Even if you’re a good swimmer, when you’re at the deep end of a pool, you still want to know where the bottom is. It’s no different for wary investors and industry watchers paddling along in these economically choppy waters. So when prognosticators proclaimed the rock bottom of the economy had surfaced in the fourth quarter 2001, there was a collective sigh of relief. A return to just paddling along.
But once the swimmers knew where the bottom was, they soon wanted to know how high they could jump on the diving board before they could dive into the pool. The prognosticators eased the troubled waters once again with projections that by the second half of 2002, the economy would do a pleasant about-face. Until the attacks.
"Things were teetering and September 11 just knocked them over," summarizes Tricia Parks, president of market-watcher Parks Associates.
But just because there is only one direction to go, doesn’t mean it will go there quickly.
When it seemed the news just couldn’t get any worse, the Wall Street Journal and other financial publications alerted their readers to be on the lookout for signs of an economic recovery. And the first sign the economy is getting healthy according to the WSJ? "When businesses start investing again, especially in technology."
Call it techonomics.
The technology sector sits at the center of the economic recovery. Technology industry watchers say they saw the sector’s pain and called the bottom back in August 2000, a full year before the federal government formally tagged the economy as in a recession. The Internet’s ubiquity, the developments in software, and the numerous start-ups in the tech sector all led to technology’s rising. When the dot-com bloom came off the rose, and start-ups stopped mushrooming, technology took a hit, dragging the economy with it.
Technology was also supporting the telecom gold rush. There were the competitive local exchange carriers (CLEC) that sprang to life in the aftermath of the Telecom Act of 1996. CLECs had lived and eventually died by Wall Street rules. While they were concentrating on growth rather than sustainability, their stock prices knew no bounds and they were consuming goods from technology players.
Then, seemingly on a dime, Wall Street wanted to see results and the start-ups’ money-handlers pulled in the reins. Venture capitalists now wanted to see an iron-clad business plan before they wrote the checks. Competition for access to the information superhighway (remember that one?) faltered. The promises of the Telecom Act of 1996 were questioned. Meanwhile, caught up in the go-go times, the telecom industry overbuilt its networks and the "build it and they will come" mantra used in so many Power Point presentations failed to attract the necessary customers. Telcos were left with too much inventory, so they stopped buying from the equipment manufacturers.
Corporate industry points to government and universities, and government points to industry as being responsible for funding new research.
The powerful equipment manufacturers like Lucent Technologies, Nortel Networks, and Cisco buckled and left thousands of employees—Lucent’s axe alone removed 16,000 heads—on the streets. Talented technology minds, once courted by top corporations, were now searching for work. Companies touting new, once-promising technologies like fixed wireless—namely Winstar and Teligent—ran into obstacles and knocked on the doors of Chapter 11, leaving even more unemployed. Even AT&T was figuring out how it could get stronger by breaking up. Blue chip no longer meant nest egg, and technology stocks no longer meant lottery ticket.
So after what has been called the longest period of economic expansion in history—lasting more than a decade—where millionaires were made on shaky-at-best dot-com premises, and venture capital was gotten easier than a flu during flu season, the technology sector credited with many of the get-rich-quick stories was suddenly left gasping for breath.
Service providers, and thereby their suppliers, are now forced to concentrate on the next immediate fiscal quarters just to continue their existence. They are not worried about the next generation of services that could warrant a competitive advantage; they are worried about survival. So likewise, manufacturers are relegated to making and providing replacement equipment rather than the more innovative bells and whistles because that’s the only thing that’s selling right now. Because, really, who needs better and faster routers if the end result is a customer who still has a painfully slow dial-up connection? And who really wants a broadband connection if the content they will be viewing is stale and static?
Which brings to the front burner the most disheartening thing in an economic downturn. That there is no money to fund new ideas. After the plug was pulled on the perks that shined in the Valley during the Internet heyday, like office backrubs and expensive lunches, bottom-liners looked to less-obvious areas for cuts. R&D, once deemed the core of a corporation, was one of the first areas to go during the downturn.
