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.

The key advantage of the industrial age was that products could be made available to the masses at affordable prices. Companies competed on the basis of their sales prices, which were related directly to their variable costs. It's taken for granted in the information age that products are available at affordable prices to everyone: Software can be copied and distributed to any number of customers for essentially no cost and with little or no human effort.

Reducing costs was simple and effective in the old manufacturing economy, and it was the preferred tactic. When today's executives regard programming the same as manufacturing, they imagine that reducing the cost of programming is similarly simple and effective. Unfortunately, these rules don't apply anymore.

Software production has relatively insignificant variable costs, so little business advantage results from reducing them. Reducing programming's cost isn't the same as reducing manufacturing's cost. Programmers' salaries appear to be a variable cost from an accountant's viewpoint, but they are much more like a long-term investment—a fixed cost.

The only available economic upside comes from making your product more desirable by improving its quality, and you can't do that by reducing the money you spend designing or programming it. You must invest more time and money on the research, thinking, planning, and design to make your product better suited to your customer's needs. Instead of reducing what they spend to build each object, software companies must increase what they spend to build all objects. This is the essence of the real new economy. The intangible but extremely complicated patterns of thought are that software has value only when it's accompanied by the programmers who write it. No company can treat programmers the same as a factory because programmers demand continuous attention and support well beyond any factory.

Architecture—the human-design part of programming that studies users, defines use scenarios, designs interaction, determines form, and describes behavior—is the part of the software-construction process businesses dispense with most frequently as a cost-saving measure. Although it's certainly possible to do too much design, there is no advantage in reducing it. Your product becomes highly desirable when you invest a sufficient amount of competent design, so it makes more money for you. Its desirability establishes your brand, increases your ability to raise prices, generates customer loyalty, and gives the product a longer, stronger lifespan. There's no advantage in cost reduction, but there's big advantage in quality enhancement. Ironically, the best way to increase profitability in the information age is to spend more.

The dotcom boom was populated with companies whose entire business model consisted of the reduction of variable costs. Their complete and spectacular failure demonstrates beyond doubt that the information age's economic rules are different from those in the industrial age. Business success in the new economy depends on adding something new and better for the consumer. The actual quality of every part of the transaction—from browsing to comparison shopping to comprehensiveness—must be noticeably better for the end user. Simply lowering costs for the vendor doesn't guarantee success today.

When Pets.com sold dog food over the Internet, it didn't offer better dog food, a customer experience better than you could get at the local brick-and-mortar pet store, or any better information, intelligence, or confidence. All it offered was cheaper shipping, stocking, and selling—variable costs all—for Pets.com. It was a classic industrial-age-economy tactic of cost reduction that ignored the new economy's fundamental principles. Far from being the first breath of a new economy, it was the last gasp of the old.

I'm convinced you can sell anything on the Internet profitably and successfully. The trick is your online store must offer a measurably greater degree of shopper satisfaction than any competing retail medium. There's only one way to accomplish this: You must architect your system to deliver the highest possible end-user satisfaction. Treating any aspect of software design and construction as if it were a manufacturing process courts failure. Software design and programming are simply not viable targets for conventional cost-reduction methods. It's certainly possible to spend too much time and money on building software, but the danger of spending too little is far greater.

Such danger is probably not shocking or unfamiliar to you, but it's nearly inconceivable to most big companies' senior business executives. They're still using accounting models popular in the age of steam, yet every aspect of their companies are fully dependent on software for operations, decision-making, communications, and finance. The terms and concepts these executives use simply are not cognizant of the unique nature of doing business in an era when the tools and products of commerce are intangible arrangements of bits instead of railroad carloads of iron. The sock puppets were cool, though.

About the Author
Alan Cooper heads the software-consulting company Cooper, where he has spent a decade making high-tech products easier to use and less expensive to build, a practice known as interaction design. Get the skinny on Alan at www.cooper.com or send him your polite, intelligent, copyedited e-mails at .