Why Tech Will Bloom Again

Sure, parts of the industry have withered. But that's the way tech works, and new fruit is on the way

To hear some folks tell it, the information-technology revolution is kaput. The industry that has driven the economy and captured our imaginations for years has peaked for good, insists a chorus of skeptics. It's true that after four decades of 10% annual growth, more than twice the growth rate of the gross domestic product, tech spending has dropped for two straight years. And corporate IT chiefs say they won't increase spending more than 3% this year. Even some of tech's titans are starting to join the dirge. "This is the new baseline," declares Oracle (ORCL ) Corp. Chief Executive Lawrence J. Ellison. "The industry in total will actually shrink." The doubts go even deeper than whether the industry will grow again.

Burned by broken promises and bewildered by a dizzying array of hardware and software that's still underused, corporate buyers are more skeptical than ever. And now, some experts say that IT can no longer provide corporations any more competitive advantage -- or growth -- than such old-standby technologies as electricity. "A lot of the core things that businesses do have already been automated," says Nicholas G. Carr, who ignited a firestorm with an article in the May Harvard Business Review entitled "IT Doesn't Matter."

Does all this mean that, from here on out, tech will be -- gulp -- boring? Slow-moving? Inconsequential? It's true that some parts of info tech have probably seen their best days. Personal computers are so pervasive that they may not top 4% sales growth in coming years. Ditto servers, and mainstream corporate software may never reach double-digit growth again. Yet we've seen this movie before. The same thing happened to mainframe computers in the 1970s, as buyers flocked to new, cheaper minicomputers from Data General Corp. and Digital Equipment (DEC ) Corp. In the 1980s, minis declined as buyers poured many more billions of dollars into cheaper, more flexible PCs and servers.

Fact is, tech has always has worked this way. Like Italian mansions built with marble from the Roman Forum, new markets emerge on the foundation of maturing technologies. Lower prices make mass markets out of niche products. And mass markets inevitably mutate and evolve into something unforeseeable. Only by the mid-1990s, when tens of millions of people had PCs, did it make sense to connect them, giving rise to what became the World Wide Web. Today, millions of people have laptops and handheld computers -- thus spurring rapid development of wireless networks. And more than 20 million U.S. homes have broadband connections. As fast Net access takes off, it will spark altogether new ways of using the Internet that we're just beginning to imagine today.

Simply put, tech hasn't settled down yet. Its days of maturity may be decades away. The IT revolution may share many parallels with previous transformative technologies such as railroads and electricity, but it differs in one key way: The underlying technologies not only aren't slowing down, they're accelerating. Computer-chip performance keeps doubling every 18 months, and disk-drive capacity and Internet-connection speeds are improving even faster. That's spurring new products, from MP3 and DVD players to Web services for corporations, that are disrupting industries from entertainment to health care. Says Intel Corp. Chairman Andrew S. Grove, who has worked in tech for more than 40 years: "The rate of change in technology is as much today as any time in my experience."

This rapid change also means that the savviest users of technology still have ample means to carve out an edge over laggards. Indeed, the titans of business today, from Dell to Wal-Mart Stores, as well as upstarts such as Amazon.com (AMZN ) and JetBlue Airways (JBLU ), owe much of their leadership to using info tech in special ways. Each employs some of the same technologies, whether that's Linux software or servers based on Intel chips. But it's their expertise in deploying and customizing those technologies year after year that gives them a continued competitive advantage. "Everybody has always had access to the same technology. There's nothing new there," says Microsoft Corp. Chairman William H. Gates III. "The fact is that some companies have taken technology and used it more effectively than others. And the ones that don't use technologies effectively fall behind."

The debate over tech's value has exploded just as the industry is finally on the rebound. From steadying orders and better-than-expected profits to the rise of promising technologies such as the wireless Internet, Linux software, and digital entertainment, tech's long winter is thawing. For the first half of the year, corporate tech spending rose 4%, according to preliminary economic data.

But let's be clear: There will be no return to the frothy foolishness of the boom. With the weak economy, global unrest, and lingering skepticism by buyers, tech spending will probably recover to a modest 6% or so next year, and just shy of its 10% historical average in 2005. The biggest problem: Many IT buyers refuse to purchase anything that won't guarantee a return in six months. "There's a big backlash against technology and a lot of skepticism about what it can do," says technology consultant and author John Hagel III.

