First posted Feb 2005
this question leaves us feeling slightly mystified, that could
be a good sign. In laissez faire free market theory, entrepreneurial
excess returns (ie. "getting rich") are born of uncertainty.
Industries tend to go through different cycles. After a new wave
of disruption ripples through an industry, whether caused by the
diffusion of a new technology or some other factor, the industry
will tend to settle down for a while. As it settles down, its
operations become more predictable. With increased predictability,
its average rate of return on capital tends to decline back towards
an average overall market rate of return. This is one reason why
stock market bull trends in all of the various broad S&P sectors
tend to be followed by corrective bear trends, as they tend to
regress back towards historical valuation metrics and rates of
mobile robotics story is about the onset of highly disruptive
and prolonged change in many areas of automation. Let us first
consider how things looked prior to this “robolution."
In his article “Tomorrow’s
Automation Leaders,” Jim Pinto explains that industrial
automation has historically not been one market, but “a
loose conglomeration of specialized applications and vertical
market segments…the problem is the variety of applications.
[As an example] there are millions of thermocouples used, but
mostly specialized and related to specific industries and requirements…You
won’t find a $1 billion thermocouple company –or even
a sensor company that is quite approaching that size…There
are a lot of systems integrators. They look like they are serving
big markets and can grow. But it takes good systems talent to
design and install a system, to develop the right cost and controls,
to expand beyond a home territory without running out of talent
In the world
described by Pinto, automation meant incremental refinements within
the manufacturing portion of the macroeconomic value
chain. By “macroeconomic value chain” we are
talking about the process in which goods are transformed from
a raw state to a refined state for end-users. Advanced automation
usually meant developing more complex sub-systems that were parts
of much bigger, more expensive, and more complex manufacturing
FULL BLOWN INVADERS
robots are breaking out of the manufacturing realm and invading
the full spectrum of the value chain. In Part
Two I discussed such iRobot examples as MicroRig used at well
sites in the oil and gas industry and the Roomba used in consumer
All of the
various industries within this long chain have very different
competitive dynamics. Therefore, no “one size fits all”
business model will work for all mobile robot ventures. We need
a broader viewpoint that takes into account the basics of entrepreneurial
calculation, industry and competitive analysis,and the analysis
of emerging industries and technological application.
SUCCESSFUL ENTREPRENEURIAL CALCULATION WITHIN THE VALUE
above, provided by economist Sean Corrigan, depicts a macroeconomic
of production” or "value
chain." The sample time scale in months at the bottom
progresses from left to right, and varies in length depending
on the goods involved. Raw materials are extracted by primary
industries, undergo manufacture with capital goods, are assembled
by intermediate industries, distributed by wholesalers, and then
retailed to consumers. The way in which the chart fans out signifies
how more firms tend to get involved as goods get closer to end
There is a
natural tendency to read this chart from left to right. We tend
to think that goods flow from their unfinished state to a finished
state. When we work on something ourselves, we like to believe
that our own labor improves it and is not wasted. Even the use
of the term "value added" in our language reinforces
this perception. However, if we confine ourselves solely to the
left to right viewpoint, this can lead to an intellectual trap
commonly referred to as the Marxist labor theory of value. It
can encourage a faulty notion that robots exist to ruthlessly
drive down labor costs while permanently putting people out of
work, rather than create whole new products with superior price
to cost characteristics that can actually create vastly more wealth
for society and many more jobs for humans. More on this later.
From the standpoint
of understanding the process of successful entrepreneurial calculation,
the chart reads more from right to left than left to right. Right
to left is the direction that free market demand flows. It is
also the direction that price information gets transmitted. As
an example, if a producer misjudges production requirements and
floods the market with goods, prices will plummet regardless of
the amount of labor or investment that went into his products.
Therefore, simply adding up the amount of capital investment or
the costs of work performed on goods as they flow from left to
right is frequently worthless in terms of determining the ultimate
value of goods. This is in an important point I will return to
later when discussing ways to uncover cost-effective robot projects.
We need to
keep in mind that not only are goods changing hands, but so is
price information. This helps all the different factors of production
adjust towards each other and maintain some form of balance, thereby
increasing competent investment and reducing malinvestment
(the arch-enemy in free enterprise economic theory). Hence, a
free enterprise economy is both an informational system as well
as a system that processes goods. Another important point I will
return to later in this paper.
AND COMPETITIVE ANALYSIS
When we say
that we want to make honest money in robotics, what we really
mean is that we want to put together an enterprise that has a
sustainable advantage that allows it to deliver excess
returns (ie. generate superior earnings and create wealth).
The chapter “The Structural Analysis of Industries”
in Dr. Michael Porter’s classic book “Competitive
Strategy.” provides a model to help us identify the
strategic elements we need to make favorable for our enterprise
to maximize our sustainable advantage.
