The most attractive thing about high technology is its exciting promise. The ugliest thing about it is money.
Of course, innovation can’t live without money. Capital, after all, fuelled the high-tech revolution.
But money has been doing the opposite. Instead of stoking the fire that drives technological innovation and development, capital is leaving technology in the ashes.
It’s more serious than just the kind of market “correction” that’s implied by the dot-bomb interpretation of the current market slump. In fact, the tech sector can’t possibly recover without recasting the fundamental ideas about what it means to invest in technology.
The problems started on May 1, 1975 when Washington deregulated the U.S. brokerage business. Brokers, who had previously earned their profits by taking commissions on sales based on the advice they offered clients, found their incomes dropping. So they started looking elsewhere for cash, and they settled on the investment banks for fresh business. In the 1980s that meant mergers and acquisitions. In the 1990s, it was the initial public offering (IPO).
The search for new sources of revenue coincided—luckily for the brokers—with the sudden explosion of high technology. Kids who had graduated in the 1980s from universities where they enjoyed free Internet access were desperately looking for ways to remain wired, and many were turning their considerable talents to making the Internet available to all people. The combination of easily over-inflatable promises of a glorious tech-improved future and a lot of loose cash looking for a lucrative parking space proved to be the fuel which made high tech burn so brightly.
But the roller-coaster ride didn’t really start until June 1995, when Netscape Communications Corp. issued its famous IPO, based on an unfinished Web browser that the company was giving away for free. Within one day, the stock—bought almost entirely by institutional investors and favoured customers of the houses brokering the deal, rather than the general public—multiplied to several times its original value.
Wow, said the investors. Fired by the realization that the World Wide Web would be the Next Big Thing, frenzied investors then jumped on Yahoo, eBay, Amazon and hundreds of other technology IPOs. Such was the demand that companies no longer had to be profitable to go public; many offered IPOs within months of attracting venture capital. By 1999, there were 547 IPOs in all sectors, raising $68.8 billion for the U.S. companies.
The pattern was an exercise in greed. Brokers would embrace any company making vague promises of high technology, and offer it to corporate insiders and favoured customers. When the stock leaped (the bigger stocks jumped as much as 400 per cent to 500 per cent on the first day), these initial buyers would then “flip” it on to what is condescendingly called the “aftermarket”, or individual private investors.
That’s where things got awkward. After the institutional investors made their profits by owning the stock for just a few days, private investors—ordinary pensioners, lunch-bucket workers, office paper-pushers and widows, who are so often cited as the backbone of the stock market—ultimately ended up losing big time by buying overheated stock.
The cash seemed to bypass the companies themselves. By the end of 1995, six months after its overcooked IPO, Netscape was still giving away its browser and its server to non-profit organizations (which meant just about everybody), making a modest income from the few people who actually paid for the browser and from a number of commercial server sales. The company earned $14 million in revenue, and had managed to accumulate a $4-million loss.
It was a scene worthy of inclusion in Charles Mackay’s classic 1841 book called Extraordinary Popular Delusions and the Madness of Crowds, which dealt with mass hysteria, including investing schemes that created stampedes such as the Mississippi Madness, the South Sea Bubble and “tulipomania.”
Ultimately, the bubble burst, and investors realized they were holding a bag created by hucksters, and so tried bailing out. Stocks crashed everywhere. Nortel, Canada’s high-tech darling, lost $167 billion off its peak value in July 2000—a drop of 95 per cent.
This is all a matter of record, and has been hashed over by journalists. But journalists themselves have also been complicit in this nonsense by applying the rules of celebrity journalism to the investment community, pumping up their glamour and, by implication, their wisdom.
So what was the final effect?
The gap between the investors and the products in which they invested has grown into a chasm. When investment is no longer based on a company’s viability, then it is also not based on the viability of the product.
In short, the insanity of the late 1990s showed that many investors no longer cared for what high-tech engineers had created. Instead, they watched the behaviour of other investors and mimicked it. And investor behaviour is a fickle thing, subject to the kind of “national delusions” that Mackay described more than a century and a half ago in his book on mass madness.
Sadly, however, high tech was actually creating tangible products—something our increasingly service-oriented society is backing away from—while the brokers were pumping up their value based on nothing more than people’s investing patterns.
Even the corporations themselves jostled to put their front hooves into the profit trough. Many enterprises were being run by managers more than willing to please the investment community, and worked on the outrageous understanding that 25 per cent or 30 per cent annual corporate profits were not only possible, but they were necessary for their continued employment. Emerging from business schools where they had been baptized into the buzz religion of “shareholder value”, they did everything in their power to satisfy the investor, leaving the product and their customers well down in their list of priorities.
High tech was particularly vulnerable to this. It was a nascent industry started by geeks in desperate need of business acumen. It naturally attracted young, aggressive MBA graduates who found themselves presiding over stratospheric corporate valuations of companies that produced items that often were a complete mystery to the people controlling the purse strings.
In fact, the product no longer really matters. It has fallen victim to a direct corollary of the belief that graduates, if they use the tools they learned in business school, could run any business at all, whether it was making potato or silicon chips.
