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Another Perspective


When the dot-com bubble burst about eight years ago, the Federal Reserve slashed interest rates to prevent what it felt was a menacing deflation.  The Fed's policies stemmed the decline but also led to the formation of a bubble in housing that has now burst.  When the dot-com bubble burst, the largest computer companies handled it pretty well.  The same is likely to be true of housing, where the two giants in housing hardware, Home Depot and Lowe's, seem to be coping about as well as the two top vendors of computer hardware, IBM and Hewlett-Packard.

There are plenty of differences between the dot-com bubble and the housing bubble, not the least of which is the enormous leverage used during the housing bubble to turn ordinary mortgages into financial derivatives and then to turn those derivatives into Byzantine securities that are impossible to understand and value.  Similar use of financial sausage-making machines during the 1920s produced trusts and investment vehicles that imploded beginning in 1929, sparking a depression that lasted until roughly 1940.  There's a case to be made that the Great Depression didn't just wear itself out but rather that it was cured in the United States by the government's vast deficit spending as the nation geared up for its entry into World War II.

So far, the damage caused by the bursting of the housing bubble has not brought about a depression.  On the other hand, there's still no solid evidence that the current crunch will be over in a mere eleven years.

Bread Line in 1937
Bread Line In 1937
Eight years after the 1929 stock market crash
the US and Europe were still amidst the Great Depression

If spending money on war is a sure cure for economic malaise, then our problems would already have been solved.  The American government says it is at war and has been since 2001, not exactly against any nation but against what it calls terror, and accordingly it has spent vast sums in battle and built up a tremendous deficit.  If this war and its resultant deficit are providing a boost to the economy, imagine what a pickle we would be in if we stopped all the deficit spending.  And if the spending is not boosting the economy, nobody seems to have an explanation of just what seems to be going wrong.  Somehow, it looks like things aren't adding up the way they did 70 years ago.  Apparently, there's a lot more to economics as understood by John Maynard Keynes and his intellectual heirs than simply using a government deficit to offset an economic downturn, to say nothing of a recovering from collapse.

Despite widespread gloom in the business world, IBM said in mid-October that its third quarter results were good and that it is not reducing its expectations for the rest of the year.  IBM didn't say how it might do in 2009, but even so its confidence in 2008 showed that the computer business wasn't so bad after all, at least not for IBM, at least not right now.  IBM wasn't alone in pointing out that conditions were not as bleak in the world of information technology as they were in, say, banking, where the industry giants seem to have discovered that the only pockets big enough to pick are those of Uncle Sam.

(Similar rescue practices have become commonplace worldwide, giving economists a chance to compare the spread of financial malaise to that of the Black Death across central and Western Europe in the fourteenth century and thereafter.)

Hewlett-Packard is widely expected to report earnings per share for fiscal 2008 (ending October 31) that are in the vicinity of a 20 percent gain from last year's results.  Its annual revenue is over $113 billion, making it about ten percent bigger, as measured by the top line, than IBM.

To round out the size comparison, Home Depot, which, like IBM and Hewlett-Packard, is one of the 30 component companies of the Dow Jones Industrial Average, had revenue of $75 billion last year.  Lowe's is smaller.  Last year it had revenue of $48 billion.  However, Home Depot is shedding some outlets while Lowe's says it plans to continue adding stores, so the gap between these companies could diminish in coming years.

One of the most notable aspects of IBM's evolution has been the company's creation of a services business that now produces about half of Big Blue's revenue.  Hewlett-Packard obviously felt IBM had the right idea and bought computer services giant EDS.  In presentations to financial analysts and shareholders, IBM refers to its services operations as an annuity businesses because it believes most customers are not only locked in by long contracts but also by their commitment to IBM systems, software, and computing culture.  So far, it looks like IBM is correct, but it still faces a conceptual challenge that could become more prominent as the current wave of financial turmoil floods the business landscape.

Home Depot
Home Depot
A carefully developed balance of goods and services aimed at consumers
plus a huge OEM business serving contractors has made this company
bigger than Big Blue or HP in the USA and nearly as large on a worldwide basis

IBM tries to encourage customers with its largest systems to develop new applications and run them on their central IBM hardware.  These big shops often use System z mainframes but some prefer Power boxes running AIX or the i package of systems software and middleware originally developed for the AS/400 line.  (There is still a huge base of legacy AS/400, iSeries, and System i iron, but IBM is pushing very hard to get these customers to move to Power Systems platforms and, chances are, it will succeed during the next few years.) The new applications that run on large IBM systems are overwhelmingly likely to involve the Internet.  Some are Web sites or portals while others allow companies to deliver cloud computing applications from a central facility instead of supporting distributed processing in the field.

But IBM's big customers sometimes view their central systems, no matter how large and sophisticated they are, as basically bookkeeping machines.  There is no doubt that IBM excels at the kind of computing we call data processing.  It is also apparent that the big companies that survived the dot-com boom and bust and went on to become world class enterprises, companies like Google and Yahoo and Amazon and eBay, for example, use clusters (or at least collections) of more-or-less industry standard computers and software that is built on open source technologies.  These companies don't use IBM data processing technology to deliver their services.  Neither do they use large IBM systems broken into logical pieces by emulation software to perform searches or conduct commercial transactions.  In Google's case, it actually makes its own servers.

