Boston papers are atwitter this morning over Dell’s acquisition of local favorite EMC, the data storage company. With that the once proud Boston area, which birthed the mini-computer and software booms with companies like Digital, Data General, Wang, and quite a few others, is without a serious leading computer hardware maker today. Not to worry, there is still a robust tech sector in robotics, biomed, and software (there are more but let’s not quibble). In light of the rise and fall of Boston as a tech hub let’s see if there are lessons to carry away.
First, and for many years, the non-compete agreements that many companies make people sign as conditions of employment are very much enforceable in Massachusetts, though other states, notably California, take a much more relaxed approach in employment law. It makes no sense to keep people on the payroll when they’d rather be inventing something for themselves. In Silicon Valley you can quit your job on Friday and start up something on Monday as long as you’re not taking a lot of valuable IP with you. The Massachusetts model assumes the most valuable thing you can take is customers. I might disagree.
I once had to deal with a similar situation regarding a non-solicitation agreement in which I could not approach former customers for a year, though in my reading they were free and unencumbered (this is America after all) to seek me out. Issued a few press releases, started my company and blog and went on with life. The former employer didn’t like it but there was little they could do. I knew I’d won when they sent me a FedEx letter containing nothing but a dog biscuit (for Beagle Research, get it?).
As a very practical matter people who leave jobs don’t have a lot of discretionary cash to pursue lawsuits and the state legislature displayed a stunning lack of intestinal fortitude last year when it failed to deal with proposed changes to the non-compete laws. People vote with their feet and they’ve discovered in droves that the climate is much nicer in California.
Of course all the changes to statutes won’t change an iron law of economics: Companies and products trend toward commoditization. The mini-computer that I started my career on now comfortably fits into a pocket and costs thousands of times less. Massachusetts, which is home to Harvard and MIT has forgotten the lessons packed into Clay Christenson’s books (The Innovator’s Dilemma series) and they stop innovating at some point. It must be very nice for a while when you stop investing in the new, new thing and your employees are more or less stable because they can’t as a practical matter go elsewhere without significant economic displacement. But that only lasts a little while.
Massachusetts and Boston are not unique in all this. As we move further into the era of apps and the GUI and operating system take more of a back seat, we can observe the same troubles besetting Microsoft. So it goes.
Perhaps biotech, the IoT, and robotics will be more forgiving to Massachusetts but don’t bet on it. Massachusetts is an expensive place to live and while it can thrive on innovation thanks to the brainpower lodged here, commoditization forces products out the back door to places where they can me made cheaper, so the ace up our sleeves has to be our willingness to invent the future every day and not rest on our laurels.
The academic-commercial partnership
Massachusetts is expensive because of all the well-paid jobs that are here and the competition for limited resources like schools and real estate. But one of the greatest inventions of the last hundred years that has come out of the area is the tight relationship between academic R&D and venture capital. It’s common to see this kind of thing in California today and certainly the VC community there is big and brash and it attracts a lot of investment capital. But it got started in Boston just after WW2.
The relationship continues today in other fields and is one reason the area’s future is so bright. I remember being in a conversation with a couple of VC’s a few years ago in which we were discussing “small” and “large” molecule R&D. The fact that they get down to that level tells me things overall are okay.
The Red Sox, Patriots, Bruins etc.
The Boston teams in general provide an indirect definition of our culture and why we live and work in this land with too little summer, rocky soil, funny accents, and a penchant for celebrating weird holidays like Evacuation Day (look it up). The Puritan work ethic got going here and it still informs much of our lives. We’re a competitive race, we like to win, and we don’t suffer fools, truth be told. EMC has been bought, fine. Commoditization continues on all fronts as it must but in Boston you can bet there are more than a few people hard at work inventing stuff that we’ll all need in the not too distant future, and so the cycle renews.
It’s easy to be blinded by the obvious. It happens in business all the time, something is right in front of you but you attribute its effect to a different cause. I see this most typically when observing a paradigm shift — the reason for the shift is not always the obvious causative agent.
For example, Dell became a great producer of PC’s (despite the company’s recent shortcomings, which mirror the entire industry) by mastering the logistics of just in time inventory, highly flexible manufacturing techniques, and great logistics. You can call them up or go to their Website and custom design a machine perfect for your need and it will arrive at your door in a few days. The impressive bit is not that your PC got delivered but that millions of others also did at the same time. So while Dell looks like the master of PC manufacturing, they got there by mastering a lot of arcane disciplines related to logistics and inventory management.
Another example is McDonalds. The company built a template for a successful fast food outlet but you could say its major strength has been in franchising and real estate management.
A third example might be Salesforce.com. They weren’t the first CRM company on the street but they were the first to figure out how to deliver a competent business application across the Internet and they excelled at marketing it.
The unifying idea in all of this is not simply having a good idea but in being first to market and executing better than others in your space. The first mover advantage has been the stuff of legend and lore for a long time and there’s a great deal of validity to it, which is why it’s legendary.
Today I am seeing more first movers than I can ever remember, at least since the dotcom boom. As usual it’s not the obvious thing that accounts for a company’s success; it’s something else. Today, the hottest idea in business seems to be subscriptions and all manner of companies are trying their hands at the business model. Everywhere you look you see new subscription companies springing up, and not just to peddle some new software app either. There is a growing cohort of companies that deliver goods as a subscription service — from the obvious like wine on a monthly basis to the utilitarian like shaving supplies and clothing.