Possible New Firms in
Within an Industry
Among Existing Firms
To illustrate this diagram, I will draw upon information already
provided in Part
Two of this series about iRobot's My Real Baby Doll. We can
also draw upon information contained in Dr. Rodney Brook's book
and Machines: How Robots Will Change Us. I provide this
information taken from a few sources to help illustrate Dr. Porter's
concept and not to offer a definitive study of My Real Baby Doll.
the beginning...The rational entrepreneurial typically
looks at dozens, if not hundreds of market opportunities for the
"value proposition" that he has to offer with a new
product. The "value proposition" really means the quality
that his product offers relative its price. (cf. again the "value
war" concept mentioned in Part
value proposition can be tricky to explain to potential customers
because it typically involves a greater long term gain to offset
higher short term costs. The robot's value proposition may increase
relative to humans as the amount of work increases, as noted in
the diagram above to explain INtelliBot's ES-700 floor-cleaning
To find a
worthy project, the entrepreneur compares his potential revenue
opportunities with his likely costs required to produce that revenue.
His cost estimates are based on his likely structure of production.
He typically selects the project(s) with the highest risk-adjusted
rates of return.
We need to
bear in mind that the end-users who drive market prices usually
are not worried about the entrepreneur's costs, margins, or about
whether or not he is using robots. It is up to the entrepreneur
to care very deeply about estimating his revenues and his costs
as accurately as possible. If he misjudges either or both, that
is, if he engages in malinvestment,
he may go out of business and be forced to rejoin the ranks of
In a free
market system, the ultimate "tyrant" is the consumer.
As an aside (and as a response to Leftist visions of robotics
that I discuss in Part
Five of this series), it may be worth reminding the reader
that the main de facto historical alternative to this tyrant has
been the tyranny of interventionist or socialist government. The
latter tend over time to accumulate detrimental special privileges,
inflate bureaucracy, undermine entrepreneurial incentives, raise
taxes, distort vital market feedback mechanisms, reward malinvestment,
and otherwise become even worse tyrants than the consumer. In
contrast the free market tends to reward competent investment
and punish malinvestment. Yes, the consumer is often a tyrant,
but he is usually the least bad tyrant known to any political
or economic system.
buyer power: This is a good starting point for Dr.
Porter's chart. In the case of My Real Baby, the buyers consist
of parents who make their purchase decisions on their own or at
the urging of their daughters. Their power is very diffuse, so
there is little danger that they are going to form a cartel to
force prices down.
if we back up a step in the cone of production and look at channels
of distribution, a different picture emerges. A big question is
how heavily My Real Baby has to rely on TV ads as opposed to word
of mouth or alternative media such as articles in magazines and
newspapers. According to Dr. Brooks, the conventional wisdom in
the toy business is that one can only get one new idea across
in a thirty second TV commercial for dolls. My Real Baby had dozens
of new robotic features to differentiate itself, but conveying
enough of them over TV to influence prospective buyers was a challenge.
The costs of TV ads presented a problem for iRobot, which was
short on cash. Another important question was the extent to which
established doll companies such as Hasbro have special advantages
in their relationships with retailers and other channels of distribution
compared to a new industry entrant such as iRobot.
Substitutes: In his talk at the March 2004 robot
conference, iRobot's CEO Colin Angle said that "smart dolls"
are priced at the high end of the market, where prices typically
range from $80 to $120. According to the Forbes article
Dreams," the smart toy market comprised 2% of the $25
billion toy market in 2001.
We might ask
how the toy market in general is segmented, and how "smart
toys" are differentiated in terms of price and performance.
How much extra behavioral sophistication is required in a smart
toy to motivate a child to beg her parents to buy one, and what
is the maximum price difference compared to non-robot dolls that
parents will tolerate?
supplier power: When Dr. Rodney Brooks and Colin
Angle first surveyed electronic component costs, their estimates
came in too high to justify the project. The rule of thumb in
the doll industry is that the cost of parts should come in at
6% of the sales price. (Brooks,
p. 110). To drive their costs way down, they decided to manufacture
and assemble the doll in China. They used super cheap computer
chips with only a few hundred bytes of RAM. They also reduced
from five down to one the number of motors that drove the baby’s
face. Lastly, they developed sensors that cost only a penny apiece.
parts suppliers comprise a very competitive and diffuse group,
so there was no danger that they would form a cartel and hike
prices if My Real Baby became a big hit. However, it would be
a good idea to look beyond them and analyze everyone else in the
value chain who has a "cut" on the doll to consider
who might try to squeeze them later on.
industry competitors: The doll industry itself is
very competitive. An iRobot invasion of this industry, or for
that matter any other industry, constitutes a kind of R&D
arbitrage. In essence, iRobot was gambling that it can create
such a strong "value proposition" through its ability
to "robotize" products that this will offset its weaknesses
as a newcomer in other areas.