Superficially an attractive concept, the notion of management’s estrangement from the product started to show its weakness when corporate structures became populated entirely by people who knew little about the products they made and cared less for them. At the end of the day, managers considered themselves successful only if their efforts paid off handsomely to the investors.
“Shareholder value” became an article of faith, and suggesting it is a flawed concept that amounts to a confession of heresy.
Where does all this leave technological innovation?
Innovation continues to march on, regardless of the mood of the investor. The people who make microchips, monitors, modems and media continue to invent, create prototypes, market and sell their products—except that now they have to do it in an atmosphere too smoky for frightened investors to breathe.
Not much has changed in the production end of things since the boom years. Innovation continues to leap forward. For example, a company such as Fujifilm introduces a new line of cameras every six months, each one a quantum technological leap ahead of the previous model. Intel, 3COM and a newly revived U.S. Robotics are also producing new networking products at a pace that can make one’s head spin. And it’s hard to keep up with the latest developments in digital cellphones (Nokia, Siemens), or the new XML-based software for Web servers (Macromedia, Microsoft).
Sure, these are large and stable companies with wise and responsible management and investment backing. But size doesn’t guarantee success. The relationship between high tech and the investment community is so strained that some large-enterprise honchos are turning to drastic measures for the sole purpose of maintaining “shareholder value.”
That’s the sole basis of the blockbuster merger between Hewlett-Packard and Compaq, which is nothing less than an attempt to keep company value pumped up by laying off enough people to populate a small city.
That was also largely the reason for the collapse of Enron Corp., > the energy broker whose accountants threw numbers around until it looked like they were massively profitable. Instead, they flamed out after faking $68 billion in equity. That was followed more recently by WorldCom, a telecom that had succumbed to the same kind of accounting legerdemain and confessed to a $3.8-billion overstatement.
All these practices—from “flipping” fresh IPO stock, through management’s lack of interest in its products, to honky-tonk accounting—have combined to burn the product out of the picture.
What we have to remember here is that high technology, unlike almost every other industry over the past few hundred years, was created and perfected mainly by kids, and that the corporations intentionally lagged way behind. We were introduced to this odd situation in which corporate customers—the ultimate customers of all this new technology—followed the crowd instead of leading it. They stalled buying the technology until the acne-ridden kids working at home had poked at the products long enough to expose and correct their problems.
Many had hung on to their corporate Windows 95 operating systems well into 2001, declaring, “Why should we upgrade? We finally got it stabilized.” What they really meant was that shareholder value would suffer if they spent cash buying and configuring a newer operating system.
The tide has changed a bit, and some of the more responsible corporations have taken a stronger leadership role in innovation. But technology is still mostly a young innovator’s field. And so the new kids, instead of being nurtured, tend to be side-stepped as the remaining tech-oriented investors move their money into larger and safer portfolios.
Still, investors behave in strange ways even when it comes to responsible high-tech giants. Microsoft benefited recently when its stock rose abruptly one day in early June. The Reuters News Agency story described the movement this way: “Microsoft Corp. shares rose almost 6 per cent in heavy trading . . . on a rumour that the company would pre-announce that it expects to beat its fourth-quarter forecast, analysts said.”
Translated, this says that investors moved millions of dollars based on a rumour, which was based on an as-yet-unmade statement that would be based on a future statement about the company’s expectation of future earnings. That’s at least four degrees of separation from reality.
It was reassuring, then, to hear some of the upper management of tech giants speak up against this nonsense. Xerox chairwoman Anne Mulcahy was one of the first to buck the “shareholder value” mentality when she recently exhorted her fellow CEOs to be more realistic and abandon the long-term profit predictions on which investors have come to depend upon each quarter.
“The expectation that we should be able to deliver the outlook for a full year on earnings per share to the penny is bizarre,” she said.
The downside of no longer issuing long-term predictions could mean companies would take short-term punishment on the stock market, she told The Globe and Mail in May, but it would improve productivity.
Sadly, it’s not likely that Mulcahy’s clear-eyed argument will be taken very seriously. No sooner were the words out of her mouth before Xerox Corp. was forced to restate revenues over a five-year period to the tune of about $2 billion because of a “hole” in its books.
But the investment community is still being guided by twitches and hints from the corporate financial wizards—not on corporate or product viability.
Craig Barrett, CEO of Intel Corp., the world’s largest chip-maker, flirted with a similar theme a few weeks later in his keynote address at the Supercomm 2002 conference in Atlanta. The communications industry must reinvent itself through innovation, he said in a carefully-worded speech. He added that “the focus during these difficult times should be the return the industry generates on its capital investments. To improve on this return, innovation must pervade all aspects of the industry from value-added services and software to the underlying communications infrastructure.”
At the bottom of that soothing management patter is a simple but powerful message: Innovation must return to being the fuel that brings a return on investment.
It will take more than a few exhortations for the situation to change. For innovation to fan the flames of the profit-making process, investors and corporate honchos are going to have to get some fire in their bellies first, and make the tough decision about what business they’re in: technology, or shareholder value.
