Marc Andreessen's WSJ article about software eating the world caused debate amongst my colleagues at Bronte Capital. It's a view that informs a fair bit of Bronte's portfolio.*
You see I wouldn't want to make guitar tuners.
After all there is a guitar tuner app on my Android phone and it works well enough. Can't plug it into my son's electric guitar and tune it whilst he is jamming out some Deep Purple covers at the local pub. (Actually he isn't doing that... he is only 11 but I think he wishes he was doing that...)
But that sort of expresses the problem. For most purposes the hardware (the guitar tuner) becomes "appified" - that is it just becomes another app on your mobile phone. A software guitar tuner replaces a hardware one except for specialist uses.
And many things have become appified. The list of devices in a mobile phone is extensive (guitar tuner, satellite navigation, alarm clock, filofax, digital voice recorder, camera, my HP15c calculator etc).
But phones are just the start. Look at this:
Cyberhotel on FreePBX
OK - for the uninitiated I will explain what this is. Its a virtual computer download. After all you can run a computer on Virtual Box (or a Vmware player) and it will virtualize a computer - that is run a computer on software that looks, feels and operates like the box you purchased online from Dell. The computer you are virtualizing with this download is (and you need to breathe deeply to get the significance of this) a hotel administration system which will manage billing for telephones, wifi hotspots, the porno movie you watched at 10.30pm because you were lonely and in a strange town and the mini-bar.
And because it is a virtual machine you can house it in any nondescript linux running box provided you run Vmware on it and plug a few nondescript switches into the back of it.
The expensive hotel PABX has been virtualized: eaten by software. This "virtual machine" the product of some French company that assembled it from publicly available bits of software just wants to sell and install a few trivial phones.
Routing systems - even quite complicated ones - have been virtualized.
Which neatly describes the problem for Cisco. Cisco you see makes complicated integrated hardware-software devices - and their product set - like most hardware-software devices - is being appified.
What is happened to guitar tuners is happening to Cisco which is the real problem with the stock - the reason it trades at such low multiples.
And you can see this in their results: we are in the middle of one of the biggest routing booms you could imagine - as we go from a world where a few devices are connected to one where every device, every tablet is connected to the web. Cisco talk about 50 billion devices but you can't see it in their revenue line.
Instead in the middle of the biggest imaginable boom they had that dreadful conference call where they talked about government spending being weak. Hey isn't this a private sector routing boom? Well it is but the private sector is appifying really fast. The government sector are all paranoid about Chinese government hacking and terrorist vulnerabilities and so are wanting the tried-and-proven hardware-software integrated device (which they think is harder to hack). Government paranoia is stopping the software eating the hardware and them guys at the Department of Homeland Security are sitting there safely in their (antiquated Cisco) box...
But whilst the government holds back the tide of history the lesson holds true: if you make hardware-software integrated devices your risk is you are going to get appified and unless you do the appification someone will do it for you.
Marc Andreessen is right: software will eat the world or at least part of it.
If you are a pure hardware maker its going to be really diabolical. I should illustrate by example. A financial firm I know (one office, two floors) runs about 70 desktop computers running Windows. They used to have a computer on each desk, a series of centralized servers and a backup of the servers (minute by minute) stored off-site and the desktops backed up once a week. You were told not to store stuff on the client computer - only the server.
There were a bunch of security risks with this. For example the client computers all had USB ports so you could plug in a USB key and steal data. So the USB ports were disabled. The client computers still had hard-drives. A staff member could steal data by downloading stuff to their hard drive and then walking out with the hard-drive in their bag. I guess you could lock up the client computers and put alarms on them.
It ain't run that way anymore. The computers are now virtualized.
I need to explain that. With a linux system you can run five computers on one box (you run linux and on that box you run a virtualization software like Vmware or Citrix or Virtual Box). Each of those computers can be different. One could be Ubuntu (a flavor of Linux which I kind of like). Another could be Windows 7. Another two could be Vista. If you are prepared to stretch the law one could even be Apple OSX. In other words one box makes five computers. Or sixty-five provided the box is powerful enough. And they share the same processing power and the same RAM which means if one person is not using it another person can.
