Competition Among Digital men
What manner of men are these? I mean this new race – these ‘Digital Men’ whom Ed Yardeni has discovered.
“I will put my jobs anywhere in the world where the right infrastructure is with the right educated workforce, with the right supportive government.” So declares the CEO of the company which is acknowledged as the greatest company in the history of mankind, Cisco.
“I can do that today with the technology we have,” said John Chambers, Homo Digitalis (and a credit to his race), heralding the new super-competitive and footloose economy, “but I can’t do it socially. I don’t know how to manage that yet.”
‘Tis a pity. Analog humans get in the way. We are the stumbling blocks of “progress”!
But Chambers is optimistic. “You give me a decade and I will be able to do it extremely well.”
And then, finally, Mr. Chambers identified the all-important ‘it’ that we Homo Analogians do not get. “That’s what people haven’t gotten yet,” he said, “This is global competition like we’ve never seen before. The Internet is not just a nice productive tool. This is about survival.”
Today’s letter will take a quick look at this “it” – to see what it is that we don’t get about it. Competition is certainly not new. In fact, its presence in the New Era is reassuring. The New Era cannot be that different from the old one. Whichever era it is, and whether companies are run by digital humans or analog ones, competition will force down profit margins. That’s what competition does.
Long-term Daily Reckoning sufferers may recall that I made Mr. Chamber’s point nearly a year ago. Referring to the intersection between Moore’s law – which describes the increase in computer processing at an exponential rate – and Metcalfe’s law – which describes how collective systems, such as markets (and the Internet), become more bountiful as they grow – I dub, dub, dubbed it territory where Bonner’s Law ruled. Bonner’s Law holds that Moore + Metcalfe = creative destruction squared.
It may be presumptuous of me to point this out to Mr. Digital Man, but the arrival of turbo charged competition is hardly good news for Cisco, Amazon, Qualcomm, Nextel, or any other of today’s tech and net favorites.
“The New Era’s stocks are far more vulnerable to competition that the Old Economy’s factories,” writes Gary North in his latest letter. “A century ago, J.P. Morgan put together the United States Steel trust. His consortium bought Carnegie Steel, which had kept lowering prices. The trust hoped to create a cartel that would call a halt too ‘ruinous competition.’ …But the price of steel kept falling.”
Not only did the price of steel rails fall – so did the price of the railroad traffic that ran upon them. “The iron horse,” says the August 5 issue of Grant’s Interest Rate Observer, “changed the way people lived and worked, just as the Internet-enabled cell phone has done (and continues to do). Yet, although wondrous, the service the railroads provided soon became a largely undifferentiated commodity.”
Railroads were the Big Thing a century ago. So sure were investors that they would be a big financial success that, as Arthur Stone put it, they “might be expected to absorb any ordinary burden of fixed charges [that is, debt] that might be placed on a railroad.” Even “an extraordinary burden could be carried, provided drastic competition could be, for the moment alleviated.”
But competition was not alleviated. It was aggravated. When investors get excited about something they do not stop at putting ordinary burdens upon it. Nor do their expectations stop at ordinary levels. They go all the way. And they are not put off by the heat of competition and the hope of fireball success. Instead, they are drawn in – like moths to a flame.
“In a nutshell,” Grants summarizes, “the railroads ran up more indebtedness than their cash flow could service.” Hundreds of railroads went belly up. And, again quoting Grants, “in 1916, the evident peak of the railroad industry’s fortunes, [after hundreds of the weaker companies had been destroyed in bankruptcy] the combined return on equity was 7%.”
As Gary North puts it, “New Era companies cannot stop the forces of competition. The closer they are to digital wealth, the more vulnerable are any expected streams of income that they may throw off. The heart of a New Era company’s profit is its ability to create value for consumers while holding off the competition. The greater the value created, the faster the competition shows up. There are no huge factories to build. There are only digits and code.”
What was true of steel and railroads is also true, even in a new millennium, of routers and switches. Chambers is right. The Internet stretches the competitive horizon. But in doing so, it speeds up the process of creative destruction in which even the best ideas and world’s best businesses are brought down – first to average levels of growth and profitability… and later to destruction.
Still analog, after all these years.