What does this mean? University professors and economists alike say the technical pipeline for new ideas that is supposed to be continually fed is now in danger of drying up. Big tech thinkers, like Peter Cochrane, the former head of research at British Telecom Labs, said that the demand for a quick-return on R&D dollars has basically mortgaged the future of innovation. "The industry was blindsided by the sheer ‘let’s make money’ of it and took its eye off the ball of what was needed next," Cochrane said.
So right now, while everyone is celebrating the feel of the "bottom" in the pool, the hidden leak in the foundation is being overlooked. There’s finger-pointing going on over R&D, that R&D needs to be done to save technology—but by someone else. Corporate industry points to government and universities, and government points to industry as being responsible for funding new research. But federal funds, like funds everywhere, are strapped. The National Science Foundation, which helped fund the Internet, watched its own budget get hacked from $475 million last year to just tens of millions of dollars this year, according to Federal Sources, a market research firm in McLean, Va. An industry can’t get shareholders to go along with hefty R&D budgets when the stock is trading at pennies on the dollar.
The lack of innovation is being noticed in all tech sectors, including the chip sector, a building block of the technology, say financial analysts.
"We are concerned that some of the new prototyping will fall out significantly," says Mark FitzGerald, managing director of semi-conductor research at Bank of America. The result? "There are not as many new products at the telco." FitzGerald is expecting the overall chip sector for the device makers to grow 6% this year, down about 32% from last year, and the equipment sector will decline 20%, down about 38% from last year.
No new ideas could mean lackluster stock performance as well. A lack of innovation doesn’t bode well for stock price down the line. While FitzGerald expects a modest improvement in 2002, he says stocks are already "ahead of themselves."
"To get to good news on the stocks, you’d have to see big surprises," said FitzGerald.
Who knows what that will mean to the up-to-this-point resilient consumer. The thinking these days is that the temperament of the American people is they want the comforts of home. They want to be entertained and enjoy luxuries, but they want to be surrounded by their family and friends. They want to have access to information. (Parks Associates found in a study that post-September 11, the desire for broadband connections rose 7%, after the wired and wireless networks were clogged with calls.) Analysts like Tricia Parks are saying the recovery will be buoyed by the steady consumer who will keep spending money, just on different things. Like entertainment purchases. PVRs (personal video recorders), such as TIVO, will finally be embraced by users. Set-top boxes that can help manage a customer’s viewing habits, and combine the Internet experience with the cable experience, will take off.
But if these consumers are rocked by the fact that their stock portfolios are not climbing as readily as they once did, or if viewing their depressing 401(k) monthly statements gets the better of them, they may start to heavily curtail spending.
Consumers need a reason to buy new things, and they need something innovative to propel them to fork over their now-more-than-ever cherished dollars. That’s where the dearth of innovation now will start to hurt companies. If they aren’t working on these new ideas now, they won’t have the products to offer when the recovery actually does happen.
Even in the best-case scenario, people in big banks and with more degrees than a thermometer who are predicting an economic turn-around in the second quarter of 2002 aren’t trumpeting any great news. It’s only a modest change for the economy they predict, citing a 3.6% growth, according to a WSJ study polling 55 economists. In comparison, previous historical recovery growth rates were closer to 6% or 7%, almost double the rates expected now.
Techonomics will have a big role to play in the economy’s recovery and the technology sector will have to start nourishing itself again with innovation before it can see any kind of rebirth. New product cycles powered by R&D, say economists, is what fuels companies forward.
For now, market-watchers aren’t overly enthused with what they see. So while it may be safe to swim in that pool, it’s not prudent to do any fancy jackknives off the diving board just yet.
"We would be cautiously optimistic," says Parks. "But it’s not a rollback to happy days at all."
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