|  By
Bahram Mahbod, Ph.D.
After
an extended period of spectacular and heady growth the United States’
economy officially entered a recession in the fall of 2000. A recession
is defined as two consecutive quarters of economic contraction,
so necessarily it is declared in hindsight. Likewise a recovery
is not recognized until it has been underway for some time. In any
recession, as well as any recovery, not all sectors comprising the
economy behave similarly. It is not unlikely that in any recession
one might find sectors experiencing growth while others performing
far worse than the rest of the economy.
The technology sector, which led the economy in perhaps the longest
period of U.S. economic expansion, is the sector that has been impacted
the most during the current economic downturn. If fact, the recession
in this sector has been so severe that some have compared it to
the Great Depression of the 1929 in the United States, during which
substantial amount of wealth vaporized and the industrial and financial
landscape was drastically redrawn. Others draw comparisons to the
recession of 1973 – 74, which also had profound impact on
the technology landscape and subsequent to which only a handful
of the technology leaders of the time survived. The crop of familiar
influential mega companies of today, the likes of Cisco, Microsoft,
Intel, and Oracle, were either non-existent or in their infancy
at that time, and the large technology companies of the period have
either disappeared or are but a shadow of themselves today (IBM
being one exception).
The changes happening today in the technology sector as a whole
are tectonic in scope, resulting in a massive restructuring of the
sector. The demise of some high profile companies such as Enron
and WorldCom, and the severe difficulties faced by other former
powerhouses such as Northern Telecom are the staple of business
news programs and publications. Quite a few large and small technology
companies have lost substantial amount of their market valuation,
in excess of 90% in some cases. The impact of this down turn in
the technology sector is pervasive, but perhaps no more palpable
than in silicon valley in the San Francisco Bay Area, the technology
capital of the world. A substantial number of commercial buildings
is vacant and carries ‘for lease’ signs. Some estimates
have put the commercial vacancy rate in excess of 40% and growing.
Buildings have gone unoccupied for so long that some are being sold
in auctions for a fraction of the estimated cost. According to the
latest reports unemployment stands at 7.9% in the Bay Area, which
is substantially higher than historical norms. What is remarkably
different about the unemployed work force in the Bay Area today
is the atypical nature of it. A substantial number of the unemployed
in this market is from the ranks of highly skilled individuals,
some educated at the most prestigious engineering, business, and
law schools, many of whom were attracted to the booming technology
sector, particularly in the late 90’s, and who in many cases
are now left with the little valued and lugubrious stock option
certificates of their former high flying companies. In the face
of such severe economic malaise in the technology sector the key
questions that arise are when will this technology downturn end?
Will the previous growth rates resume? Who will be the survivors?
Is it likely that we will enter a period of prolonged economic stagnation
similar to the one Japan has been experiencing over the past several
years? To answer some of these questions, one needs to study other
hot sectors in previous time periods and understand how industries
within those sectors fared over time. While one can argue that each
industry has its own unique traits and developmental path, there
is substantial amount of historical evidence to suggest that in
fact there is also a large degree of commonality in the way such
industries grow and mature.
Historical Evidence
Two industries that are most interesting and relevant as a study
vehicle for predicting the development of the technology sector
are the railroad and the automobile industries in the United States.
From their inception these two industries have had the kind of profound
and pervasive impact on the economic development of the country
that the technology sector has today on global development. Just
as the dawn of the Internet is profoundly affecting and enhancing
the way people and businesses communicate and interact, the establishment
of rail connectivity across the continental United States dramatically
changed people’s lives. The automobile industry also impacted
the society with similar depth and pervasiveness.
In the early days of the railroad industry there were in excess
of 200 railroad companies, along with a substantial number of component
suppliers providing the various parts and subcomponents for the
locomotives, the tracks, the facilities and related industries.
Likewise, in the 1920’s there were in excess of 800 automobile
companies in the United States alone. By the 1950’s the landscape
had narrowed considerably, only four major auto companies had remained,
Ford, General Motors, Chrysler Corp, and American Motors. Today,
auto companies are operating at the global level, and only two “American”
auto companies remain, Ford and GM. The model of operation is quite
different than in the earlier days. Mass market automobiles are
not designed top down, rather around existing components, and it
is not uncommon for competitors to use the same parts and components.
Likewise the railroad industry is down to five players, only one
of which is focused on human transportation today.