In order for
iRobot to sustain its competitive advantage in the doll industry,
the R&D departments of competing companies have to remain
asleep at the wheel. It turned out that
within a year after the debut of My Real Baby, all the major toy
companies decided that robot toys could become big sellers and
began to engage in competitive retaliation with their own products.
the threat of new entrants: It is impossible to
predict who will roil the toy market next with a catchy concept
that can be executed at very low cost. An example of an important
offbeat “smart toy” concept that preceded both My
Real Baby and Furby in the mid 1990’s, was a small cheap
toy with a few buttons and an LCD screen called a Tamagotchi.
The Tamagotchi buyer paid about $16 for a game in which he or
she was required to care for a virtual reality pet portrayed on
the LCD screen. Tamagotchis sold by the millions. Who could
have predicted this?
In many respects
both Furby and My Real Baby were “me to” entrants
after the Tamagotchi. Furby took the situated Tamagotchi
virtual reality smart toy concept to the next level by creating
an embodied robot. "Situated" in robot jargon
means the device can interact like a computer game but has no
body. "Embodied" means it has a physical being such
as arms or a head with sensors on them that physically respond
to the environment. My Real Baby boosted Furby's embodied concept
to a new level of interactive behavioral sophistication. As an
example, My Real Baby stops crying when you put a baby bottle
to its lips. A sensor in the baby bottle tip activates a senor
in My Real Baby's mouth.
overview of iRobot’s foray into the toy business helps to
explain why Colin Angle remarked during his luncheon talk at the
2004 robot conference that he felt the toy business is generally
too risky to merit sustained initiatives by his company.
To the extent
that Mr. Angle wants to be a generalist and build many different
types robots for different industries, he is probably wise. The
doll design industry probably has a lot in common with being a
fashion designer, Hollywood script writer, or musician. So much
is subject to public whim that one usually needs to have a certain
passion for the art form to want to stay completely focused on
this business area. Rather than bet his company on a blockbuster
doll, Mr. Angle probably made a wise decision by selling My Real
Baby to Hasbro for $1 million plus a 5% royalty once Hasbro achieved
side of the coin is that if iRobot wants to become a generalist
robot builder, then the company may need to decide how to position
itself as a diversified company. .iRobot has already diversified
itself into the consumer products industry through its Roomba
vacuum cleaner and into the defense industry with its PackBot
What is implied
by becoming a diversified robot company that builds robots for
On one end
of the spectrum of the diversified business model is the merchant
builder approach. Here, a robot company would focus on building
robots for other companies for contract fees. It would refrain
from taking equity positions in robot ventures. Theoretically
it could achieve a fairly steady income from a wide pool of clients
by building up a large backlog of contracts. It would avoid the
risks that go with launching ventures in competitive industries.
Conversely, it might also suffer major opportunity costs by not
participating in major growth opportunities.
other of the spectrum are strategies involving equity exposure
to get more upside.
The most decentralized
equity participation approach involves using joint ventures or
spin off companies formed around particular robot product lines.
Spin-off companies typically provide more entrepreneurial incentives
for their managers, are more flexible and innovative, and are
closer their markets than subsidiaries of large companies. Although
the parent company retains a major stock position, it usually
exercises a low level of control.
mean,decentralized, transparent, focused, hands-on, market-responsive,
no-frills companies are consistently extolled in various investment
classics such as The
Warren Buffet Way by Robert Hagstrom and Beating
the Street by Peter Lynch. They also resonate with that whole
genre of management guru literature that began with the blockbuster
Search of Excellence by Waterman and Peters over a couple
of decades ago.
In the middle
of the equity participation spectrum is the diversified technology
company. It has medium decentralization, and is subject to medium
control by top management. A classic example was the old Hewlett
Packard under its deceased founders William Hewlett and David
Packard. HP organized major product lines into separate divisions
that were kept wholly owned. The company tried to combine elements
of both decentralization and centralization into its corporate
structure. More on this later in this paper.
At the far
end of the diversified company matrix we have the imperial conglomerate.
The poster boy image in my mind is the old "Gulf + Western"
conglomerate under former commodities trader Charlie Bluhdorn
in the 1960's and 70's. G + W originally owned an auto parts company
and a sugar operation and later squeezed Paramount Pictures for
the liquidation value of its real estate assets. One senses that
G + W was parodied by Mel Brooks in his comedy Silent Movie
as "Engulf + Devour" with its literally foaming-at-the-mouth
CEO and plaques that read, "Our bathrooms are nicer than
most people's homes." G+W's financial operations were so
aggressive that Wall Street never really trusted the company and
usually awarded it a relatively low P/E multiple. G+W later changed
its name to Paramount Communications, which was later acquired
I want to
dwell on this kind of company for several more paragraphs because
of it's powerful leadership influence in the American economy
today. It provides an interesting contrast to my discussion of
the old Hewlett Packard and Cisco Systems as possible robot company
role models later on.
conglomerate has wholly owned subsidiaries in unrelated industries.