The commonality for all of these companies is not the quality or quantity of goods sold, though they are important, but the back office operations that make the subscription model possible. These companies all know, or they should, how important it is to get the customer’s order right but they are also fanatics about three other things, what I call imperatives. First, they are good at managing churn, the propensity of customers to leave a service over time. They measure churn and attrition but they also understand the average customer’s lifetime value and can forecast value remaining.
Second, they know where their recurring revenue comes from. Whether it’s cash in the bank or cash promised in a contract they can calculate to a high degree of certainty what’s in the pipeline once things like churn are factored in. Finally, they also have a keen grasp on the cost of revenue. A wise man once told me you can’t eat revenue, you can only eat margin and that idea is on full display in a subscription company. New customers require some handholding, so do older customers though not as much. But subscription companies are adept at understanding how much their revenue costs them and what the margin really is.
Now, it would be nice if everyone understood all of this but they don’t. There are lots of subscription companies that are not fanatics about these three imperatives and they are the companies most likely to not succeed. Wherever you look whether it’s Dell, McDonalds, or Salesforce, each company had a raft of competitors when they got started and the winners were the ones who understood their paradigm better than the rest and executed within it.
The expansion of the subscription business model is likely to continue for many years as new niches open up to subscription vendors. But the niches are tiny. There might be a lot of fast food companies today but as you look at the modern business landscape, the ideal niche for a subscription company seems to have room for only one vendor. There’s only one Amazon, one Facebook, and the number of solo market niches is growing. The company that owns the niche has the most descriptive name of the niche. Unlike department stores, the subscription companies quickly iterate on a model and once set, there’s little room for a competitor regardless of how big the market is.
So if you intend to own a market in a subscription world you only have one shot at it. You need to manage the back end operations like your life depends on it, because it does.
This week kicks off the third annual Zuora user meeting, Subscribed. Zuora is one of many companies providing billing, finance and payment solutions for subscription companies. They’ve made a science of mastering the big three imperatives and that mastery will be on display at the Intercontinental Hotel in San Francisco. A couple of weeks ago the venture capital world signaled its approval with the company’s $50 million series E tranche of funding. Stay tuned for more.
Just last week I was writing about the importance of sometimes ignoring Wall Street analysts whose focus on quarterly earnings can force a company into neglecting its best interests. Bowing to the demands of quarterly reporting (and profits) reflects short-term thinking that might prevent long-term success. Today Dell decided to go private in a $24 billion dollar deal that involved about $15 billion in debt, private equity and an assist from Microsoft and I think it reflects Dell’s need to step away from that thinking.
It’s a gutsy move but one that I think will benefit Dell. It is also somewhat like a restructuring under court supervision during a bankruptcy but this has none of the stigma of a bankruptcy nor does it have the outsiders looking over your shoulder that can make such a restructuring so difficult.
Dell will be free to chart its course though it must be said that its partners in this endeavor can’t be expected to be silent. But neither can they be expected to be naïve about what’s ahead, they presumably are smart people who went into this with open eyes.
So, what are they doing and why? Well, PC and laptop sales have peaked. The industry will sell a lot of boxes this year, but the growth is out of the market and it is becoming a zero-sum situation of replacements and takeaways. In Q4 2012 the majors, including Dell, shipped a combined 90,372,942 units — 4.9% less than in 2011’s Q4 according to Gartner. At the same time, smaller devices are ramping like crazy — headline: “Gartner: PC sales continue to slide as tablets eat their lunch” and as the PC makers sneeze, Intel, the maker of the CPU chip, catches cold — headline — “Intel profit sinks 27% on dreadful PC sales”. So the play now is to compete in tablets and smart phones and try to make it up on volume and software. But the prices are lower for smaller devices and so are the profits.
When Dell was a public entity, no Wall Streeters wanted to know about declining sales of big boxes or rising sales, but lower margins, of devices. But that’s the reality. As a private company Dell will be freer to attack the device market and to more aggressively go after the market for cloud computing where it can remake itself into a twenty-first century tech company.
Dell already has substantial assets in non-hardware related areas. For example, it owns Boomi, a cloud integration product that enables Dell’s service group to bring together multiple cloud systems into a single solution for its mid-range customers. It partners with Salesforce.com in delivering Sales Cloud and Service Cloud solutions using Boomi and third party apps. It ties the deals together with financing from Dell Finance. So the company has some significant assets it can use to innovate new products and I expect we will see a lot of that.
Lastly, as I look at this I see a similar story in Sun Microsystems which Oracle bought a couple of years ago when the once high-flying computer maker began to stumble. In concert with Oracle’s database gurus, the hardware division has rolled out some impressive next generation devices that will certainly drive cloud computing to new heights. But there’s no reason to concede that market to Oracle/Sun and Dell might have something to say about high performance cloud computing infrastructure as it begins to innovate anew as a private company.
Dell’s announcement this morning is studded with opportunity and peril. But the fact that it has taken control of its destiny and that founder Michael Dell is still at the helm means that the company should now attempt to kick its innovation into high gear. The outcome is uncertain but if successful it may present a new model for what aging and once successful companies can do when the market shifts beneath their feet. This will be fun to watch.