What's the Matter?
No longer does bigger, heavier, and more solid mean more value.
By Chris Meyer
Suddenly, the thought of a ThinkPad is unfathomable. It's just too...big. I'm trading in my ThinkPad (once the laptop with the greatest power-to-weight ratio) for the new VAIO, a lighter, smaller PC, weighing in at less than 3 pounds but with a mere 10-inch screen. I'm sacrificing screen size for portability.
The reduced size of chips, Moore's law, and microminiaturization have all become clichˇs in the technology business. True, yet underlying them is a bigger concept that is less understood: We don't "matter" anymore. No longer is a bigger, heavier, more solid product a sign of quality. Value is in the intangibles like knowledge, information, services, software, and entertainment.
Consider our analysis at the Ernst & Young Center for Business Innovation: The weight of the gross domestic product in the United States was less in 1997 than it was in 1977 (Chart 1). Meanwhile, its dollar value has risen 70 percent! Even though our economy has grown at an annual rate of 3 percent during this period, the amount of matter we used per year did not grow at all.
This trend is even clearer when we turn to the individual. In 1977, each American accounted for $19,404 of output, which weighed about 5,300 pounds. In 1997, your average $26,843 of output-up 38 percent -weighed 4,100 pounds, down 23 percent. As a businessperson, think of it this way: The value-to-weight ratio of a pound of GDP has gone from $3.64 in 1977 to $6.52 today, a 79 percent increase (Chart 2).
Hence, the first rule of the New Economy is Matter: It Matters Less. Some specifics: The 3- to 10-pound PC is disposable, while the weightless software rises in value. This high-tech trend extends across industry lines as software increasingly becomes a part of every product.
Consider the automobile, once the icon of heavy industry. I estimate that today as much as 90 percent of vehicle value is in the software, whether on board (running the engine, traction control, entertainment systems, diagnostics) or in the factories (running the robots, production, and logistics systems).
Looking downstream, the effect of diminishing matter on the economy becomes even clearer: When iron and coal and other matter-intensive materials dominated our economy, the railroads were a great leap forward over the waterborne transportation previously used for massive freight. Now that chips and circuit boards carry the value, however, air freight and speedy intermodal transportation links become the economic choice. And as more of our products are embodied in software and information-"information goods" with an infinite value-to-weight ratio-our networks become our transportation infrastructure.
Does money still matter?
The evolution of money parallels this trend toward the intangible. Before the Industrial Age, heavy metal was used to facilitate trade. But when President Richard Nixon closed the "gold window" in 1971, disentangling the value of the dollar from the number of tons of gold in Fort Knox, the definition of money was fundamentally changed from something of weighable mass to something of invisible speed. Walter Wriston, chairman of Citicorp at the time, said that information about money has become almost as important as money itself. The new information-based money created an opportunity to accelerate the rate at which companies transacted and set the stage for the invention of a myriad of new connections, alliances, and risk-sharing arrangements.The New Economy's emphasis on the intangible forces us to think about value in a new way. The economies of the past-the Agrarian Age and the Industrial Age-were characterized by the mass of their outputs, be they crops or steel. We became accustomed to thinking about worth in terms of weight. But the intangible economy is harder to define because there's less stuff to look to for an indicator of value. We have, in theory, made commodities of agriculture, manufacturing, and soon software (Chart 3). Today, potatoes go for about 79 cents per pound. A car goes for $5.95 a pound on average. Computers? They go for $168 a pound on average. And drugs? A whopping $23,199 per pound.
While we are all conditioned to think in terms of that which we can touch and feel, actual "matter" has significantly less relevance in the New Economy and value has become all about velocity. Matter matters less.
Myth #1: Strong economies need powerful manufacturing sectors
Substantial hand-wringing was done during the 1990s over what was referred to as the "hollow corporation," that is, the enterprise that operates entirely on intangibles such as style, relationships, and management. Most of those frets assumed an economy that does not produce huge amounts of glass, concrete, and brick lacks real validity. To paraphrase Lee Iaccoca, real economies don't flip burgers. But the massive capital assets that represented power to the markets of the 1920s are no longer the essentials of wealth. In the 1990s, these assets-factories, coal mines, everything you see in those Works Progress Administration manuals-now hang like an albatross around the corporate neck.The physicality by which manufacturing has traditionally been defined is disappearing. Value has shifted from the tangible to the intangible, from steel mill to know-how, from supply side to demand side, and from dealer network to customer loyalty. The Industrial Economy created corporations with highly tangible assets that manufactured weighty products. Huge factories with looming structures held the equipment; assembly line machines that were cumbersome to the eye and powerful to the process. Today, manufacturing uses software, not labor or energy, to become more automated, networked, and integrated across company boundaries. Information and coordination are ever-greater parts of the cost and the value.
Chrysler has gone so far as to plan an assembly plant with a five-year life span. This way, the company can minimize its heavy machinery ownership. The disposable auto plant looks to the software that manages the production as the source of its added value. It is a laboratory for a manufacturing system that will carry over to the next plant. Thus, the "hollowing-out" of the U.S. corporation is in reality the migration of our economy to higher value-added businesses.
Of course, for years, the majority of the economy has not been involved in manufacturing but in services (Chart 4). Even the product industries add more value through service.
With the economy becoming less about goods and more about the transfer of information and delivery of service, we must all challenge the fundamental assumptions about value. That is, with less emphasis on measuring a physical property, the economy will increasingly focus on intangibles like ideas and speed. Which leads us to our second myth.
