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Why the IT dinosaurs should be planning for extinction

The planned merger of two dinosaurs of the hardware world, Dell and EMC, offers a useful insight into how to manage corporate extinction

That planned merger of Dell and EMC, two dinosaurs of the hardware world, gives a useful insight into the world of companies that are, in the words of Wired, “!*£$ed by the cloud”.

The essential analysis suggests that large-scale computing is being inexorably commoditised by everyone’s ability to do their work off in those cloud services run by the likes of Google, Amazon and Microsoft. Those committed to high margin and high end in both hardware and software are accordingly going to find the ground dug out from underneath them. This applies to HP and IBM as inevitably as it does to EMC and Dell.

One thing that economists will tell you about commodities is that there’s little to no profit margin in them – the defining point of a commodity is that it has simple and direct substitutes. A bar of nickel is a bar of nickel, red wheat is red wheat, oil is oil. With very little difficulty any consumer of any of these products can change suppliers – that’s what commodity means. And that also means that the supplier has no pricing power.

When computer cycles operate in the same manner, which is really the economic change that the cloud delivers, then computer cycles become not an issue of which kit to buy, technological lock-in nor systems reliability – nor even reputation, the thing that kept IBM’s Big Iron working all those years. Instead, it’s just a matter of opening a new account and directing the firehose of information you want computed in a different direction. In such a world there’s little chance to earn margins and thus little place for businesses that survive by generating fat margins.

For us out here this is, of course, wondrous. It’s an economic standard that economic growth, rising productivity and even job creation derive from the entry of new firms into the marketplace, not from extant ones improving their offerings. And this switch in the basic technology of computing makes starting up a software company or operation vastly cheaper than it used to be, for computation is now charged as used, rather than requiring significant capital investment in kit before starting. Significant software operations can therefore get up and running with little more than the expense of coding time, potentially bringing such costs into the hundreds of thousands of pounds range rather than the millions it used to require.

The same scenario also applies to database providers such as Oracle, of course – most cloud computing is now done with open source code.

The profits of doom

This does not mean the Big Tin companies are all about to go bust. The long-term future there is as it was with the PC and then IBM’s server business – to be sold off to the likes of Lenovo. But the long term stretches over decades and there’s a lot of money to be made in correctly managing a declining business.

Precisely because of the technological lock-in and pricing power that the old environment provided, there will be people still using their own large hardware onsite for a few decades yet. And that kit will need to be maintained, replaced and repaired. It’s no secret that AOL is still making very fine profits from dial-up internet access. It doesn’t have to advertise it, upgrade it, research it, or really do anything except keep the process ticking over, and people still send the company monthly payments of a size originally designed to cover all of those items.

So running a business that is gently jogging to its doom can be very profitable indeed, because accepting that doom is approaching can allow large amounts of costs to be stripped out. However, it does require management to accept that there’s little to no point in trying to escape that doom by giving the technological development dice another toss. Many of those costs can be stripped out only once the end has been accepted.

Rolls-Royce could be, for example, massively more profitable than it is today simply by stopping all R&D completely. The maintenance revenues of the installed fleet of jet engines would produce very fat profits for decades – and then, of course, nothing at all.

Big Tin’s task is done

And so it could be at Big Tin. There’s no shame or tragedy in such an admission. A company is just a vehicle for doing a job. Economist Ronald Coase won his Nobel for pointing this out. And when that job no longer need doing, then it doesn’t have to find another job to do. For we might well find that some other form of organisation, or one with a different mix of talents and advantages, would perform that new task better.

The situation is like the usual shouting that oil companies should all be investing in renewables. Why? They know how to find, drill for and distribute oil and nothing of the engineering of electricity from solar panels. If we no longer require the task of finding and delivering oil to be done, then we can be entirely happy to see the organisations that used to do that split up into their component parts of skilled labour, capital and so on, and redistributed to other organisations doing the newer tasks we want done.

If it is indeed true that bespoke hardware and software has had its day, then putting those companies into run-off is the right strategy. Otherwise, the mistake lies in spending those still abundant profits on trying to prolong the life of a basic technology that has no future.

It could well be a tad premature to insist that this is the moment. But the basic point of technological development is that this happens to every company eventually. And thus every company management should be thinking about whether they really need to continue to exist. The cloud’s impact on Big Tin is going to have that effect. The only question is how quickly it will take place.

Tim Worstall is a writer and senior fellow of the Adam Smith Institute

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