In theory, the conglomerate can use cash generated by operations
in some areas to diversify into other areas that might provide
counter cyclical market risk reduction. One example is General
Electric, which has heavily diversified out of anything to do
with its roots in electronics and widgets and into unrelated industries
such as financial services and broadcasting.
already beginning to go down this path to the extent that earnings
from its defense contracts help to pay for its consumer products
operations. There is nothing wrong with this, to the extent that
the U.S. Government has real needs, is the largest de facto venture
capitalist in America, and in the absence of significant US corporate
investment in robotics the government has been a major source
of funding to help robot companies stay alive. However, there
are big potential dangers downstream, as this paper will continue
to make clear.
As part of
its cash redeployment schemes, General Electric has raided its
own retained earnings and heavily leveraged itself. Financial
writer Adam Barth observed
in 2002: "For every dollar invested in GE stock at the present
time, the shareholder has a paltry $.08 in Net Tangible Assets
and a whopping $1.47 in liabilities." He added that this
is not only a GE problem but also an issue for the thirty "All
American" companies that make up the Dow. ".The Dow's
net tangible assets are presently leveraged at a 6/1 ratio -a
capital structure bearing far greater resemblance to a hedge fund
than a prudently financed corporation."
In other words,
a great many of America's largest companies are de facto hedge
funds. Their "diversification" (Peter
Lynch preferred the term "di-worse-ification") resembles
that of imperial conglomerates. This is not exactly good news
for a country with out of control debt growth and intractable
balance of trade deficits linked to declining product competitiveness.
big conglomerate may appear decentralized to outsiders because
of its involvement in many unrelated industries, in reality it
usually operates as a highly centralized, highly controlled imperial
order. Top management robs the cash flow of vassals in one area
to pay themselves or hegemons in other areas. Quite often the
self-anointed corporate aristocracy does not know enough about
any particular area to do anything really innovative, visionary,
or responsive towards a particular market, and instead contents
itself with financial reengineering activities that include asset-juggling
operations, accounting sleight-of-hand, and engaging in nonproductive
mergers and acquisitions (I discuss their track record later),
all of which increase the odds of malinvestment throughout
the economy. Last, but not least, high-greed top management teams
typically award themselves outlandish salaries, stock options,
and golden parachutes. Dr.
Paul Craig Roberts wrote on this topic, "According to
William McDonough, chairman of the Accounting Oversight Board,
in the bad old days of President Reagan’s “trickle-down
economics,” the average Fortune 500 CEO made 40 times more
than the average person who worked for him . . .By 2000, it was
between 400 and 500 times, and last year I believe it was about
prestige, and complexity created by cobbling many firms together
into a large conglomerate often provides enough maneuvering room
to subtly and cleverly plunder shareholders while real underlying
wealth-creating performance actually declines (and malinvestment
rises). As part of their sorcerer's bag of tricks, imperial conglomerators
typically have enough cash flow to pay for big ad budgets, big
consulting fees, major lobbyist services, and big transaction
costs. All of this helps to bribe elements of the media, academia,
the consulting profession, Washington, and Wall Street into saying
nice things about them.
It is not
uncommon to see America's high tech companies travel the left
hand spiritual path of the imperial conglomerate. If a majority
of Fortune 500 CEO's are cutting corners and raking it in, we
should not be surprised to see lots of little guys out in the
heartland get tempted to go in the same direction. As soon as
they have enough product line successes to get some good "story"
into their stock and run it up, they team up with Wall Street
firms to use their stock as currency and go on acquisition binges
to cobble together companies as quickly as possible. They usually
wind up with mediocre products, lousy accounting standards, a
weak corporate culture, and poor quality of earnings --and you
guessed it -- greater malinvestment. Even though the insiders
may get very rich, they obviously are not reinvesting back into
people around them the way others have invested in them, so there
is usually some extreme selfishness, hypocrisy, and a major lack
of foresight and delayed gratification going on here, if not outright
fraudulent or covertly hostile exploitation of other people. This
really gets down to some very basic human decency issues regardless
of one's ideological persuasion, be it socialist, liberal, conservative,
anarcho-libertarian or whatever.
VS. EMERGING INDUSTRY PERSPECTIVE
We can normally
conduct a mature industry analysis by covering in detail all the
elements addressed in a Red Herring (prospectus) or a Form 10K.
These elements include the financial strength of the company,
the quality of its management, the quality of its products, and
other elements of standard fundamental analysis. I would also
point the reader's attention to insights spread throughout Dr.
Porter's books that I have already mentioned.
I just provided regarding My Real Baby Doll came from a mature
industry perspective. In the case of My Real Baby, this is probably
appropriate. iRobot introduced its robot toy concept as a "feeler."
It apparently did not have the funding or corporate structure
in place to keep iRobot focused on the the My Real Baby product
line with constant upgrades.
technology-related question regarding My Real Baby doll is how
well it can "scale." That is, how well incremental levels
of technology investment will relate to increased revenues. This
is the kind of question that IBM had down to a science with its
very profitable successive mainframe generations in the 1960's
and 1970's. As another example, the Intel corporation turned its
succeeding generations of microprocessors into a money machine
in the 1990's, as did Microsoft with its generations of Windows.
