Into the New New Economy: Old Models and New Tools
Eli M.
Noam
Columbia
University
April
10, 2001
Keynote
talk to the German Economic Forum, Cologne
We find ourselves today in one of those great
divides of economic history, where we can either go forward into the unknown,
or go back, with a sigh of relief, to familiar territory. The new
economy—dot-coms, new style telecom entrants, new media companies, e-commerce
sites etc.—has become an old-style bust. The adults are back in charge. Legacy is in. Balance sheets are in Blue
chips are in. We need not listen anymore to the purveyors of hype, about how
bits play by different business rules than atoms, how the silicon economy is
different from the carbon one, and how a P/E ratio need not have any E that
stands for earnings, as long as that e-stands instead for electronics.
All this was mostly hot air, but its promoters had
success and riches as their unassailable arguments. And where were the controls to irrational exuberance, the serious
journalists, the academics, and, above all, those allegedly rational financial
markets? We certainly have learned that
financial markets do not work well or quickly as information processors in
periods of fundamental change.
In that gold rush, some top American business
schools lost 20 % of their students after their first-year summer job, not
because of poor grades but because the opportunities of the new economy proved
an irresistible siren song. Other students were sitting in the classroom,
day-trading with their tuition money. But now students have returned to
old-style B2B and B2C again, back to banking and back to consulting.
Now the tables are turned, and the contempt has
changed direction. Stars have now become shooting stars. Now the New Economy
types are the butt of a global and gleeful outpouring of schadenfreude.
Yet it would be tragic if we would let the pendulum
swing too far, use this breathing space for smug self-satisfaction rather than
regrouping, retooling, and re-planning. The black ships challenging the old
economy may have retreated over the horizon, but they will be back. No temporary slowdown should obscure that we
have just gone through something very fundamental.
We have gone through arguably the most creative
period in business history, ever. Even after the meltdown, more wealth has been
created in a shorter time than ever before. (Of course, more wealth has also
been lost in a shorter time than ever
before).
The “new economy” was a gigantic redistribution of
resources and control, from the old to the young; from the industrial sector to
the service sector, from blue collar to white and black collar, from Europe and
Japan to America, from the East Coast to Silicon Valley, from everybody to Bill
Gates. And now, the reaction has set in.
We often hear a comparison of the new economy
speculative bubble with the Dutch tulip craze of the 17th
century. But that would be unfair to
the tulips. Their growers never pontificated about the new civilization and new
economy they were creating, all they wanted was to create beautiful flowers.
And we should also note that tulips are still a very good business for Holland,
which has ever since the bubble burst been the world’s market place for
flowers. Each night flowers from all around the world converge by air to
Schipol airport and trans-shipped again within hours to global destinations.
Many of the trades are based today on Internet transactions. This marriage of 2
bubbles—tulips and e-commerce-- seems to work remarkably well, a much better
business than the flower dot-com business, which gets more headlines but less
volume. Last Valentine’s Day; there were 22 e-flower companies in the US. This
Valentine’s day, there were only 4 such companies left, and of those 2 were
shaky, and the other two did most of their business off-line. Whereas the old
Dutch flowers business, with its new web tools, is more successful than ever.
There is a real lesson here: take old business substance, add new business
tools, and you have a powerful combination.
Now that the dust is settling, what have we learned
about the new economy?
All economic goods are a mix of the physical and the
virtual, of the material and the informational. A TV broadcast is purely
informational and on one extreme, and a stone quarry is on the other. Most
goods and services are in-between, such as tourism or automobiles. There are
also differing mixes of processes in producing the good. Airlines produce
physical transportation, but use enormous amounts of information systems in the
process, much more than garbage collectors, who are also in the transportation
business. Typically, firms are the more information intensive in terms of
inputs and process the more numerous and volatile the variables are that they
need to manage, and the larger the business activities are. Not surprisingly,
the change to the new economy has been most profound the when the economic good
is information rich and its production is information-intensive, such as
financial services. Change is even more
profound where the good in question has not been feasible without the new
technology, such as in the case of consumer-to-consumer auctions.
Change is perhaps most disruptive when the good in
question used to be physical but now flips to the digital, which might be in
store for books and magazines once the displays become truly user friendly.
Change has also been profound in the infrastructure that enables information
processes, in particular telecommunications. And it has affected virtually
every firm in its internal processes.
Different countries are affected differently,
depending, among others, on their economic mix. The U.S. had a troubled
industrial sector, and the new economy was a way to resume growth. The US
society also is capable of change, being perhaps strongest in situations of
accelerating change --“2nd derivative” situations. In contrast,
Europe and Japan had stronger old economies, and are stronger in managing
steady growth –“1st derivative” economies. And less developed
countries had, for a multitude of reasons, the greatest difficulties of
changing to new economy activities, primarily because these require substantial
societal modernization and infrastructure investments.
