Friday, January 23, 2009

8 miles high and when you touch down....

A bit prematurely, Roger McGuinn really hit the tone that describes global economic sentiment.

Today, I spent time with a long-time friend who has spent a successful career making GDP sized bets around macro market themes. As a reference, last winter he was a raging pessimist as he was bemoaning that a prudent person could not short the market enough to reflect true underlying value. In our meeting, he shared an updated perspective for his core concerns:

1. The lead US banks are heading towards being nationalized. We are caught between choosing amongst a lesser evil; the existing mismanagement and misalignment between employers, shareholders and customers on one hand, and on the other, the potential that, under government management, it could be worse.

2. Our economy experienced faux growth over at least the past 5 years, the only question is how rapid will be the adjustment to a more normalized (lower) standard of living be.

3. This adjustment is deflationary and governments, with decades of experience in handling inflation are woefully ill equipped to handle declining prices, tax bases, and output.

4. Odds are that well meaning government actions will give us unintended consequences which only exacerbate an unsteady situation.

Given this sober perspective, he also noted that the best safe port he sees in this maelstrom is the Information Technology sector. "It is an industry with the mindset that next year's products must be less expensive, and offer more value than last year's. It is not capital intensive, and balance sheets tend to be flush with cash."

While I agree with many of his points, I think an important extension of the thesis is in order. When innovating, Information Technology companies export deflation to their customers. They enable them to perform tasks with less labor, lower overall costs, and to do them faster.

In the past few years, our industry was built on a 'permacheap' product management culture, fueled by Moore's Law, and augmented by Metcalf's . Over the past 25 years, customers learned to rely on important vendors, such as MSFT, CA, and Oracle to help them reduce costs, and share that value with their customers. They looked forward to learning about new vendors, with innovative sparks, that may accelerate this trend. In many ways, we have strayed from that vision...and our customers are letting us know it.

The fundamental elements (reduced infrastructure and development expenses, real-time feedback, and a wired globe) are in place to recapture the customer value that drove extraordinary shareholder returns for decades. A return to the time tested trilogy of 'faster, better, cheaper' seems like true religion to me.

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