My guess is
that with iRobot's current level of technology and cost constraints,
the My Real Baby Doll product line was unlikely to scale well.
Interestingly enough, Dr. Brooks talked about coming out with
a different product concept altogether, namely a new walking dinosaur,
within a couple of years after My Real Baby (Brooks,
p. 133). Later, Hasbro discontinued production of the doll.
make a living by producing serial toy “hits” puts
us back in the fashion design firm mode reminiscent of Hollywood
script writers, musicians, and other artistic entrepreneurs. In
this kind of business, success has a lot to do with having the
"gut" to anticipate fickle public tastes. It has much
less to do with the robotic engineering competencies over which
iRobot has much more control.
NEED TO ALSO FOCUS ON EMERGING INDUSTRY ANALYSIS
is emerging as an insurgent technology through its ability to
redefine products and work concepts. If we only use the perspective
of the mature industry competitive analysis, we will probably
miss an important"robolution" dimension.
it is probably not all of one type of analysis vs another, but
rather we need to simultaneously perform both a mature industry
and an emerging industry analysis and then reconcile the two together.
insurgent technology. It remains so easy to underestimate.
I believe that we can apply a number of characteristics identified
by Professor Clayton Christensen in his landmark book Innovator's
Dilemma: When New Technologies Cause Great Firms to Fail.
mobile robots still tend to be complicated, clunky, and expensive.
They are still not particularly desired by major clients of America's
major tech firms. Robot producer margins are still low. Robot
production costs still have not come down enough to price for
a mass market (with a few exceptions such as the Roomba, Furby,
and My Real Baby). In terms of the corporate culture of robot
companies, they tend to require a generalists' mind set that harmonizes
mechanical engineering with computers. This is a different focus
than that of most leading high tech firms today. Current mobile
robot market applications are still too small to satisfy the growth
needs of major companies. Lastly, their "killer apps"
of the future can not be analyzed because their markets do not
differ from mature industries in some significant ways. I will
outline a number of the differences that are also covered in Dr.
Michael Porter's book Competitive
the promise of new opportunities often attracts more companies
than mature industries. Historically, more new companies exist
during the emerging industry phase than during any other time
in the industry maturity cycle. During later phases there is typically
an industry shake out and a consolidation process. In the beginning,
however, it is usually not clear who the dominant players will
that an industry is emerging implies that its products are new
and that industry standards have not been set yet. A big part
of the sales job of emerging industry companies is to convince
people to become early adopters, that is, buy a product that they
have not experienced before.
In an environment
usually characterized by rapid technological change, quite often
companies are under enormous time pressure to come up with new
products and overcome bottlenecks. They lack sales data and experience
running channels of distribution. In this kind of fluid, pioneering
environment, management is often forced to be highly opportunistic
typically have high up front cash needs in order to begin production
of their products. Once they get into production, they typically
begin to experience a steep cost decline curve. If they can get
over the production hump before competitors, they can make profits
first, and then drop prices to create barriers to entry for the
"me to" companies. . A classic example is the way in
which Intel was able to steadily reduce prices after each new
generation of microprocessors in the 1990's, leaving its competitor
AMD perpetually struggling in its wake.
companies tend to put a premium on obtaining a first mover
advantage and maintaining technological leadership.
many advantages to becoming a "first mover." The first
mover of a unique product has no direct competition, although
there may be indirect substitutes. First time buyers of this unique
product become habituated towards its use. It is much easier to
retain their loyalty than to win someone over who has first been
broken in on someone else's comparable product. First movers stand
a better chance of defining the new standards of the industry,
which saves them the trouble of having to adapt to someone else's
standards. Lastly, as already mentioned, the first mover is able
to get his profits first and drop his prices ahead of competitors.
technological leadership is also very critical. It positions a
firm to retain a first mover advantage with follow on generations
of products. It also gives a firm prestige that helps attract
the best talent, therefore augmenting its technological leadership
and creating a virtuous circle.
that lose their technological leadership usually find it much
harder to get it back than to keep it in the first place. Often
second place in a rapidly changing technology environment means
the road to continual decline.
From my own
Wall Street experience, the concept of a sustained "value
rally" in a busted junior technology growth stock is frequently
a joke. Even among the big players, Forbes publisher Rich Karlgaard
pointed out in one of his columns that approximately 80% of the
major high tech companies that are dominant in one decade fail
to remain dominate the following decade. The comebacks made by
Apple and IBM in the late 1990's are rare.
EMERGING INDUSTRY ANALYTICAL FOCUS
the technology, stupid! Not surprisingly, emerging
industry analysis tends to focus on "Everything You Wanted
To Know, But Where Afraid To Ask" about all the technologies
involved in the emerging industry itself.
The list of
tech questions one should not be afraid to ask are almost endless.
