[ale] Last Gasp - New Economy?

[Hogg, Russell E]

Thought the list might appreciate this.
Sorry for the length.

-Russ



____________________________________________
ctcrreho at opm.gov





The Last Gasp

by Alan Cooper

November 2003 Issue

As the dotcom bubble inflated during the last few years of the 20th century,
truckloads of ink were used to sell the idea that there was a "new economy"
on the Internet. The pundits said selling things on the Web was a
fundamentally different way of doing business, and the "old economy" was as
good as dead. Of course, almost all those new-economy companies are gone,
the venture capitalists who backed them are in shock, and the pundits who
pitched the new economy have recanted, claiming it was all a hopeless dream.
The new, new thinking says we must still be in the old, old economy.

I believe we are in a new economy-and that the dotcoms never even
participated in it. Instead, they were the last gasp of the old economy-the
economy of manufacturing. 

In the industrial age, before software, products were manufactured from
solid material. The money it took to mine, smelt, purchase, heat, form,
weld, paint, and transport dominated all other expenditures. Accountants
call these "variable costs" because they vary directly with each product
built. "Fixed costs," as you might expect, don't vary directly and include
things such as a factory's initial cost and corporate administration.

The classic rules of business management are rooted in the industrial age's
manufacturing traditions. Unfortunately, they have yet to address the new
realities of the information age where products consist mostly of software.

Some fundamental truths do hold for both the old and the new economy. The
goal of all business is to make a sustainable profit, and there's only one
legal way to do so: sell some goods or services for more money than it costs
you to make or acquire them. It follows that you have two ways to increase
your profitability: reduce costs or increase revenues. Reducing costs worked
best in the old economy. Increasing revenue works much better in the new
economy.

Software products consume no raw materials and have no manufacturing and
transportation costs. They require no welding, hammering, or painting. The
information age involves little or no variable cost, whereas variable cost
was the dominant factor in the late industrial age. The absence of variable
cost is what makes this a new economy.

One hour of programming isn't related directly to one product sale; you can
sell the same code repeatedly, so it's not a variable cost. However, it's
not a fixed cost either. Writing software is an ongoing, revenue-generating
operation-not the same as constructing a factory. Some might suggest that
programming is research and development; the comparison works, but
traditional accounting separates R&D from revenue-generating operations, so
this doesn't fit either. You'd be wrong to discount this little terminology
mismatch as a minor quibble for bean counters to debate. It has a huge
effect on how software is funded, managed, and-most significantly-regarded
by senior executives.

You and I create software, and business executives create revenue streams
and profit centers. You and I measure our success by the product's quality,
and business executives measure their success by their investments'
profitability. They do this by applying the language of business
mathematics, which recognizes fixed costs, variable costs, corporate
overhead, and R&D, but, unfortunately, has no model appropriate for software
or programming. Accounting is the basic language of business, and its
categories are so fundamental to all business measurement and communication
that contemporary executives have internalized them completely. They see
programming as another corporate expense to fit into an existing category.
Most simply treat programming as a manufacturing effort-a variable cost.
This is the worst possible choice because it prejudices their business
decision-making hopelessly.

The key advantage of the industrial age was that products could be made
available to the masses at affordable prices. Companies competed on the
basis of their sales prices, which were related directly to their variable
costs. It's taken for granted in the information age that products are
available at affordable prices to everyone: Software can be copied and
distributed to any number of customers for essentially no cost and with
little or no human effort. 

Reducing costs was simple and effective in the old manufacturing economy,
and it was the preferred tactic. When today's executives regard programming
the same as manufacturing, they imagine that reducing the cost of
programming is similarly simple and effective. Unfortunately, these rules
don't apply anymore.

Software production has relatively insignificant variable costs, so little
business advantage results from reducing them. Reducing programming's cost
isn't the same as reducing manufacturing's cost. Programmers' salaries
appear to be a variable cost from an accountant's viewpoint, but they are
much more like a long-term investment-a fixed cost. 

The only available economic upside comes from making your product more
desirable by improving its quality, and you can't do that by reducing the
money you spend designing or programming it. You must invest more time and
money on the research, thinking, planning, and design to make your product
better suited to your customer's needs. Instead of reducing what they spend
to build each object, software companies must increase what they spend to
build all objects. This is the essence of the real new economy. The
intangible but extremely complicated patterns of thought are that software
has value only when it's accompanied by the programmers who write it. No
company can treat programmers the same as a factory because programmers
demand continuous attention and support well beyond any factory.

Architecture-the human-design part of programming that studies users,
defines use scenarios, designs interaction, determines form, and describes
behavior-is the part of the software-construction process businesses
dispense with most frequently as a cost-saving measure. Although it's
certainly possible to do too much design, there is no advantage in reducing
it. Your product becomes highly desirable when you invest a sufficient
amount of competent design, so it makes more money for you. Its desirability
establishes your brand, increases your ability to raise prices, generates
customer loyalty, and gives the product a longer, stronger lifespan. There's
no advantage in cost reduction, but there's big advantage in quality
enhancement. Ironically, the best way to increase profitability in the
information age is to spend more.

The dotcom boom was populated with companies whose entire business model
consisted of the reduction of variable costs. Their complete and spectacular
failure demonstrates beyond doubt that the information age's economic rules
are different from those in the industrial age. Business success in the new
economy depends on adding something new and better for the consumer. The
actual quality of every part of the transaction-from browsing to comparison
shopping to comprehensiveness-must be noticeably better for the end user.
Simply lowering costs for the vendor doesn't guarantee success today. 

When Pets.com sold dog food over the Internet, it didn't offer better dog
food, a customer experience better than you could get at the local
brick-and-mortar pet store, or any better information, intelligence, or
confidence. All it offered was cheaper shipping, stocking, and
selling-variable costs all-for Pets.com. It was a classic
industrial-age-economy tactic of cost reduction that ignored the new
economy's fundamental principles. Far from being the first breath of a new
economy, it was the last gasp of the old.

I'm convinced you can sell anything on the Internet profitably and
successfully. The trick is your online store must offer a measurably greater
degree of shopper satisfaction than any competing retail medium. There's
only one way to accomplish this: You must architect your system to deliver
the highest possible end-user satisfaction. Treating any aspect of software
design and construction as if it were a manufacturing process courts
failure. Software design and programming are simply not viable targets for
conventional cost-reduction methods. It's certainly possible to spend too
much time and money on building software, but the danger of spending too
little is far greater. 

Such danger is probably not shocking or unfamiliar to you, but it's nearly
inconceivable to most big companies' senior business executives. They're
still using accounting models popular in the age of steam, yet every aspect
of their companies are fully dependent on software for operations,
decision-making, communications, and finance. The terms and concepts these
executives use simply are not cognizant of the unique nature of doing
business in an era when the tools and products of commerce are intangible
arrangements of bits instead of railroad carloads of iron. The sock puppets
were cool, though.

About the Author
Alan Cooper heads the software-consulting company Cooper, where he has spent
a decade making high-tech products easier to use and less expensive to
build, a practice known as interaction design. Get the skinny on Alan at
www.cooper.com or send him your polite, intelligent, copyedited e-mails at
acooper at cooper.com.


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