FOOL ON THE HILL: An Investment Opinion
While innovative technology will always be valuable, access device firms in the Connectivity Age will also be able to create value with technologically "Agnostic" business models -- where business efficiency and brand strength are more important than cutting-edge intellectual property. Using PC Era asset optimization lessons from Dell and branding ideas from firms such as Intel and Nokia, the Agnostic model has the potential to be the most compelling of all the models emerging to take advantage of the future's converged networking environment.
Just as in the PC-centric world that dominated the 1980s and 1990s investment environment, investors can expect to see substantial value creation in the Connectivity Age on both sides of the business/consumer divide. While some companies may primarily focus on serving one market over the other, both areas should see their fair share of digital data-fueled growth in the years ahead. But in the consumer side especially, some of the dominant business models of the future will most likely borrow certain attributes from the PC era, especially for firms at work on the question of how to access today's converged networks. This will be the playground of the companies operating under what we'll term an Agnostic model.
Defining the Agnostic
If the PC Era has taught investors anything, it's that substantial shareholder returns can be reaped by all kinds of players, even those that lack a definitive technological edge. High returns are possible even if a consumer-oriented firm does not expressly have the types of distinctive technological advantages examined in the first part of this series and, just as importantly, despite the natural downward pricing bias of technology as it permeates throughout society.
Rather, ultimate success can boil down to employing a business model that focuses on such things as business efficiency and brand strength and will work regardless of which way the technological wind might blow. Calling this an "Agnostic" model may be useful, as the term rightly downplays the smaller role that cutting-edge intellectual property plays as a competitive advantage.
Blast from the Past: The Dell Model
While it often gets heaped into what commentators ambiguously define as the "tech sector," a company such as Dell Computer (Nasdaq: DELL) in reality fits the PC Era's Agnostic mold fairly well. Dell's value creation ability over the past decade owed more to its ability to execute as a precision manufacturer and derive exceptional returns on capital through deft asset management than through any proprietary IP. This strategy has worked equally well in consumer PCs as in corporate PCs, as Gateway (NYSE: GTW) has proven.
The main takeaway for investors from the direct PC version of the Agnostic model is how balance sheet and cash flow efficiencies can be used to effectively offset the outsized margins that tend to flow exclusively to companies offering a technological advantage. Motorola's (NYSE: MOT) recent decision to outsource some of its wireless device and set-top box production to contract manufacturer Flextronics (Nasdaq: FLEX) is one instance of an Agnostic seeking an advantage through supply chain efficiencies.
Certainly, this trend bodes well for Flextronics and other electronic manufacturing services (EMS) companies, which already play a significant role in many areas of the converged network. By providing Agnostics with the means to lower their costs and improve the time to market for their products, the EMS firms are in a way an extension of the asset optimization model that has fueled the likes of Dell for years.
The Low Price, High Value Model
It would be shortsighted of an investor to assume that an asset optimization model will not be relevant in the Connectivity Age. In fact, efficient asset deployment could be an even larger determinant of value creation ability as Agnostics in the converged network have a harder time gaining a competitive advantage by offering high value at a low price.
The "greater bang for the buck" theory of value creation is not new; it has been at the heart of industries ranging from hard-line retailing to fast food for the better part of the last half-century. Without a doubt, if a company like a Psion (OTC: PSIOF) or a Research in Motion (Nasdaq: RIMM) can manage to jam greater amounts of functionality into a wireless handheld access device than its rivals and sell it at a lower price point, it will almost certainly take market share. However, at least on the consumer side, competing long-term on price in the Connectivity Age will prove to be a dicey proposition based on the quick rate at which pricing for tomorrow's access devices is likely to fall.
As a 1997 report by the Federal Reserve Bank of Dallas noted, the average price of a PC declined by about a 10.5% annual rate between 1984 and 1997. Meanwhile, the average price of a cellular phone declined by a much faster 29% annual rate over the same span. (The declines for both products are only slightly more dramatic using the report's preferred yardstick of "time at work" as a proxy for real prices.)
While it would be an error to read too much into these figures, it's certainly reasonable to expect that prices for the consumer devices that will be used to access the converged networks of the future will fall just as fast -- if not faster. After all, the Internet has only accelerated the overall population acceptance rates of PCs and cell phones over the past few years, prompting even steeper price declines.
Brand Value in the Connectivity Age
Faced with a high probability of such a hostile pricing environment, the players looking to become the dominant Agnostic companies of the Connectivity Age will need to find other ways to set themselves apart from the rest of the competitive crowd. The old business standby of economies of scale will surely still hold weight as a competitive advantage in the years ahead. However, winning ever-greater "mindshare" through branded products with strong reputations will continue to be one of the best ways to build sizable shareholder value in the Connectivity Age.
While it's not always clear whether flashy TV advertising campaigns from today's companies are aimed at potential customers or potential investors, it's obvious what a firm such as Nokia (NYSE: NOK) is trying to achieve with spots featuring its sleek, aluminum-finished model 8890 digital phone. The company is trying to build a well-defined brand identity of quality and style with consumers, and is by all appearances doing a good job of it. According to consulting firm Interbrand's latest survey, Nokia ranks fifth among the world's most valuable brands, ahead of such brand powerhouses as Disney (NYSE: DIS) and McDonald's (NYSE: MCD).
While such lists are far from scientific, investors should not overlook the potential value of a brand-centric model. If that brand strength can be combined with innovative technology, that's even better. Just ahead of Nokia on Interbrand's list is Intel (Nasdaq: INTC), which benefited greatly from its famous "Intel Inside" branding strategy in the PC Era. Folks can argue all they want about Intel's technology, but it's branding strategy has been a clear winner and differentiator.
The Ultimate Connectivity Company?
Whether Intel or another firm such as Texas Instruments (NYSE: TXN) can replicate the success of that branding model in the Connectivity Age remains to be seen. However, investors should recognize from the PC Era how a strong brand can fuel business growth. United with the proper asset optimization strategy, the end result could be a powerful value creation ability and quite possibly the paramount business model for the Connectivity Age.
Tomorrow, Bill Mann will continue the Convergence Emergence series with a look at the companies that are looking to dominate the Connectivity Age by providing the technology "Standards" for the various telecommunications and networking markets of the future.
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