Here are some samples: How can we utilize technology to create
new products that offer a whole new level of usefulness at reduced
costs? Where is the technology in our field headed? Can it create
a new approach to conceptualizing how we go about satisfying certain
needs or performing certain tasks? What are the supporting technologies
throughout the value chain? Who has the best resources for creating
and implementing new technologies? How can one define an area
of core competence in developing a new technology and sustain
a competitive advantage? How well does the technology we are interested
in "scale," that is, what is the amount of investment
required to bring in incremental revenues?
synergy. Developing "synergy" is very
important to economize on limited resources. No matter how brilliant
the R&D folks are within a particular company, they only have
so much time to stay abreast of all the latest developments within
a certain area of technology. One can only afford to hire a limited
number of R&D staff members and supply them with finite resources.
Therefore, it makes sense to keep ones product lines with the
core competence areas of your R&D staff.
barriers to entry. The size and quality of an intellectual
property estate can have both a cause and an effect relationship
with technological leadership. Its existence may signify substantial
innovative competence. It may also signify barriers to entry and
sources of royalty income that support further development. (cf.
The June 24, 2002 Forbes article by David Raymond, “How
to Find True Value In Companies.” which discusses how
forward citations can be an important underlying indicator of
the IP strength of a tech company).
financial barriers. These barriers can be extremely
formidable. Carnegie Mellon Tepper School of Business associate
professor L. Frank Demmler provided some important insights in
his talk: “Raising
Money for New and Emerging Companies” He discussed five
phases of a new development project, namely the idea, feasibility,
verification, demonstration, and commercialization stages, and
the obstacles involved with each stage:
to Pass Through the Embryonic Stage
first-timers underestimate the time it takes to build a business
from the idea phase to the point where success or failure in
the commercialization phase is clear. A study of 120 ventures
showed an average time of 8 years to reach positive cash flow
and evolve from the idea phase to the commercialization phase.
[While I vaguely remember that there was such a study, I have
no recollection of its source.] Others estimate the average
time to profitability from 6-14 years.
there are exceptions to this average, and the exceptions are
often the most publicized. Buying a franchise can have great
appeal because it greatly reduces the time to commercialization
by eliminating the idea and feasibility phases and shortening
verification and demonstration phases. Someone else has already
done the pioneering work.
time needed by an individual firm to pass through the embryonic
phase is an important factor that influences the amount and
kind of money that a firm can seek.
Needs Increase for Each Phase
cash needs of a venture increase with each phase. The stakes
go up to play in the next phase, and the costs of failure or
exiting from a phase also increase.
rule of thumb is that the cash needs for each phase increase
by a factor of 5 to 10. By far, the most expensive step in the
process is the commercialization phase.
$1 is needed to establish an idea;
$10 is needed to prove that it is feasible;
$100 is needed to verify that it works in the field and that
it really fulfills customers’ needs;
$1,000 is needed to demonstrate that the product can be produced
efficiently, that a marketing and selling formula is successful,
and that the management team is effective;
$10,000 is needed to produce the product in full-scale volumes
and to develop a national marketing and sales campaign and
...BY OTHER MEANS
that lack the cash to make it through various project phases,
there are a number of alternative strategies they can consider:
This allows a company to draw income from its technology without
having to proceed to a next stage. The danger is that it puts
ones technology directly into the hands of competitors, which
may make it easier for them to reverse engineer ones trade secrets
and eventually invent around ones proprietary advantages.
forces or make acquisitions: Mergers
and joint ventures can be good ways to find the additional resources
necessary to cover overall costs, albeit at the cost of the dilution
of equity in the enterprise. Alternatively, it may cost a company
less to acquire another company and its products than to develop
is that overall, joint ventures and mergers and acquisitions have
a poor track record. According to “When to Ally and When
to Acquire” by Jeffrey Dyer and Prashant Kale, and Harbir
Singh (July-Aug 2004, Harvard Business Review), “Most
acquisitions and alliances fail. A few succeed, but acquisitions,
on average, either destroy or don’t add shareholder value,
and alliances typically create very little wealth for shareholders…Acquiring
firms experience a wealth loss of 10% over five years after the
merger completion, according to a study in the Journal of
Finance. To add to CEO’s woes, research suggests that
40% to 55% of alliances break down prematurely and inflict financial
damage on both partners. When we analyzed 1,592 alliances that
200 US companies had formed between 1993 and 1997, we too found
that 48% ended in failure in less than 24 months…”
To set the stage for a new industry, someone usually
has to help finance a gestation period where the return on investment
on long term developmental initiatives is not clear. In Part
One I discussed how robotic commercial applications in one
decade is often based on academic research performed in a prior
decade. As specific examples, I mentioned how IRobot has received
forms of subsidy through its defense contracts. Robot projects
in Japan have received massive subsidy from major Japanese companies
in the form of very long term visionary “investment.”
LAST, BUT NOT LEAST
culture: It is a paradox in high tech that while
technological innovativeness is everything, maintaining a corporate
culture that fosters trust, teamwork, and balance between all
the different corporate functional areas is everything as well.