The digital economy is
subject to severe shocks and discontinuities. The industrial revolution was not
linear, either. There were recessions and depressions. In the 1830s, 1840s, 1870s, 1890s.
Intellectual movements like the Romantic Movement rose in opposition, as they
do today. Over-expansion is a hallmark
of health, not weakness. Early railroads were vastly overbuilt in the US. One
could take 12 different private railroad routes between NY and Chicago alone.
There were hundreds of companies making automobiles, motorcycles, airplanes,
and microcomputers. One of the
functions of slowdown is consolidation.
That is, to reduce competition. To reduce the commodification that
lowers profitability and investments.
Another lesson we have learned the hard way is that
E-commerce operations are difficult. Vastly more is
involved than running a website and a shopping cart. Many systems need to be in
place and integrated. Supply chain EDI, Payment systems, Integration with
financial institutions, Fulfillment systems, Customer data mining, Production.
Customization, Community creation and maintenance, Creation of consumer lock-in
by additional features. Intermediaries need to be re-shaped. Processes are
accelerated. Domestically and internationally, at lightning speed, with great
reliability, with easy scalability, and flexibility of configuration. It’s not
for amateurs, as a lot of hopefuls have found out.
All this is till truer for the emerging broadband
Internet. The costs for consumer e-commerce sites will skyrocket. Text and
stills will not be good enough in a competitive environment, and expensive
video and multimedia will be required.
What are some of the
implications?
Instead of being that frictionless competitive
capitalism that people rhapsodized about, many parts of the new economy will
actually be a hotbed of market power.
·
Economies of scale are back.
On the supply side, the fixed costs of e-commerce
operations tend to be high, but the variable cost of spreading the service to
the entire world are relatively low—the classic attributes of “natural”
monopoly with electronic tools, intra-company transaction costs decline. On the demand side, there are “positive
network externalities” of having large user communities. Put these three things
together –high fixed costs, low marginal costs, and network externalities-- and
there are real advantages to being large.
For a while, we could ignore
these economies, because the inefficiency of the incumbents masked them, and
provided an umbrella. But the inefficiency has declined with threats of
competition, and now economy of scale and scope are back, and the small
entrants are on the ropes.
The implication is that
·
E-commerce markets will
often be less competitive than brick-and-mortar markets.
This is what this consolidation period is all about.
To get out of the commoditization of the new economy, in which companies were
running on their financing rather than on revenues and cash flows is worked for
a while, with stocks rising, and with the expectation that the new companies
would be bought by the old companies for huge premiums. But now, some of the
most likely buyers are slowing down, by their own actions. Telecom companies, for example, have
mortgaged their credit rating for the licenses of 3G wireless and for
international expansion.
The new economy favors the big. But is it the new
big or the old big? When insecure
customers brave into the new economy, they want to feel safe about the deal and
the quality of the merchandise, and whether that dot- com will be around next
week. Established brands are trusted (But at the same time, such brands will
not remain static. The tools of individualization will assert themselves, and
create customized branding, and a hierarchy of sub-brands and meta-brands).
Those without quality brand will have to find market
niches, and some of those we will not like as a society. The often anonymous
and offshore nature of transactions will inevitably lead to consumer protection
issues. In other cases, societies and established interests will desire to
expand old rules to new activities, such as for e-medicine or distant education
or e-stock transactions. This will lead to a situation where
This is quite different from the conventional story
of the libertarian cyberspace. It is a noble vision, but it will not prevail.
There will be too many losers to the new economy, too many problems they can
seize, such as impressionable children and helpless adults, for e-commerce to
be a libertarian island.
In fact, electronic flows will become so important
that there will be entirely new types of efforts to control them. Within a few
years there will be attempts to control the velocity of information flows on a
macro level, like money
The new tools
Thus it seems that the new economy will not look so
new, after all. But that would be the
wrong conclusion, too. Just as in 2000 some people claimed that the old rules
do not apply, we should now not conclude in 2001 that there is nothing new
under the sun. To the contrary. The last few years have created a set of
enormously powerful tools that have not even begun yet to transform the old
economy.
Perhaps the biggest problem for new economy firms
was that they had to do at least 2 big things at once: first, to develop new
business tools and models. And second, to enter and compete in a substantive
market they did not know as well as established old economy firms did.
The new
economy firms are retreating, but their tools go marching on. And these tools
are now available to the old economy firms.
We are moving to 2-way interactivity, customer identification, customer-centric marketing customer self-segmentation, customized marketing, and customized production. All this challenges the basic concepts of the industrial age mass-production and mass marketing. Dell Computers is selling made to-order equipment. Some websites charge people different prices depending on exhibited shopping behavior. But on the whole, business has not begun to integrate this individualization tools into their business processes.
Broadband Networks.
