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  • Writer's pictureJeff Matthews

A Funny Thing Happened on the Way to Unlimited Productivity…

In the longer term, productivity growth appears to be decelerating—a sign that the business cycle, now in its fifth year of expansion, is maturing as companies gradually exhaust their ability to get more out of their workers. —Wall Street Journal.

No kidding.

A mere week ago, the poster child of Alan Greenspan’s theory of endless rising worker productivity—Microsoft—announced a shocking ramp-up in spending that sent Wall Street’s Finest back to their earnings models and wiped $30 billion off the company’s market value in a few hectic minutes of trading.

Microsoft’s new, higher-cost business model appeared to be a one-off, sparked by Google’s ascent to the top of the Internet pyramid and Microsoft Network’s fast slide into obscurity. Analysts blamed it on Microsoft’s own mistakes—and the world moved on.

And then along came Electronic Arts.

Two nights ago “ERTS” (as Electronic Arts is called on the Street owing to its stock ticker of the same four letters) likewise shocked Wall Street’s Finest by announcing a large ramp-up in costs necessary to deal with the diffusion of gaming hardware choices, which are shifting beyond the simple teenage-boy-on-computer-at-2 a.m. platform to handhelds, cell phones, PDA’s and wirelessly-connected modes of play.

As with Microsoft, this change in “The Model” of a company formerly known, loved, and given an extremely high P/E multiple owing to its ability to beat Street estimates by the proverbial penny no matter what the external environment, was viewed as a one-off.

And maybe it is.

But maybe it isn’t. When we looked at Google’s high capital expenditures—bigger than Caterpillar Tractor, as a percentage of sales (see “Down and Out in Mountain View” from March 9)—it was strictly in the vein of an interesting factoid regarding Google’s business model.

But perhaps the experience of ERTS and Microsoft show that Google may in fact be foreshadowing where the digital world is going. Perhaps the digital economy is just a lot more expensive than envisioned.

In the brick-and-mortar world, physical costs are mainly plant and equipment, lots of sales people and administrative support. Pricing is not always transparent, and inertia plays a part in determining whether customers stay with their old supplier or whether they go with a new one.

In the digital world, the costs are office buildings and lots of computer equipment, and the engineers to run the equipment and design the software and keep it running 24/7 against viruses and spam attacks and network outages. Pricing is highly transparent and speed is essential. Inertia evaporates: with a keyboard click a customer can do an internet search on Google rather than Microsoft; buy a digital camera from Amazon rather than Best Buy; list their car on eBay rather than Yahoo; outsource their back office through an auction to a lower cost supplier that may be next door or may be in Bangalore.

And while all of this transparency lowers costs to the customer, it raises the costs for the companies doing business in the digital world.

A funny thing happened on the way to unlimited cost compression: companies have to pay to play. Perhaps it’s no coincidence that the era of endless productivity enhancements appears to be—appears to be—waning.

Informed opinions and observations on this topic are welcome.

Jeff Matthews I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

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