This should be especially true in robotics. Gareth
Branwyn points out that there are so many different technologies
that come together in robotics that it is very much a generalist
to teamwork issues, I find it helpful to use two role models as
reference points, namely the old “HP Way,” and the
company-building approach used by Cisco CEO John Chambers. The
"HP way" seems to illustrate successful teamwork between
the marketing, engineering, and financial sides of the company,
with an emphasis on internal growth. John Chamber's approach seems
to illustrate teamwork between the marketing area and other functional
areas of Cisco Systems, with an emphasis on growth through mergers
and acquisitions that remain focused on core technologies.
The old “HP
Way.” For the uninitiated, I am referred
to the old Silicon Valley icon under the management of its late
founders, Bill Hewlett and David Packard. Hewlett Packard was
famous for its open, honest interpersonal relations and flexible,
innovative culture. HP was able to keep its organization decentralized
enough to be able to flexibly focus on a variety of new product
areas, while at the same time it benefited from the economies
of scale and stability offered by a large company and the expertise
of headquarters staff personnel.
Chambers: Let me preface my comments
by stating that I realize that in this day and age it is risky
to use someone who is still living as a role model, particularly
in the wake of frequent corporate accounting fraud scandals and
Stewart case. (What next?) However, there seems to be enough
about the CEO of Cisco Systems that rings true, particularly in
regard to his ability to integrate acquisitions, that I think
he is worth discussion. Harkening back to my earlier commentary
about abusive conglomerators, I find Chambers fascinating because
he might show how robotics companies that are strapped for cash
might pool their resources, take on more projects, and grow and
increase shareholder wealth in ways that are socially productive.
who founded 3Com before it was acquired by Cisco, commented
“There are lots of people working here who could be running
their own companies--who were running their own companies. John
treats us like peers. If he treated us like employees we'd be
out of here.” According to Chambers, “A large part
of our business is based upon trust and working together. Nothing
changes behavior like survival.” It’s
no longer the big that beats the small, but the fast that
beats the slow.” “You want to beat your competition,
you want everyone to win.” Chambers insists on staying
extremely close to the market. He said, “At IBM and Wang
[where Chambers worked before taking over Cisco], we fell in love
with technologies and paid
a terrible price.”
who has founded three Silicon Valley companies with market caps
over $1 billion, has echoed
John Chambers, “A leader must always strive to get the very,
very best people—people who threaten you because they’re
smarter than you. You also have to make sure you don’t have
high turnover. I have a rule: Never lose the first good person.”
is more than Boy Scout talk.
There are a number of very practical reasons why the aforementioned
values are necessary to sustain high tech leadership. Innovation
is based on the scientific method, which depends upon scrupulously
identifying problems, inviting debate to help overcome them, and
providing real world verification through experimental tests.
It requires an honest world, where people state what they believe
to be the truth, not the truth as perceived by others. This means
using logic to get down to the root of things.
From the Latin
word for "root" we get the term "radical."
Science and technological innovation tend to be inherently radical,
impersonal, and logical in nature.
are inherently personal, emotional, and subjective. This instinctive
element is a huge and vital part of human nature that I address
again towards the end of Part
Six of this series. However, at some point organizations become
so infested with varying levels of politics and intrigue that
cater to the instinctive side that they poison the climate required
for successful implementation of the scientific method and for
I have already
discussed the perverse politics of imperial conglomerators. Harry
Browne's classic work Why
Government Doesn't Work. includes other good examples
of intrigue in action. According to Browne, when government programs
become dysfunctional and produce the exact opposite of what was
originally intended, unless there is a major public outcry (as
Phillips put it: "Eternal vigilance is the price of liberty"),
the government tends to "keep up appearances" and give
these programs even more money and add even more dysfunctional
programs in order to act as if it is doing something to solve
problems it helped exacerbate in the first place. The net result
is that both government and taxes tend to continually grow regardless
of performance. According to Browne, government is ultimately
about bureaucracy, politics, and force, not about sound economics.
process is typically a zero sum game in which its players "spin-doctor"
appearances to benefit themselves at the expense of others. At
some point the appearances game involves fraud, which entails
theft of truth. It steals a person's capacity to make a rational,
well-informed decision. It ultimately throws sand in the gears
of the scientific process and innovation. This is particularly
true in the technology community where so much of its "structure
of production" and its incentive structure depends on converting
intangible ideas into tangible goods. Fraud undermines the climate
of trust required to sustain long term project gestation periods.
If I were
to try to summarize the last few decades of management guru literature
in three paragraphs, it would be as follows. In the long run,
we have to deal with reality and create real and useful tangible
things to create wealth. Successful management involves harmonizing
at least three areas a) the "genetic" or instinctive
side of human behavior (both individual and social) b) utilizing
the scientific method to uncover truth and make sound decisions
and c) utlizing sound entrepreneurial calculation and implementation
methods, to include conducting competitive industry analyses and
using discounted cash flow techniques.
leadership levels, a great many if not most people lack the right
combination of experience, knowledge, emotional maturity, self-discipline,
independent analytical judgment, or organizational support to
be really truthful, personally effective, or rational, and feel
that they have to rely on shortcuts and deceptions to survive.