In stark contrast to the boom, nowadays the customer is in the driver's seat, and tech companies must come to grips with this reality. This suggests a bracing shift in industry economics and company behavior. Partly, it's that lower prices will give customers more of tech's benefits -- and profits. To accommodate these value-conscious customers, producers must focus even more narrowly on what they do best and outsource the rest to lower-cost providers. Companies increasingly rely on contract manufacturers such as Flextronics International (FLEX ) Ltd. and Solectron (SLR ) Corp. to do the heavy lifting. And the process is picking up speed as companies start to farm out basic design and programming tasks as well to lower-paid workers in India and elsewhere.

Just as important in this new post-frenzy period, tech suppliers no longer can act like door-to-door salesmen, making quick deals and skipping town. Instead, they need to be craftspeople, plumbers, teachers, and insurers, too -- slowing down, fixing software bugs and hardware glitches before shipping products out the door, and guaranteeing that their products play well with others. Says W. Brian Arthur, an economist at the think tank Santa Fe Institute: "The main beneficiaries will be the Wal-Marts and the General Foods -- the overall economy."

A raft of new technologies hints at the promise. As everything from the transistor radio to the PC to the cell phone has shown, technologies that attract entirely new waves of customers are the key to tech's renewal. And they do it by making tech not just cheaper but also much easier to use. Wireless networks, for instance, are extending the Web to the wide world by cutting our electronic leashes. Networks of tiny sensors give us a digital view into the physical world, allowing inventory to be tracked precisely and ultimately producing digital products that are much smarter, such as home-security systems that recognize family and friends. And corporate IT wizards are hard at work trying to make software available as Web services. The hope, ultimately, is that they can offer computing like a utility, as easy to tap as power from a socket.

Getting there will be a wrenching process for everyone involved. Success and even survival in this new era will require big shifts in strategy by startups and giants alike. The largest and strongest may survive dwindling margins and slower sales by building huge economies of scale: Think Hewlett-Packard (HPQ ) purchase of Compaq, Oracle's hostile pursuit of PeopleSoft (PSFT ), and Dell's solitary romp through the computer industry. At the same time, many tech companies will have to adopt brand-new business models. Software makers, for instance, will have to switch from shipping shrink-wrapped boxes to providing services over the Net.

The economy depends on the tech industry getting this right and recharging its growth. Up to 10% of the gross domestic product comes from tech, which accounts for nearly 50% of all capital spending. Many economists believe IT's productivity benefits fueled much of the prosperity of the 1990s, so it's crucial that advances keep coming for our standard of living to improve.

Trouble is, obstacles abound. Tech's finance infrastructure remains a mess, with venture capitalists awash in money but timid about investing it in new ideas. Just 15% of venture capital has gone to early-stage companies this year, compared with 35% in 1995. Maybe you can't blame them: Corporate customers are wary of buying technology from startups that may not survive. Legal and regulatory issues dog such potential growth markets as digital entertainment. Record companies and movie studios claim they lose up to $5.6 billion from illegal file-sharing and digital copying. And heightened fears about security and privacy could easily put the brakes on adoption of new digital technologies. According to the FBI, reports of Net fraud tripled last year, to 48,000 cases. In short, it's a mine field.

As disruptive as these transitions are, they're nothing new for tech. From the steam engine to the automobile, every technological revolution has suffered such cyclical downturns. Yet according to Carlota Perez, author of Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages, they don't mark the end of a revolution. Invariably, they set the stage for the longest periods of growth -- the true economic golden ages lasting roughly two more decades beyond the crash.

The last tech age, the mass manufacturing revolution led by the auto, offers close parallels to info tech today. As the price of cars plummeted early last century, sales rocketed. The number of cars sold tripled between 1919 to 1929. But financial speculation following autos' "installation period" got out of hand during the Roaring Twenties, leading to what Perez calls the "turning-point recession": the Great Depression. Today, that turning point is the recession, albeit less severe, sparked by the telecom and dot-com meltdowns.

This is where the comparisons become most striking. Continuing low prices driven by manufacturing efficiencies, plus plenty of cheap oil, pushed car sales up well before the Depression was over. Sales rose more steeply after World War II and through the 1960s -- the golden age of the automobile. Today, tech still has its equivalent of cheap oil: the relentless march of greater chip density at lower costs, plus even faster jumps in storage capacity and the accelerating spread of fast Net access. "Steam engines and electricity went through one big wave of improvement -- and not even one as big as the one for IT," says economist Eric Brynjolfsson of Massachusetts Institute of Technology. "IT keeps improving, year over year, exponentially."