Myth #2: Value is tangible From the fairy tale of the Three Bears to the All You Can Eat smorgasbord, we are taught to think that value is in mass. But as businesses concentrate more and more on the flow of information and speed at which connections between customers and suppliers are made, velocity has become a substitute for mass. Think about inventory-to-sales ratios. Dividing sales by inventory tells you how fast that part of the economy is turning over.
I estimate that before the industrial economy, two to three turns a year was about right, meaning products stayed on the shelves for four to six months before being sold. Now, companies are investing to accelerate the speed at which things are made and delivered.
The apparel industry, for instance, has created what is referred to as a "quick response" system that has cut months out of its supply chain by tying its production to daily sales activity. United Colors of Benetton created a system in which it polls its stores daily. Only the hottest items are replenished, so there is less inventory and little backlog at the end of the season. Just-in-time sales data on the color of the hot-selling item determine what color apparel will be replenished. Similarly, Wal-Mart provides Procter & Gamble with daily information on what is selling in which stores. P&G, in return, restocks Wal-Mart's shelves as needed. While this practice is commonplace today for many supplier/distributor partnerships, Wal-Mart has achieved significantly greater inventory turns and hopes to continue increasing turnover rate in the future. The company's cash flow also has become more efficient as a result.
And we're not just talking about retail. Today's software companies have an even more startling situation. They have no inventory, yet infinite inventory. That is, they don't need to have any discs, packages, or manuals, yet they can download and bill for as many copies as are demanded, instantly. Don't even bother measuring inventory. You no longer need to spend huge amounts of overhead on a backlog of mass sitting on shelves in the warehouse. To accelerate the speed at which you turn your products around, substitute connection to customers and real-time supply chain information for static inventory.
Integration is the answer
Size has been getting a bad rap in the business press as of late. Bigger is better-if you're talking about mammals. Studies of scaling and biology from the Santa Fe Institute show that a human being weighs 10,000 times more than a rat, but its metabolic rate is only 1,000 times faster. This shows that human beings are 10 times more efficient than rats. The bigger the animal, the more efficiently it uses energy.
So size does matter. Which is all well and good until you think about speed-turning a rhinoceros on a dime is a problem. While bigger is more efficient, efficiency is no longer the game.
Surprisingly, the downside of bigness can be seen even in the intangible world. The Y2K problem represents a kind of inertia that has nothing to do with physical mass. The inability to change is brought on by the sheer scale of the software and the number of logical connections it contains. This software was written to use memory and processing power-scarce resources at that time- efficiently. Then advances in chipmaking technology flooded the market with memory and processing power. As a consequence, we have "bloatware" that acts as if it had the mass of a rhinoceros.
In the software world, we are beginning to move away from operating systems that do everything, toward software "components" that run special-purpose devices. These devices are more effective because modules can be updated as necessary or even replaced without completely overhauling everything connected to them.
In today's hospital room, for instance, you'll see a rack on the wall that allows the staff to plug in different logic modules, which relay their outputs to a display screen. Each type of sensor-pulse, blood oxygen, blood pressure-is run by a piece of software in its module. Each rack has access to a high-speed local network, so the information can be monitored remotely. Thus, each patient can have a unique system put together by connected components that change as the medical needs change.
While inefficient in one sense, component software will allow us to respond to customer needs faster and with greater agility. Engineers are beginning to write software components that fit known interface standards-look at the library of shareware that's grown up around the PalmPilot. This trend makes the small amount of matter in the thing increasingly more valuable, not through bigger, new releases, but through connections to creative people. While the capital equipment of the Industrial Age taught us to conserve, the intangible software and the drive for speed of the Information Age are telling us to dispose. Like most small animals, the life spans will be shorter. But shouldn't software be as replaceable as hardware?
Chris Meyer (blur@ey.com) is director of the Ernst & Young Center for Business Innovation, which researches emerging issues facing business. With more than 20 years of experience in general management and economic consulting, Meyer is an authority on the evolution of the information economy and its impact on business.
SIDEBAR:The Corporate Weight-Watchers Program If you're still managing your business under the myths of the Industrial Age,
get the lead out! How do you begin to comply with Rule #1 (Matter Doesn't Matter) of the New Economy? Here are some suggestions for losing the fat: 1. Maximize the ratio of intangible
to tangible value. That's where the growth is. Knowledge is embedded in everything: people, processes, technology. You must think of your company not in terms of a finished product but in terms of the value you create by leveraging knowledge. 2. Value motion, not mass. Measure the value/weight ratio in your company and track your company's velocity. Determine at which points of production your operating system could benefit most from speed and, as a result, generate greater value to your customers. 3. Divide and connect. Hollow out your
company by outsourcing where possible or creating shared services. Break up your monoliths with simple, pre-existing parts rather than creating new solutions; recycle knowledge objects where you can, and maximize connections with partners. We all have a set of attitudes toward mass that we learned from the physics of the tangible world. More mass means more inertia, more momentum, more energy, more gravity. In the Industrial Economy, powered by energy and governed by thermodynamics, physics provided a useful metaphor for economics. In today's economy, value is governed by the laws of information theory; speed is infinite, distance disappears, and allocating our attention among competing connections becomes our hardest choice. We are in the midst of a learning process that demands we embrace the disappearance of matter in our economy as a sign of progress, just as the move away from the land was evidence of a more productive economy. It's a triumph of mind over matter.
© 1998 Imagine Media Inc.