There are untold millions of short cuts, ruses, and gimmicks they
can use to get by, ranging from accounting manipulation to leadership
practices that give the appearance that they are being
effective when in reality they are parasitically running down
the organization. What gets really dangerous is when the short
cuts become accepted as conventional wisdom, and dysfunctional
practices get added on to "solve" other dysfunctional
practices, creating vicious circles.
It can be
tricky to discern the "reality" required for success,
how we define "success" in terms of financial data or
overall benefits to society, and the leadership traits required
for a particular situation. For a sales organization that deals
in intangibles to meet quotas, dealing with "reality"
may require a relatively charismatic manager who can motivate
people to handle rejection in making cold calls and keep them
focused on closing prospects. For a high tech R&D company
where the "value added" of its products is highly measurable
in physical terms, and "reality" means innovative engineering
problem solving, a highly effective leader may be a very bright
but relatively anti-charismatic and unassuming person who does
not allow his ego to get in the way of achieving tangible results
working with technically brilliant colleagues.
My Real Baby
doll was an impressive effort to commercialize technology. It
bought a ticket in the doll industry "lottery" which
unfortunately did not score a blockbuster jackpot. iRobot probably
deserves an "A" for effort anyway.
From a risk-adjusted
perspective, smart dolls probably represent the opposite kind
of market where the best rewards may be found in mobile robotics
over the next five years. My Real Baby was designed for purchase
by price sensitive and relatively unsophisticated and fickle consumers
and does not scale very well. How wonderful it would be to design
a robot for a market that can support the old IBM mainframe lease
model (much more lucrative, particularly with embedded consultant
fees, than the more commoditized purchase model), is strongly
appreciated by tech savvy people (whose appreciation helps create
technical barriers to entry), who have an immediate and consistent
market need (rather than wavering with fads), who have ample spending
power that is fairly price insensitive (market inelastic), and
who comprise a growing market for which the robotic product scales
A major source
of funding for robot companies in America has come from the government,
particularly DoD. But government funding is typically a two-edged
sword. Yes, government contracts help cover overhead and provide
a cash cow for roboticists to continue practicing their craft
and exploring important R&D areas. The money the US Government
has spent on robotics is probably one of the few areas it has
actually done something really right. However, there is that other
side of government covered by Harry Browne which distorts free
there is a legitimate place for government. I support national
defense. However, I recognize how it can become very unhealthy
for companies to become too dependent on feeding off the public
survives on taxes, which are backed by the threat to use police
and military power to kill citizens who do not pay up. Every penny
that someone receives from the government has been collected with
an implied death threat. In addition, government leaders are typically
rewarded rather than punished for malinvestment. In contrast,
the free enterprise sector survives by offering goods and services
traded by voluntary consent, and is incentivized to engage in
competent investment. There is a big difference.
of Boston University voiced concerns about the future of government
funding in his 17 May 2004 Fortune article "Why
Things Could Get Really Bad." He stated, "Hyperinflation
is a real and present danger for the simple reason that the U.S.
Government is effectively bankrupt. Its fiscal gap is $51 trillion,
when measured as present value. That's 11.6 times official debt,
4.5 times GDP, and 1.2 times private net wealth. Coming up with
$51 trillion without a printing press would require, immediately
and permanently, either hiking federal income taxes 78%, cutting
Social Security and Medicare benefits 51%, or eliminating more
than 100% of federal discretionary spending, which ain't easy."
For over a
decade the Fed has been ramping up the money supply at around
10% a year. It increasingly needs to buy America’s debt
to substitute for the increasing unwillingness of foreigners to
finance America’s continuing balance of trade deficits and
its deficit government spending. As the American economy continues
to look more like that of Argentina and Brazil, we can expect
a growing squeeze on government funds available for robotics-related
education and research.
government R&D contracts, American robot companies have typically
been forced to use a relatively short-term time horizon and“bottom
up” market-driven approach. One important reason is that
major corporate technology players such as IBM, Microsoft, Intel,
and Cisco have held back (so far) from making major investments
in this area. Hopefully in the near future they will begin to
adopt a more far-sighted attitude like their Japanese counterparts.
anything that increases involvement in the robotics arena by American
companies with proven track records in the free market will probably
be very good news.
V of series
report is for research/informational purposes only, and should
not be construed as a recommendation of any security. Information
contained herein has been compiled from sources believed to
be reliable. There is however, no guarantee of its accuracy
Bill Fox is VP/Investment Strategist, America
First Trust. Bill welcomes phone calls and email responses
to this article. His most current contact
information is at his web site: www.amfir.com.
Short URL for this web page: http://tinyurl.com/2brzlk2