FOOL ON THE HILL: An Investment Opinion
The Standard Bearers rest upon processes or technology that they own in an open architecture environment. While any company may use the network, it must still pay the Standard Bearers for the right to use their intellectual property. The Standard Bearers depend both upon interoperability and an uncircumventable process to lock themselves into a technological bottleneck on the network, where none may pass but to pay them. But Standard Bearers that place too much dependence upon their current status and not enough upon future innovations will eventually be replaced.
Of the structural models of data/voice convergence, the newest and arguably least understood strategy is that of the Standard. This relates closely to the Ubiquity model, except for the fact that Standard holders try to bend the will of the industry to their superior technology.
In effect, Standard bearers have a unique technology or process which, given sponsorship by other official or industry consortiums, becomes a bottleneck through which all participants must pass. Ubiquity is slightly different in that the practitioner finds a niche along the converged network chain and provides a full range of products and solutions at that point, resting upon its technological advantage and customer familiarity for its long-standing edge.
The Standard Bearer, on the other hand, depends only partially upon technological superiority, and instead looks to other factors, such as mass adoption, interoperability, patents, and government dictum, to build a toll booth somewhere along the network where all companies seeking to use a network including this functionality must pay.
Although this business model has existed elsewhere (heavy industry, construction, etc.), it is perhaps the communications network that best lends itself to mass standardization, given the heightened nature of interoperability requirements. Without set or assumed standards, communications networks would be unable to efficiently communicate with one another.
The Microsoft Model
To recapture a theme from yesterday's report, the groundwork for the standard bearers has some genesis in the public switched telephone network (PSTN) and some in the PC era model best practiced by Microsoft (Nasdaq: MSFT) with the hegemony of its Windows operating environment.
Windows was neither the best nor the first operating system utilizing graphic user interfaces (GUI's), but Microsoft both jockeyed for and benefited from making Windows the near-standard interface for PCs. As computer users have migrated from stand-alone requirements to networked ones, and then further to the Internet, Windows has maintained a vice grip hold on the PC market. The greatest danger to its hegemony is that the PC itself becomes supplanted by other hybrid communication devices. The wireless revolution may be the discontinuous innovation that knocks the PC off its seat at the center of data communications, opening up a large enough window for a new Standard Bearer to emerge.
Adoption of a Standard: Technology, Plus a Little Boosterism
The Standard Bearers always begin serving a niche within the Network, which they then begin to press outward. In order for the Standard to be worth forming, the technology or process must show promise for dramatic future growth, either as an improvement of or as a replacement for current technology.
For instance, Qualcomm's (Nasdaq: QCOM) patents for Code Division Multiple Access (CDMA) technology existed for years before wireless communications became commonplace. But as wireless communications becomes more data intensive, CDMA offers a standard allowing for the highest level of data throughput for customers on a cell by allowing multiple users access to the same spectrum. Digital wireless advances like CDMA have revolutionized a certain portion of communications by adding efficiency for voice communications and allowing wireless data applications to use bandwidth on demand.
The selection of technology is often the result of a little boosterism, in which the potential Standard Bearer has insinuated itself to consortiums or regulatory bodies to make its intellectual property part of the standard solution. Qualcomm for its part has chosen to license its intellectual property to any carrier or equipment provider wishing to implement it (a strategy resembling an Agnostic model), with the proviso that they pay Qualcomm a royalty. At the same time, Qualcomm continues to insinuate itself deeper into the future of wireless Internet by providing proprietary CDMA-based chipsets to those same equipment manufacturers.
The risk of this gambit is simply that in certain situations, particularly ones in which government bodies can mandate, there is no guarantee that the logical choice of a superior technology will be made -- for reasons ranging from protectionism to ultimate cost concerns to petty jealousy. Further, it is also possible that another innovation will unseat the current standard. Qualcomm is facing many of these issues now, along with lingering doubts that it can enforce its patents throughout the range of CDMA protocols. Standard Bearers Phone.com (Nasdaq: PHCM), IDC (Nasdaq: IDCC), and Geoworx (Nasdaq: GWRX) share these same risks as well.
Interoperability and Barriers to Entry
For a company to become a true Standard Bearer, as opposed to just a propagator of a pretty neat technology, its technology must be squarely situated so that potential customers cannot get around it due to expense and compatibility constraints. Geoffrey Moore calls it "open proprietary architecture," where a company owns a patent or otherwise has a moat built around its technology, which is at the same time the only real choice for customers. Once the Standard has been raised, the Standard Bearer's intellectual property is integrated so deeply into the architecture of the total network that it cannot be extracted without considerable expense and a widely coordinated move.
Siebel Systems' (Nasdaq: SEBL) customer relationship management (CRM) automation tools are a prime example here. Siebel has so deeply integrated itself into the value chain and resource planning functions of its customer companies that they are patently unable to extract it. Further, Siebel's CRM product as a customer interface has become the standard in this point of the network. As such, the barriers to entry for competitors are almost insurmountable absent a sea change of customer demands. Even so a competitor must then approach customers and participating co-vendors and entice them to switch from one standard to another. The risk of failure even after massive capital deployment is massive.
Patent Protection and an Ultralight Capital Model
A final note for Standard Bearers. Once their intellectual property has been accepted as the standard, they do not necessarily even need to produce the technology anymore. Qualcomm has licensed out production of technology based upon its intellectual property. Qualcomm's domination of the CDMA wireless market is thus based upon its ability to defend and press out its patents and insinuate itself into newer applications to retain and enhance the value of that IP.
Additionally, this model provides an incredibly light capital structure for the Standard Bearers, as royalty payments have no production costs. Instead the Standard Bearers can retain massive amounts of capital that would otherwise go toward production costs for research and development and marketing.
But a dependence on patents and their enforcement is not a long-term recipe for value creation, unless those patents happen to relate to a technology so rare and unique that further improvements are physically impossible. In the Motley Fool Research coverage of Siebel Systems, John Del Vecchio characterized Siebel's greatest risk as execution risk, meaning that despite its entrenched position, the company could eventually be marginalized if it fails to provide increasing value to its customers.
As investing guru Phillip Fisher once said, "As has been true many times before and since, it is the constant leadership in engineering, not patents, that is the fundamental source of protection." The Standard Bearers that place too much dependence upon their current status and not enough upon future innovations will eventually be replaced.
Tomorrow, we will sum up some of the major themes that have emerged from our examinations of the Ubiquity, Sunk Assets, Agnostic, and Standard Bearer businesses models and share some thoughts on a charting a proper course for investor action.