Similarity In Tech
The technology industry is going through the same maturation process,
albeit at a much faster pace. As in the early days of the railroad
and auto industries, there have been myriad players providing multiple
components with comparable functionality, yet sufficiently different
as to make the products uninterchangeable. This incompatibility
is particularly conspicuous in software related components. If a
large company wants to automate its business processes, the customary
approach has been to engage a consulting house, which then recommends
the various software components from the vendors of its choice,
and then spends significant resources and time to integrate such
components. The net effect is a complex and custom implementation
that is costly to maintain and upgrade over time. This is not unlike
how automobiles were built in the early days. Likewise, in the early
days of the Microsoft Windows operating system users had to acquire
various components from alternate vendors, and there were multiple
offerings for each subcomponent such as networking. Over time as
the capabilities were built into the Windows operating system these
component vendors were marginalized. Today the information technology
spending, commonly referred to as the IT budget in organizations,
constitutes a major item of expenditure. The key issue for businesses
is therefore is the optimization of their investment in information
infrastructure, which in some cases is the largest cost item.
In the 90’s businesses went on a frenzied technology acquisition
spree as a defensive tactic, worried that any hesitation would cost
them their competitive edge. The issue of analyzing the return on
investment was deferred. The spectacular failure of some high profile
technology integration efforts, combined with the economic downturn
and focus on cost, has now brought the analysis of the return on
infrastructure investment to the fore. Companies and businesses
are concerned about the costs of integration, maintenance and future
upgrade of their technologies, and survivability of their technology
suppliers has become an important consideration.
Unfortunately this does not bode well for smaller niche suppliers,
which have narrow product lines and provide only a few components
of the overall system. Furthermore, because of their feeble size
and cash position, their survivability comes into question, which
in turn exacerbates their revenue generation problems. Additionally,
as larger companies expand their product offerings to include more
pre-integrated components, these smaller players are marginalized,
much the same way as Microsoft did to companies providing networking
stacks and other components for Windows. In the context of enterprise
software, companies such as Oracle Corporation and German enterprise
software giant SAP are providing more complete and integrated sets
of enterprise application management solutions that are ever expanding,
taking business away from the smaller niche players such as Ariba,
Inc., e-Piphany, and Manugistics. A recent survey of the Chief Information
Officers (CIO) of companies has only solidified what has been suspected,
that the approved vendor lists are getting shorter, with the large
technology companies moving to the top of the list. In most cases
the majority of the IT spending is slated to go to only a few names
at the top of the list, such as Microsoft, Cisco, Oracle, SAP, and
IBM.
Winner Takes All
The technology sector also has a “winner takes all”
characteristic that sets it apart from the other industries. Because
of the vast impact and dependency technology creates, the market
gravitates towards “standardizing” on one technology
at the expense of other competing ones, since so much investment
needs to go into building complementary components for a particular
technology. This positive feedback loop very quickly confers “gorilla”
status to a particular technology company and hastens the demise
of its competitors. Sometimes the winning technology may not be
the very best, it is other non-technological factors that crown
it. For example, Microsoft’s Windows desktop operating system
pulled away from its competitors very rapidly, since the industry
needed to standardize on one in order to build complementary components
around it. Another example in the consumer space was the triumph
of the now ubiquitous VHS video recording format at the expense
of the superior Betamax technology. In order for the video production
and rental industries to grow it was necessary that only one format
remain, and factors other than technology were responsible for the
demise of Betamax. The dominant positions of Oracle Corporation
in the database market and Cisco Corporation in the router market
are also examples of this phenomenon.
What consolidates the position of such companies in their respective
markets is the cottage industry that grows around them, making their
products ever more complete. More importantly, however, it is the
prohibitive cost of switching away from the particular technology
that entrenches such companies firmly in the market. While superficially
it may appear that one can move information from one relational
database to another, or replace one router with one from another
vendor, in practice this is extremely costly but for the most trivial
applications. It is precisely this immense switching cost factor
that confers gorilla status on such companies, making it extremely
difficult to dislodge them. Furthermore, as a gorilla builds a large
client constituency, in tough economic times when there is a scarcity
of new clients, it can go back to the existing customer base and
generate more revenue by cross selling, a venue not open to small
competitors, even those with superior technologies. In downturns
and tough economic times these well-entrenched companies gain market
share at the expense of their competitors, acquire new technology
inexpensively as the valuations tend to be lower, and generally
further consolidate their positions. In previous recessionary times
Applied Materials, Inc., a dominant supplier of chip manufacturing
equipment, has expanded its product line and its technical capabilities,
and in every subsequent recovery has emerged a stronger competitor.
It is important to distinguish the gorillas from other large erstwhile
successful companies whose continued success may be untenable. It
is such companies that during tectonic moves are at risk of falling
by the way side.
