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Silicon Valley spark fades

Saturday 12 January 2013

By Martin Hutchinson

All major industries go through an innovation life cycle. They provide a fundamentally new product or service when they first appear, then as their use becomes more widespread their changes to the world become even more fundamental. Later on however, while capital flows to them in vast profusion, their innovations become more marginal, although there is still money to be made.

Finally, generally after a monumental shakeout with many bankruptcies and much capital destroyed, they settle into maturity, in which innovations are minor, their products commoditized and they grow only in line with the global economy, while innovation shifts to some other sector. Silicon Valley, the source of growth and inspiration for the last four decades, is about to shift into this last phase. The transition will be painful.

We saw this cycle first with the advent of steam power. The first steam engines, invented by Thomas Savery in 1698 and Thomas Newcomen in 1712, were used primarily to pump water out of mines and were very inefficient. Then the separate condenser of James Watt’s 1774 engine improved the engines’ efficiency enough to widen their use, while the higher boiler pressure of Richard Trevithick’s 1804 engine allowed it to power a locomotive.

The second, world-changing period of steam power came after Watt’s and Trevithick’s innovations, which led to steam-powered mills and railways, the first being the Stockton-Darlington line of 1825. There followed a period of immense innovation and prosperity, with both factories and railroads appearing in immense profusion, absorbing gigantic amounts of capital and powering stock market booms in 1825, 1836 and 1845. The culmination of this period was the opening of the US transcontinental railroad in 1869, the ultimate application of gigantic amounts of capital to steam-powered technology.

Steam-powered industry suffered a gigantic stock market crash in 1873, which was followed by two decades of downward pressure on wages and prices, even though globally productivity growth remained rapid as entirely new industries were created. After 1869, innovation in steam-powered engineering was modest, and new investments of capital such as the major railroads of the 1870s through the 1900s proved marginally profitable at best.

Similarly in the automobile sector, the early years produced a profusion of models, powered by steam and electricity as well as gasoline. However the major impact on society came after Henry Ford’s Model T of 1908, with major innovations (the self-starter, the synchromesh gearbox) continuing until automatic transmission appeared in 1939.

The automobile’s transformation of global existence came slightly later, beginning in the 1920s in the United States, but delayed considerably by the Great Depression and World War II. Thus the transformation spread to Europe only in the 1950s and China only within the last couple of decades - automobiles being expensive, a fairly high standard of living is required before they can be purchased. Innovation in the automobile sector has continued, with developments such as the platinum catalyst and anti-lock braking systems solving major problems. Nevertheless in spite of the industry’s market growth, its profitability has been marginal since the 1970s and innovation has been modest.

The early years of information technology were similar to the Savery/Newcomen years in steam engines. The first computers were designed to solve very specific, minor problems - the British Colossus, the first such, designed to break German codes, remained a state secret for 30 years. Though today we mock Thomas J Watson, the CEO of IBM who in 1943 is said to have forecast the world market for computers as five units, a similar forecast would have been made about steam engines around 1710 - both machines were initially so underpowered, expensive and inefficient that they had very few imaginable uses. Until the invention of the personal computer in 1974, the sector remained economically unimportant.

The period from 1974 until the bursting of the Internet bubble in 2000 brought Silicon Valley’s maximum impact on the global economy, in areas from modern finance to retailing. The Internet itself, which burst to prominence in a very short period around 1995, was the most important information technology advance in terms of its effect on life as a whole, but the personal computer and the cellphone were not far behind.

By the late 1990s, massive amounts of capital were being deployed in IT, in very much the same way as in the railways in the 1840s and 1850s and in the automobile industry in the 1920s. Huge fortunes were made, the industry expanded very rapidly and valuations reached sky-high levels.

In retrospect, the dot-com crash was similar to the Railway Crash of 1846 and the stock market crash of 1929; it punctured the balloon of valuations and killed off some of the sillier uses of capital, but it did not kill the industry, nor significantly slow its rate of innovation. Just as 1846 was not the end of steam’s innovation and dominance and 1929 did not mark the end of the automobile’s efflorescence, so tech sector innovation continued after 2000.