Those improvements are starting to bring tech buyers out of hiding. JetBlue Airways Corp. has invested in a new technology called "voice over IP," which lets corporate data networks handle phone traffic using Internet protocols. That allows its reservation operators to take customer calls from home -- and not just to save on office costs. "They're a happier, more motivated, more loyal workforce," says CEO David G. Neeleman. As a result, he says, JetBlue's call-center attrition rate is just 5%, vs. 30% industrywide. That's helping JetBlue earn industry-leading profit margins of 19%.

Buyers also are getting excited about newly emerging technologies that promise to make their operations more efficient. Wal-Mart Stores Inc. is making a big investment in radio-frequency identification (RFID) chips, which will allow it and its suppliers to track goods all the way from the factory to the checkout counter. Such tracking is expected to reduce theft and other losses, cut the number of people in warehouses and stores who must track goods, and boost sales by making sure no item is out of stock. Sanford C. Bernstein (AC ) & Co. estimates that by 2007, Wal-Mart alone could boost earnings 38% by using RFID widely. "It's a great example of where a pretty proven technology has a potential to have a huge impact," says Wal-Mart Chief Information Officer Linda Dillman.

Most promising are new technologies that appeal to the digital unwashed, potentially tech's greatest opportunity in the years to come. Less than 12% of the world's population has a PC, and, even with Net-connected cell phones and Internet cafés, just 13% are on the Web. One example of the new products: smart phones that are in every way computers, with Web connections and cameras. Gartner Dataquest (IT ) expects revenues from such products to jump 140% this year, to $4.9 billion. Indeed, consumers can't seem to get enough technology. Some of the fastest-growing new markets are consumer products, from DVD players to MP3 players. Says Roger B. McNamee, veteran tech investor with Silver Lake Partners: "The consumer has gone from being a marginal opportunity to being a huge opportunity [for tech]."

To take advantage of these new opportunities, however, tech companies must reinvent themselves -- fast. Instead of applying the advances of silicon, storage, and network economics to hiking performance on existing products for the same old customers, they must turn those forces to making products, existing and new, that are cheaper. That's a tough transition.

Intel, for instance, is struggling to reconcile the billions of dollars it spends each year on chip factories with the fact that many customers don't need PCs with the latest chip. So it's aiming at entirely new markets, such as cell phones, handheld computers, and networking gear, whose much larger volume could make up for their lower profitability. Those three markets alone are a potential $45 billion opportunity, reckons market watcher Precursor Group Advisors LLC, compared with $25 billion for PC and server chips. It also has vowed to give each chip wireless capabilities, hoping to ride that wave.

All the way up tech's value chain, it's the same story. As its PC-software business slows, Microsoft is moving beyond its mainstay corporate market into new fields such as video-game players. That's increasingly forcing it to become a different company, selling not just bits on disks but machines and multimedia programming.

The pain of existing tech suppliers, however, is the gain of startups. Newcomers with solid technology, from Salesforce.com Inc. and its software-as-online-service to Google Inc. and its ace search engine, are still getting venture money and even eyeing IPOs. There are also huge opportunities in new IT services, suggests Intel's Grove. Just as Ross Perot created a multibillion dollar services business in Electronic Data Systems (EDS ) Corp., Grove thinks startups could emerge to run legitimate file-sharing operations for entertainment companies or medical databases. Particularly promising is that startups are getting funding for risky new technologies such as nanotechnology and biomechanical livers.

This constant renewal is the essence of tech. It was in the last big tech downturn, in 1985-86, that some of today's titans got rolling -- Dell, for one. Today, Dell dominates PCs, with sales having risen 14% last year, to $35.4 billion. Founder Michael S. Dell's view today? "There's no shortage of new ideas and new technology coming. The evolution of technology is showing no signs of maturing whatsoever." The industry may well require more steady leadership in the difficult years to come. But for tech to remain a vital part of the economy, its leaders must make sure they don't slow down as they grow up.

By Robert D. Hof

Contributing: Wendy Zellner and Andrew Park in Dallas, Jay Greene in Seattle, and Jim Kerstetter in San Mateo, Calif.

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