Innovation Is What’s Keeping Prices--and Power--in Check

With mergers worth almost $3 trillion occurring in the U.S. and world economies this year and investment analysts using the word “oligopoly” to describe the concentration of giant firms in major industries, why don’t we see more evidence of monopoly power and rising prices?

In one word: innovation.

If you want to understand the forces driving the economy, look at such companies as EMC and Dell Computer. And look at Cisco Systems and a host of small companies now experimenting with ways to construct the Internet.

All those companies illustrate the principle that innovative companies are bringing lower prices to the economy. And large older firms, huddling together like cattle in a storm, are struggling to keep up with headlong change.

Companies virtually unknown a decade ago have come to the fore on the strength of information management.

EMC, based in the Boston suburb of Hopkinton, provides data storage software that facilitates businesses’ use of computer networks to communicate with customers, suppliers and their own employees.

EMC is the leader in the data storage field, even though it is relatively small at roughly $4 billion in annual sales and its history is anything but a model of planning or oligopolistic power.

The name EMC comes from the last names of Richard Egan and Roger Marino, college buddies who founded the company in 1979 to sell office furniture. After a decade of unremarkable performance selling memory devices for minicomputers, EMC hit on its data storage product line in the 1990s. It realized that companies needed storage for their growing amounts of network information.

It focused on delivering storage software and hardware at a lower price than IBM. As a result, EMC is the leader in information storage, even though it is barely 1/20th IBM’s size in terms of annual revenue.

IBM, in fact, is bringing out a more powerful storage product to compete with EMC. And EMC is moving further to meet the needs of companies using the Internet. Two weeks ago, it agreed to acquire Data General, a pioneer minicomputer firm of the 1970s. The acquisition will give EMC lower-priced products to reach smaller firms as customers.

EMC, in short, is the kind of company referred to recently by Alan Greenspan, chairman of the Federal Reserve Board, when he told Congress that information technology has reduced costs of doing business and lessened the risk of inflation.

“The remarkable surge in the availability of real-time information has enabled business management to remove large swaths of inventory and worker redundancies and has armed firms with detailed data to fine-tune product specifications to individual customer needs,” Greenspan said.

Whether the chairman and his fellow Fed governors hike interest rates a bit this Tuesday, as predicted, Greenspan recognizes that innovations have changed the economy.

Companies with new ideas attract capital. Take Dell Computer, the Austin, Texas-based company that innovated the simple idea of selling made-to-order computers by mail and Internet.

Dell can do that because it farms out the manufacture of most parts--as does EMC--retaining design and quality control.

That’s not the way things were done when large corporations saw control of every part of their product as essential. But outsourcing gives Dell lower costs. And investors reward Dell’s kind of thinking with a total market value of $111 billion, one-half that of IBM even though Dell’s revenue is one-fourth that of the bigger company.

That’s not to disparage IBM, which now gets more than half its sales from computer services rather than computer hardware. Investors like the fact that IBM is adapting to changed circumstances and give its stock a high value as well.

“Adapt” is the operative word for industry today. All companies must adapt to the Internet, the force that promises to bypass sales reps, agents and brokers to dramatically lower costs in the economy.

A team of analysts at Morgan Stanley Dean Witter has analyzed the prospects of the Internet for the financial services industry, including banking, brokerage, insurance, estate planning, mortgages and credit cards.

The analysts foresee annual growth of at least 34% a year between now and 2003 for online financial services, which cut out brokers, bankers and other intermediaries. The companies they pick for long-term success (modestly excluding Morgan Stanley itself) are: America Online, American Express, Bank One, Citigroup, Countrywide Credit Industries, Fannie Mae, Freddie Mac, Intuit, Charles Schwab and Yahoo.

Note: Only two banks are on the list, but three Internet firms. The list is a remarkable recognition of the coming strength of the Internet.

So far, Cisco Systems, the San Jose-based supplier of 85% of the world’s routers and switches, has a clear lead in building the Internet. But the business is in its infancy. Competition for Cisco is heating up from Lucent Technologies, the one-time manufacturing arm of AT&T;, and Nortel Networks, the Brampton, Canada-based former Northern Telecom.

And the real leading edge of Internet technology, reports Ashley Dunn of The Times, resides with a group of start-up companies--Avici Systems, Nexabit Networks, Pluris and NetCore Systems.

The message, of course, is that headlong development, not concentration, is the prospect for the Internet. Venture capital is rushing to fund small companies because the Internet is entering a new phase of development, says Tom Dyal of Institutional Venture Partners, a Menlo Park, Calif., firm.

In this new phase, Dyal says, digital television will open greater possibilities for individual, interactive communication. Also, broadband capabilities will allow expansion of Internet services. Both extend the new economy’s anti-inflationary pattern.

Also, Dyal says, “optical networks, an advance on present technology in which light pulses will carry data packets, will be a focus” of the new $500-million venture firm IVP is forming with members of Brentwood Associates, the Los Angeles-based venture partnership. One of the new firm’s first investments will be in Alidian Networks, a company now organizing in Silicon Valley to work with light pulse transmission.

Venture investors understand that the Internet is not a fad or a stock market bubble, but a long-term force of innovation for the economy.

Such forces take time to evolve. For perspective, Regis McKenna, a Silicon Valley pioneer, recalls development of the electronics industry. “If you took the semiconductor industry--with the transistor invented in 1948, the integrated circuit in 1959 and the microprocessor in 1972--it took the entire industry until 1985 to reach consistent earnings. Losses were very big for years.”

But the semiconductor industry changed the world and created enormous wealth. And now the Internet promises even more innovation and wealth creation.

That’s why innovation and not oligopoly is the force driving the world economy today.

James Flanigan can be reached by e-mail at jim.flanigan@latimes.com.