In the past decade, the Internet revolution was
mostly driven by advances in bit processing technology. Transmission, in
comparison, grew more slowly. But that is changing. We are reaching the end of
the narrowband Internet as the driver of change. We are now engaged in the next stage, that of expanding to
broadband. Networks are growing from skinny to fat. For George Gilder, the rate
of transmission capacity increases twice as fast as Moore’s law. That is, a
doubling every year, or even more. We are moving from the kilobit stage of
telecommunications to the megabit stage.
Communications become largely distance and time insensitive,
flat-priced, ubiquitous and always-on. A commodity.
This capacity and price revolution has not yet been
absorbed into economy and business behavior. It will enormously affect mass
media and marketing. The velocity of knowledge distribution. And the very
structure of markets and of companies themselves. Firms will increasingly
become networks, and integrators.
Suppliers, producers, and distributions will cluster in networks. The
workforce is distributed worldwide. Some of these networked relationships will
compete with each other, others collaborate in meta-networks. The ability of
firms to be part of networks becomes critical.
·
Machine to machine
communication.
As processing becomes cheap, it will be anywhere. Computers
and cell phones have started to be given away for free. People will be the
minor part of information generators. We move from person-to-person to
machine-to-machine communications. Data machines will be everywhere. The IP protocol will be in every device.
Suitcases will complain to airlines.
Electronic books will download from publishers. Front doors will check in with police
departments. Pacemakers will talk to
hospitals. Light bulbs will haggle with utilities. Television sets will
download from video servers.
Increasingly, devices will communicate with each
other and control business processes, bypassing the slow and unreliable human
element for routine transactions.
Many business processes will be automated, such as procurement,
reducing input cost. 15% are often promised, 5% are more realistic and add up.
Internal and external coordination increase, and production cycle accelerate.
Databases becomes a resource used in real-time operational, not an archived
resource as in the past.
Mobility.
Mobile communications operate at narrowband
capacity. Despite the UMTS hype about wireless video etc, we’ll be lucky to get
ISDN speed. And mobility is not a good environment for most transactions and
content. We should therefore not
over-estimate M-commerce as the savior for the laggards of e-commerce. At the
same time, it provides geographic and temporal ubiquity, and, with adequate
security provisions, a micro-transaction billing mechanism. In a next version
of WAP it might also have an always- on connectivity, like I-mode in Japan,
which is not a matter of higher speeds but of packetization and of a sensible
billing arrangement. Always-on,
everywhere, is a truly revolutionary development. Because it makes increasingly
most people in the world totally connected to each other, all the time. And
they will never go back and disconnect. Always-on mobility is also a tool that
has not yet been really created and absorbed into the business process.
Encryption.
Encryption translates into an ability to create micro-payment systems, which create the economic foundation for many new business activities. Advertising models, and subscription models have not worked. We need direct payment models like the rest of the economy. "If you can’t bill it, kill it" will be the test for many electronic transactions. Automatized micro-payment systems will create revenue streams that make business models possible. But so far, they have not been convenient, and have not been absorbed into business processes.
So far, we described new tools of the new economy
that are mostly technical. But there are also institutional and psychological
tools. These include
Vast institutional network of VCs, angels,
incubators, investment banks, and exchanges has emerged around the new economy,
and has created financing channels of risk capital of awesome magnitude. These
investment changes will not go away.
·
Mindset and style
The sociologist Max Weber showed us how mindset
affected early 19th century economic transformation. This is true
today, too. The new economy is also a mindset. It has shown us what amazing
things it can accomplish. But changing the culture and style of organizations
is the hardest thing to change. Change management becomes a priority.
Old and new styles will not easily merge. We are only at the beginning here.
We have not seen yet the virtual organization, the network organization.
Conclusion
The new economy is proving to have many similarities in its market structure and policy issues as the old economy, and will therefore be absorbed by it. It has created important business tools, models, and styles that will endure in a new economy.
It was Lenin who said that Communism is Socialism plus electrification. Maybe we can summarize the new economy as the old brands plus digitalization. Brick plus click. The brick aspect creates trust. The Click creates speed, networks, individualization, and style. Brick and click.
The new economy innovators will supply the new
tools, which is what they do well. They will continue to get rich in the
process. With some exceptions, They will be functioning less as providers of
outputs and consumer products—because those are hard to run day in day out and
require experience, management, and capital—as much as providers of vital
inputs and innovative tools and processes. In other cases, they can package and
market elements in novel ways, until traditional companies catch up with them.
But on the whole they and their innovations will be absorbed into old economy
firms, by acquisition or partnerships. In the process, competition will be les
between new and old economy firms, but among traditional firms, based on their
ability to absorb these new tools, optimize their processes, integrate their
various activities, and streamline their relations with suppliers and
customers.
In the process, the new economy of e-business, and
the old economy of blue chip brands, become the new new economy. And
Schumpeter’s process of the creative destruction of capitalism moves to its
next level.