There
are a number of large previously successful companies that unlike
WorldCom and Enron are not saddled by debt, and in fact are sitting
on large cash positions, whose position in the market place is at
risk. These companies are not gorillas; their technology can be
replaced with relative ease. A discontinuous innovation, defined
as a process of commoditization and mass-market development, at
times combined with a change in technology which competes with the
products of such companies, poses the biggest challenge to such
companies . Past examples of this are the commoditization of the
graphic workstation market by Intel and Microsoft, unseating the
prior highflying king of the market Silicon Graphics, Inc., and
the demise of Digital Equipment Corporation at the hands of Compaq
Computer Corp. and Dell Corporation. Some current giants that are
at risk today are the vendors of Reduced Instruction Set Computer
(RISC) based processors for enterprise computing. The power of fast
evolving commoditized processors from Intel Corporation and the
freely available and rapidly improving Linux operating system is
making it possible to run major applications which otherwise would
have required more expensive systems from such vendors. It is likely
that the market for large expensive computers produced by these
companies will narrow. Even if RISC processor technology maintains
its performance lead, it becomes increasingly difficult to compete
with the economy of scale created by the commoditized processors.
Once the early adopters have proven the viability the mass adoption
rate accelerates rapidly.
It is not the case that such companies are oblivious to the market
transformations and the commoditization process. A number of constituencies
and management groups within these companies are fully aware of
what is transpiring. Unfortunately some of these companies get caught
in a cultural bind that prevents them from transforming themselves.
Ironically the same culture that helped them succeed will become
an impediment, and unless they are able to transform themselves
they continue down the same path until failure, acquisition, or
marginalization. Previous examples are Silicon Graphics’ foray
into large enterprise servers when the culture of the company and
its core competency was built around the graphics workstation market,
and Digital Equipment Corporation’s attempts at building workstations
and competing against Sun Microsystems and Compaq when their culture
was built around mini-computers and vertical markets.
It Pays to Be a Gorilla
The longer the technology depression lasts, the better the opportunity
for the gorillas to quash their weak competitors and consolidate
their already formidable positions. So long as they are not threatened
with a discontinuous technology challenge to their cash cows, they
continue to thrive and prosper. Opportunistically they venture into
new markets that take advantage of their competencies and allow
them to leverage their significant position in one market for success
in another. Cisco Systems’ entry into the storage switch market
takes advantage of Cisco’s considerable experience in network
switching design, and its huge footprint in the enterprise market
poses serious threats to technology vendors in that space such as
Brocade Communications. Likewise, Oracle Corporation’s entry
into the Application Server market leverages Oracle’s significant
technology experience in the enterprise database market, and its
huge installed base of some 200,000 customers offers it the opportunity
to compete against and displace much smaller niche vendors such
as BEA. Microsoft’s entry into the game console business against
such entrenched rivals such as Nintendo and Sony is another example
of such moves. Microsoft can leverage its core competency in consumer
operating systems and its strong channel partnerships to advance
its agenda and gain market share against the existing competitors.
The gorillas, enriched over time by having had highly successful
and profitable cash cows, can afford to stay in the game and outlast
the weaker competitors, who become more disadvantaged in difficult
economic times.
There are other advantages the gorillas enjoy that are not easily
shared by weaker competitors.
On the global scene countries with a highly skilled labor force
with much lower labor costs and a stable political environment are
becoming economically attractive to the large entrenched companies.
Communication inefficiencies and other cultural impediments are
far outweighed by the sheer economic advantages of expanding technology
and product development activities in these countries. Such difficulties
are ameliorated over time as large multinational companies gain
experience in global development. Examples of such countries are
Ireland, India, and most recently mainland China, where economic
development zones have been established. Gorillas are global in
nature and already have presence in these countries, and can and
will expand their facilities very rapidly, allowing them to keep
the research and development costs low while increasing the output.
It is much more difficult for smaller companies to overcome the
logistical difficulties of establishing facilities and coordinating
activities on a global scale.
Summary
So does this mean that small companies will face dire prospects?
Not so at all. In the auto industry, there are a large number of
small companies that produce goods consumed by larger companies
who in turn produce more complex parts which are ultimately consumed
by the handful gorillas of the auto industry. Similarly, as the
technology sector matures, the gorillas in each technology will
completely dominate their respective markets. There will be substantial
opportunities for a host of small companies whose products complement
their respective gorilla’s, and whose livelihood is tied to
the success of the gorilla. Such companies will be successful and
profitable, but the likelihood of their becoming another Cisco or
Microsoft is miniscule. As the gorillas of the mature sectors have
shown, with maturity the opportunity for discontinuous innovation
diminishes, allowing the entrenched gorilla to prosper for a very
long time, only to be dislodged by severe self inflicted wounds
and not from any external threat. The longer the inevitable economic
recovery is delayed, the more the technology demand will build,
and this can only be good for the gorillas of the technology sector.
[1] Geoffrey Moore has coined the term Gorilla in reference
to a dominant company with defensible technology position. For an
in depth treatment of the unique characteristics of the technology
sector please see his book, “The Gorilla Game”.
[2] Dr. Clayton Christensen addresses this topic in his great book,
“The Innovator’s Dilemma”.
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