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The Last Gasp

by Alan Cooper

November 2003 Issue

Alan Cooper
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As the dotcom bubble inflated during the last few years of the 20th century, truckloads of ink were used to sell the idea that there was a "new economy" on the Internet. The pundits said selling things on the Web was a fundamentally different way of doing business, and the "old economy" was as good as dead. Of course, almost all those new-economy companies are gone, the venture capitalists who backed them are in shock, and the pundits who pitched the new economy have recanted, claiming it was all a hopeless dream. The new, new thinking says we must still be in the old, old economy.

I believe we are in a new economy—and that the dotcoms never even participated in it. Instead, they were the last gasp of the old economy—the economy of manufacturing.

In the industrial age, before software, products were manufactured from solid material. The money it took to mine, smelt, purchase, heat, form, weld, paint, and transport dominated all other expenditures. Accountants call these "variable costs" because they vary directly with each product built. "Fixed costs," as you might expect, don't vary directly and include things such as a factory's initial cost and corporate administration.

The classic rules of business management are rooted in the industrial age's manufacturing traditions. Unfortunately, they have yet to address the new realities of the information age where products consist mostly of software.

Some fundamental truths do hold for both the old and the new economy. The goal of all business is to make a sustainable profit, and there's only one legal way to do so: sell some goods or services for more money than it costs you to make or acquire them. It follows that you have two ways to increase your profitability: reduce costs or increase revenues. Reducing costs worked best in the old economy. Increasing revenue works much better in the new economy.

Software products consume no raw materials and have no manufacturing and transportation costs. They require no welding, hammering, or painting. The information age involves little or no variable cost, whereas variable cost was the dominant factor in the late industrial age. The absence of variable cost is what makes this a new economy.

One hour of programming isn't related directly to one product sale; you can sell the same code repeatedly, so it's not a variable cost. However, it's not a fixed cost either. Writing software is an ongoing, revenue-generating operation—not the same as constructing a factory. Some might suggest that programming is research and development; the comparison works, but traditional accounting separates R&D from revenue-generating operations, so this doesn't fit either. You'd be wrong to discount this little terminology mismatch as a minor quibble for bean counters to debate. It has a huge effect on how software is funded, managed, and—most significantly—regarded by senior executives.

You and I create software, and business executives create revenue streams and profit centers. You and I measure our success by the product's quality, and business executives measure their success by their investments' profitability. They do this by applying the language of business mathematics, which recognizes fixed costs, variable costs, corporate overhead, and R&D, but, unfortunately, has no model appropriate for software or programming. Accounting is the basic language of business, and its categories are so fundamental to all business measurement and communication that contemporary executives have internalized them completely. They see programming as another corporate expense to fit into an existing category. Most simply treat programming as a manufacturing effort—a variable cost. This is the worst possible choice because it prejudices their business decision-making hopelessly.