Even though the Great Depression reduced the US automobile industry to an oligopoly of three major manufacturers, it did not mark the end of innovation, nor the end of the industry’s growth and prosperity, which peaked in the 1950s. Only after the exuberant tail-fins boom of the late 1950s expired did the automobile industry become fully bureaucratized, with declining innovation and profit margins. 1958’s Edsel, not 1928’s Ford Model A, marked the end of the automobile’s growth era

If 2000 was the tech sector’s 1929, the subsequent era has represented an amalgam of the 1930s and the 1950s. New entrants such as Google and Facebook have appeared, as they did outside the United States in the automobile industry. Of the top eight current automobile manufacturers by sales volume, General Motors, Ford and PSA Peugeot-Citroen predate 1929, but Nissan (1933), Toyota (1937), Volkswagen (1937), Hyundai (1947) and Honda (1948) postdate that watershed.

However tech sector innovations have been notably less fundamental than before 2000. The two latest, the tablet and the smartphone, appear to this outsider to be considerably less fundamental than the self-starter or automatic transmission; indeed the latest Apple range of products bears a startling technological resemblance to the Harley Earl-designed automotive behemoths of the tail-fin era. The Young Master assures me that the ability to send and check Twitter messages in the middle of Grand Central Station is fundamental to his existence; no doubt the young of 1959 were similarly attached to their automobile styling that suggested their hot-rod was about to take off on a visit to the Moon. For those under 50, let me assure you that tail-fins were really, really cool!

The post-tail-fin history of the automobile industry suggests a number of things. First, Apple’s margins are unsustainable. In the long run, people were not prepared to pay a large premium for more extravagant tail-fins, as the Edsel’s unhappy history demonstrated. Similarly, Apple’s margins are almost certainly due to return to the Earth-bound levels to which its competitors are limited, affecting its earnings and indeed its stock price. Apple will remain a successful company, as did General Motors after 1959, but its stock price is likely to see $100 again before it sees $1,000.

Second, just as the research laboratories of the automotive industry failed to turn up world-changing innovations after the end of the tail-fin era, so the innovation productivity of teams of software developers may similarly be sharply lessening. The complexity of software innovation has increased with each new generation of computer chips, so that Microsoft’s new Windows 8 operating system and Apple’s new iPhone 5, both involving gigantic, extremely highly qualified teams of developers, have been less than overwhelming in their impact on consumers.

Within a year or two, after a few more less than rapturous roll-outs, the public may start making silly jokes about Silicon Valley’s finest and most qualified: Q: How long does it take a team of 100 MIT-graduate software engineers to change a light-bulb? A: Five years, and $200 million in venture capital funding!

Curiously, the one innovation that may preserve Silicon Valley’s ability to amaze us for another decade or so involves the automotive industry also: the driverless car. Google has been testing these on the streets of Silicon Valley, reportedly satisfactorily, and if bugs can be ironed out and regulatory Luddism overcome, it seems likely that they will play a major role in our lives over the next generation.

With this innovation, the elderly with failing reactions and eyesight will no longer be confined to their homes, while commuters will no longer be compelled to spend two hours per day separated from their beloved smartphones (or endangering the lives of others if they are tempted). Furthermore, road capacity will be increased, fuel economy improved and, most important, the toll of traffic accidents reduced far below its current levels - teenage parties, for example, will become much less anxiety-producing for the parents. This innovation is not quite equivalent to the Internet or the automobile itself, but it’s at least the self-starter or automatic transmission.

Generally, however it seems likely that Silicon Valley is about to enter the automotive 1960s, with a consumer reaction against its design excesses, a series of very boring economy-based products, and congressional hearings at which some new young cyber-Ralph Nader will succeed in making the industry look greedy and misguided.

Careers in tech will no longer be fashionable, just as the best and brightest of my 1970 generation no longer sought careers in the automobile industry. (One classmate, who went into GM and rose very high there, gave a remarkably self-satisfied presentation at our 20th reunion, after which a friend remarked: "X was always a jerk, and I guess he hasn’t changed." You’d better believe that those who had been equally successful in less passe fields got a much better reception!)

Somewhere, tinkerers in a garage are producing the first highly inefficient specimens of the next Big Thing. But where - and what?

Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) - details can be found on the website www.greatconservatives.com - and co-author with Professor Kevin Dowd of Alchemists of Loss (Wiley, 2010). Both are now available on Amazon.com, Great Conservatives only in a Kindle edition, Alchemists of Loss in both Kindle and print editions.

(Republished with permission from PrudentBear.com. Copyright 2005-13 David W Tice & Associates.)

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