It's pretty easy for any user company to see that it is possible to provide very effective business functions without using traditional large central systems.  Moreover, Google and other post dot-com companies are now aware that their future growth might well depend on helping other enterprises use their computing technologies.  If Google lets IBM, HP, Microsoft, and other vendors define all the systems and software available to companies that need a computing infrastructure, it will eventually find itself culturally isolated, its opportunities foreclosed by rivals that claimed all the good expansion territory for themselves.  The same can be said of other companies that grew out outside the data processing world.  Amazon and eBay are always looking for ways to extend their influence and to derive revenue from technologies that they initially developed for their own internal use.  Amazon's EC2 utility computing service is a notable example.

The competition between venerable vendors like IBM and younger firms like Google is not as simple as a two-way contest.  While all the large information technology vendors have some characteristics in common with some of their rivals, each has unique cultural and technological gifts, and each can best succeed if it can find a way to market its special gifts, much the way IBM has established its franchise in data processing.

A similar process of evolution is underway in the home maintenance market where Home Depot and Lowe's dominate.  Both companies sell goods to do-it-yourself types.  Both provide advice on how to use the materials they sell through personnel working in stores and also via educational materials they publish on their Websites.  But both also have other interests.

Home Depot and Lowe's both reach out to contractors with the help of special pricing aimed at buyers of larger volumes of materials than a solo do-it-yourselfer would want.  They also have support and service departments that try to win the loyalty of contractors.

Hewlett-Packard offers products to individuals, small businesses, large enterprises, and resellers.  IBM used to, but since it got out of the PC business it no longer serves individuals, home-based businesses, or even small companies.  The home improvement companies are more like HP than IBM, dealing with customers of all sizes and juggling a body of business relationships that can, at times, pit a company's vendor role against the same company's service provider role.

Just as HP and IBM sell to service providers with which they may compete, home maintenance retailers compete with their contractor customers by offering services directly to homeowners.  These services range from the basic installation of large appliances to the complete installation of windows, siding, roofing, and floors.  The retailers provide warranties and they base their reputations on the credibility of these guarantees.  At their best, the home maintenance retailers do a better job for their homeowner clients than large computer companies do for their computer users.  Their guarantees are baked into the purchase price.  By contrast, computer vendors that install systems and networks provide limited warranties that are designed to lead customers into maintenance agreements that can, over time, add quite a lot to the total cost of a computer installation.  It's not that keeping your house in proper shape is free or cheap, but that caring for a home is a bargain compared to keeping a computing infrastructure alive.

John Maynard Keynes
John Maynard Keynes
This British economist explained how governments could use
their economic and fiscal powers to fight problems
that seem to be inherent in capitalist economies

The two big players in home maintenance see potential opportunities arising out of the housing finance crisis .  .  .  if the solutions implemented by governments, banks, and other institutions don't bring the whole economic world to a halt.  If individual families start to get out from under their financing problems, many of them will still have to move to less costly dwellings.  As they churn the market, there will be a vast opportunity for companies that help homeowners redecorate, refurbish, insulate, and otherwise adapt homes to their needs.  This will create opportunities for Home Depot, Lowe's and many other companies, some local, others national.  Some firms that now build new homes may move into the renovation business, at least for a few years, to improve revenue and to hold onto skilled employees that they will need in the future, when conditions in the housing industry are healthier.

If the authorities set priorities that put civilization, culture, and country ahead of quarterly or annual earnings, the problems caused by greed, foolishness, and mob madness can probably be solved in a few years at a cost that, with some difficulty, can be paid.  If our leaders turn out to be no wiser than the ones whose failures led to the disaster we see around us, well, that's another matter.  Have a nice Dark Age, The Sequel.

There are parallels in information processing.  The computer industry managed to survive the dot-com bust and get back to inventing iPhones, expanding network computing, improving hardware and software (or at least making it more ornate), and creating new services to compete with in-house systems that have grown too complicated.

But this rebound from the depths of the dot-com bust took place during the real estate boom that had not yet spawned a manic market of overpriced if not worthless derivatives.  Nobody had to think too carefully about the practical value, if any, of high tech apparatus or computer-based services; money was growing on trees planted on mortgaged land.  These days, buyers of information technology good and services understandably question the value of what they buy.

It is quite possible that the pendulum is swinging too far in the direction of caution.  Ordinary and quite sustainable risks associated with acquiring emerging technologies may be frightening prospective buyers.  IBM might have an easier time selling mainframes than blade servers under such conditions, and that could boost Big Blue's business.  However, in the long run, if IBM's biggest customers lose their technical edge, neither the users nor IBM will end up in a strong position.

HP might seem to have a smaller legacy component in its diverse business, but its acquisition of EDS cannot blossom when EDS is about preservation rather than progress.  Nor can HP do well if its server customers fail to study the emerging virtualization technologies that hold great promise even though they present a possibility of challenging applications development issues.

Neither IBM nor HP want to discover that their systems customers have decided to shift to cloud applications from Google, Microsoft, or another vendor for negative reasons.  The full range vendors could suffer if customers become reluctant to make capital investments in technology, or if the users decide they would rather let a cloud computing supplier define their future applications.  But many customers may choose not to choose, neither pushing ahead with traditional in-house computing systems nor with a migration to Web-based alternatives to local applications.  Customers could, out of fear or uncertainty, simply freeze.

Even when business conditions begin to improve, it will take more than a rising stock market or the end of scary headlines in the business news to get computing back on the track to prosperity.  The vendors that hope to lead their customers along a progressive path, whether they have deep roots like IBM and Hewlett-Packard or are relatively young like Google and Amazon, could do a lot worse than keeping the kind of promise that has become Home Depot's motto:

You can do it.  We can help.

— Hesh WienerOctober 2008

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