Feature Stories | Apr 19 2006
GaveKal Research is an independent economic research house and consultancy created in 1999 in the US by Charles Gave and partners. GaveKal has a reputation for “original thinking”. The following feature series is drawn from a GaveKal publication of 2005 entitled: Our Brave New World.
For over ten years a wide majority of market strategists and economists from respected investment banks, a large number of respected financial publications, and a number of highly respected consulting firms have turned to history to suggest that rampant expansion in US consumption in the past decade was doomed to end in tears. Real estate markets would collapse, stock markets would collapse, and the world would enter an economic “ice age”.
It hasn’t happened.
Some observers have not changed their view – they’ve just extended the time frame. Others have tempered their view, and still others have thrown their text books out the window and gone fishing. GaveKal is one organisation that has been prepared to say “things are different this time”. This is a big call, as those who utter these immortal words in the world of financial markets tend to become mortal pretty quickly.
It was Alvin Toffler who coined the first, second and third wave phenomena. The shift from hunter-gathering to agriculture and the formation of the civilised society was the first wave. The invention of the steam engine brought us the massive boom that was the industrial revolution which became the second wave. Toffler suggested the third wave would see information substituting for material resources, and the gap between producer and consumer bridged by technology. This is pretty impressive when you consider Toffler predicted the third wave in his publication of 1980.
There are not many economists who have adjusted to the third wave. Their worlds are still all about industrial production, inventory levels, trade balances and so forth. In the third wave, these measures become increasingly irrelevant.
The first economists appeared in the late 1900s. Their recommendation for value-adding was all about efficient agriculture. Unfortunately they refused to take notice of the industrial explosion going on around them at the time. History repeats.
While economists are slow to wake up, successful companies are no longer operating on business models of a generation ago. Relationships between countries have evolved. Social structures have been transformed. We have entered a brave new world, and that world has given birth to a new phenomenon – the platform company.
Traditionally, a company has followed a long-standing, straightforward process: design a product; manufacture the product; sell the product. To use a US example: Ford designs a car; it is manufactured in Detroit; it is sold through dealerships all over the country. This model has been in place for about fifty years. Global expansion has been added, for example: Toyota designs a car in Japan; it is manufactured in Australia; it is sold through Australian dealerships.
This is yesterday’s business model.
The new business model is to produce nowhere, but sell everywhere. This is how a platform company operates. It simply stamps its logo on a product someone else has actually produced.
Platform companies keep the high value-add parts of research and development, treasury and marketing in house, and farm out everything else. Out of the three steps of designing, producing and selling, producing is a mug’s game.
Producing is capital intensive, often labour intensive, and requires one to keep expensive inventories. It is a volatile business. Manufacturing businesses usually trade at a discount to non-manufacturing businesses on the stock market because returns are volatile, and generally lower. Cut out the middle, and a platform company can concentrate on designing and selling while keeping a nice lean balance sheet.
And the model can extend well beyond the manufacture of widgets. For example, many global hotel chains have sold off their hotels, but have kept the branding and simply operate now as managers. This “light balance sheet” concept allows companies to change and adapt quickly and efficiently. It could be compared to travelling with a small backpack as opposed to a trolley load of suitcases.
When executed properly, the platform company business model makes for very high, and stable, returns on invested capital. With that in mind, can we safely say the platform company is here to stay?
Of all the examples and anecdotes in GaveKal’s treatise, this one is a cracker: The laptop on which the treatise was typed was made in China. The PCB was made in Singapore and the motherboard in Malaysia. The flat screen was made in South Korea. The semis were made in Taiwan, on a US design patent. Some of the software was complied in the US, some in India, some in Sweden and some in Russia. The design was created in Texas, and the laptop was assembled in China. On the bottom, it says “Made in China”. On the top, it’s stamped Dell. And who do you think makes the real profit?
Consider two very strong forces which have contributed to growth in the capitalist world – growth that has led to the concept of the platform company. Firstly, growth can come from the rational organisation of talents.
If a surgeon can type faster than his secretary, should he do the typing? No – that would only take up his time, and he earns a helluva lot more slicing and dicing. He’ll stick with a secretary. The benefits derived from this example are enhanced in the global marketplace by free trade. France makes great wine and Senegal produces great football players. So the Senegalese should stick to French wine, but their footballers should play in France.
The second growth force is invention. (The mother of all growth forces?) Build a better mouse trap and the world will beat a path to your door. A new invention can trigger demand, lead to new products, new management techniques and new markets. Since faxes, emails and broadband, who would invest in telex? (Younger readers may need to ask me what “telex” is at the end of the lecture).
Growth through the rational organisation of talent requires low trade barriers. Growth through invention requires low regulation, tax incentives, easy access to capital and, most importantly, the ability, and the right, to fail. This is a pretty good summation of most of the Western world, so what’s the big deal about the brave new world?
The Dell example shows that free trade opens up the potential for countries to be economically integrated with one another. Not only does this help in promoting peace, it promotes faster economic growth. The more countries that join economic forces in a global network, the greater the economic benefits. And the benefits can be exponential.
A world with two centres requires one line of communication. Add a third and you need three lines. Add a fourth and you get six lines. Keeping going and you get what is known in mathematical parlance as “lots”.
Every day, some new pole is added to the global economy. Yesterday it was China, today its India. Tomorrow it could be Vietnam, the Ukraine or Egypt. With each new addition the lines of communication grow exponentially. And shortly following, in order to cement the opportunity, comes massive spending on telecoms, aircraft, roads, ships, tourism – everything needed to be part of the global society.
The exponential growth in communication lines sets in train other possibilities. The exchange of ideas leads to more new inventions. Suddenly the lines of communication that kick-started the relationship may spawn new ideas, for example, in communication (Skype?).
Within the brave new world it quickly becomes apparent that econometric models, based on second wave principles rather than third, will struggle to quantify such inherent possibilities and potential outcomes of the new system. Each time a new player enters the game the whole game is enriched. For emerging economies, even the impetus and wherewithal to build something as simple as a road can take food and other goods to subsistence peasants, while sending labour back in the other direction. But this inherent opportunity has never been accurately forecast. (Who really saw the ramifications of China, not five years ago?)
Technology, free trade and infrastructure are three of four pillars on which the platform company business model rests. The fourth is overcapacity. Rome wasn’t built in a day, and in Aldous Huxley’s Brave New World there were alphas and there were epsilons. But more on that later.
Part II to follow. The ideas and examples put forward in this series are the work of Gave, Kaletsky & Gave: Our Brave New World, self-published, 2005. The journalist has added some lame comments as well.