Ouzilly, France August 16, 2000
*** The Internets continue to suffer. Yesterday, the digital humans at Living.com announced that they were filing for bankruptcy. Living.com is one of Amazon.com’s partners and had been named the “best on-line furniture store” by research group, Gomez.com.
*** If the best on-line store can’t make it, who can? But Amazon drifts along, through the jungle of competition and the merciless alligators in the venture capital community. AMZN sold off yesterday – but is still well above the critical $30 mark.
*** During the 2nd quarter of this year, AMZN lost $110 million on its investments in companies such as Living.com.
*** The Internets owe a big debt to Henry Blodgett, the analyst who made a name for himself by being so bullish on the sector. As reported here a few weeks ago, Henry set target prices for stocks such as Amazon at hallucinatory levels. And then he held his bullish stance – even as the whole group collapsed.
*** But last week, Henry downgraded 11 of his net favorites – after they had declined 80.34% from their highs. Rumor has it that Henry – who surely ‘gets it’ – has been offered a job piloting Russian submarines.
*** The Dow gave back some of its gains yesterday. The index retreated 109 points in very light trading. The Nasdaq went nowhere – gaining just two points in the session.
*** The number of stocks making progress fell sharply yesterday – just 1161, vs. 1690 falling back. Still, new highs were impressive – three times as many as the new lows.
*** Here’s another bullish signal – the St. Louis Fed reports that cash, as measured by MZM (money of zero maturity), is rising at an accelerating rate. MZM often seems directly connected to stock prices. When cash increases, so do stock prices. Over the last quarter, MZM rose at a 5.6% rate.
*** The dollar slipped. Once again, the greenback approached its May highs against the euro but could not go all the way. A euro is now priced at more than 91 cents.
*** The battle between the dollar and the euro is probably the most important one we’re watching. Neither side has much room for maneuver – with the euro backed up against the rocks of 9% unemployment rates…and the dollar with a sea of current account deficits behind it. Neither side can raise interest rates easily. So, re-enforcements and retreat may be out of the question. It’s a fight to the finish. Which will win?
*** You may not know what a “dol” is. I didn’t either. But it is a unit of pain. Will the “dollar,” though, continue to be the unit of joy that it has been for so long? We’ll see.
*** Steve Leuthold reports that insiders are now selling stock at twice the rate of the last two years. And bond yields are now 8 times the yield of the S&P – a record. The pros, the insiders, the smart investors cannot resist – they’re moving to the yield.
*** Gold and oil did nothing yesterday. But platinum rose $8.20.
*** A price increase in paper came yesterday – with major producers announcing an 8% hike.
*** DR reader VN opines: “Addison is right.” [Addison, you may recall, informed me that the Daily Reckoning itself was proof that the Internet was not increasing productivity, but decreasing it. People spent time reading DR instead of working.] VN continues: “Productivity is crushed by the Internet. Countless hours are left undone, flitted away searching for the “Holy Grail” of benefits in a dream-like state believing there is a pot of gold just over the rainbow, one more click-through and the brass ring will appear. The silicon valley yuppies spend 16 hours a day working at their computers believing it is efficient when actually it is the post-modern version of the seventies when executives whined “how can I get any work done when I’m in meetings all day?” It’s all idea researching and praying the buried treasure is just around the next website.”
*** Another DR reader, who was kind enough to say he read it anyway: “Quite right, Addison is, quite right, indeed. I think every day of all the projects to complete, work to do, books to finish, to read, but I sit here totally addicted to the Daily Reckoning. Sometimes, like today, I sat down to read three issues, when I should have been in my vegetable garden doing what Mr. Deshais does. This is nuts, I think sometimes. Think of the terrible drain on output there!”
*** Does time spent reading really depress output? Should we begin a 12-step program for DR readers? Information may be free on the Internet. But knowledge…and (I add immodestly) wisdom…is not. It takes time. And effort. You have to think, as Heisenberg put it, “until your brain hurts.” And even then, you’re almost as likely to be wrong as right.
*** So much for privacy on the Internet. The U.K. government has just been granted the power to poke into any email message it chooses. “Under the provisions of the RIP bill,” comes the news report from London, “the U.K. government… can demand encryption keys to any and all data communications. Those not complying with the order could face a prison sentence of two years.”
*** Yesterday was Napoleon’s birthday.