, 20 years from now? I think so. Look at the trends. Talent: dispersing to best-of-breed suppliers. Global labor costs: dropping because of oversupply. Distribution costs: dropping because of the Internet. Consumers: growing smarter.

Conclusion: unstoppable.

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