But also Linux boxes can be used a different way. You can run ten boxes linked together and pretend they are one computer - and from the perspective of the user they are one computer. Indeed you can run a million computers together that way and they will behave like a single integrated supercomputer. We have an example - its the Googleplex in which it looks like you are sending your request to a single super-computer but the whole thing is run on desktop computers racked in huge storage barns. The beauty of the linked computers is massive redundancy. If 1000 computers went out simultaneously in the Googleplex you would not even notice. The other computers - Borg like - will just take up the slack.
Now you can do this in combo - you could run 70 Microsoft machines on two linux boxes each box being redundant. That is pretty much bombproof because linux machines barely crash and virtual machines barely crash (for reasons explained in this post).
And that is what this financial institution does. It has two largish linux boxes linked and running 70 virtualized Microsoft boxes.
And because it is a financial firm the two linux boxes are backed up second-by-second at a remote site 70km away.
The staff have their old computer sitting under their desk. They see it. They just have no idea that it is non-functional - a dumb terminal for their virtual machines with only the graphics card doing anything. (For some reason graphics cards don't yet virtualize well though that is changing...)
Given the boxes under the desk do nothing they are never going to be upgraded. The linux machines will be upgraded - but that is little more than throwing in another server blade.
Its OK for Microsoft: Microsoft is still renting 70 software licenses to run on 70 virtual machines. It is still renting office and the whole suite of other Microsoft products. But it is diabolical for Hewlett Packard who like Dell are highly dependent on corporate computing businesses for their margin.
Those businesses are stuffed. They don't exist in ten years. And the only fast-growth section is going to be server blades (see above) and those only need to run commodity linux so they will be commoditized.
Hewlett Packard is right to think there is no future in the PC business. The people who are whining at HP's actions are wrong. They should have realized there was no future in that business and sold HP stock. I never owned it (as I noted once in this post**).
Andreessen in on the board of Hewlett Packard. He thinks software will eat the world but in this case it is his company that is being eaten. He desperately wants to salvage it but salvaging it is expensive if you start from the platter Mr Hurd left him.
Anyway if pure hardware businesses are stuffed (and I think they are) then what happens to hardware-software integrated devices? If they can be replaced by software only they are stuffed (example Cisco). But it is not always that clear. Andreessen's article gives the example of military drones - pilot-less planes which can kill. The pilot is being not replaced by software but turned into a jockey with a joystick who may go to war someone in the Continental USA - killing people with drones before going back to be with his wife and kids. But the plane still exists and they still needs guns. It is a software-hardware device and it is not getting eaten. It may be getting better but the bullets are real bullets and they can't be virtualized. So they look safe enough from being eaten by software and it is the fact that the drones are lethal which makes them safe.
The point here is that software does not eat the world - it changes the world but the drone business doesn't get eaten in the way guitar tuners or Cisco routers get eaten.
So lets change the title of Andreessen's piece: software eats a good part of the world but supplements other parts - and as an investor in existing technology you need to know whether you are eaten or not.
I think I have a ready answer for this: every time you look at a piece of kit (a hardware device) you have to ask yourself whether the output of your hardware device is information or the manipulation of information or whether it is something else.
If the output of your hardware is information or the manipulation of information then you are going to get eaten. If the output is something else then you are not.
So lets do the division.
Guitar tuner: information. What is the pitch of the guitar? Doomed.
Alarm clock: What is the time? Do I need to wake up? All information. Doomed.
Military drone: Output is violent death. That is not information, it is a brutal physical reality and hence it is not eaten by software.
Cisco router: manipulation of information. Doomed.
Other items in Andreessen's article
Telephone companies. That is pure information manipulation. Ultimately doomed except for linking all this together. Certainly the old analog phone network is problematic.
Walmart distribution systems. Well the output is shopping for physical goods. Not doomed. Information is just an input.
Oil and gas exploration where computers drive drills etc: not doomed - the output is oil and gas.
Traffic lights. Doomed - but that will take time to get the controlled cars up.
You can go on.
*We are - despite appearances on this blog - primarily long investors and we spend a lot of time thinking about our longs.
**Disclosure: I once shorted HP but made no money. The analysis was right. Our timing and execution left a lot to be desired.
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