Weekly Update #265: Is Spending on Proprietary IT Driving Inequality Among Companies?

Chart of the Week - Is Spending on Proprietary IT Driving Inequality Among Companies?

Source: Based on data from the Bureau of Economic Analysis

If you feel like the corporate landscape is increasingly splitting into groups of winners and losers, with the biggest corporations seizing outsized economic spoils, then you would be correct. As the WSJ notes, the dominant tech companies like Amazon, Google and Facebook, as well as their peers in other industries, are pulling ahead in every meaningful measure of prosperity, including revenue, profits and productivity. For example, since 2001, productivity has grown over 44% among the 5% most productive U.S. service companies. Conversely, all other U.S. service companies have grown only ~7% more productive over the same time horizon.

While there are multiple hypotheses floating around to explain the diverging fortunes of these companies, a new viewpoint focuses on company investment spending patterns. As made clear in the chart above, the increased inequality among the nation’s companies has come with strong growth in spending on proprietary IT systems, which has increased from ~7% in 1986 to a rolling average of nearly 23% in 2016. A company’s proprietary IT spending goes towards creating software to be owned and used exclusively by the home firm, such as the software developed to enable Amazon Web Services or Facebook’s artificial intelligence capabilities.  

While some economists believe that previous technological advancements would diffuse throughout the private sector, bringing greater prosperity to all companies, the most successful companies of today are hoarding proprietary IT at the expense of everyone else. This viewpoint comes to the forefront as some economists also believe the tech titans are on their way to monopoly.  

How should these trends impact investment decisions, particularly in emerging companies hoping to challenge the status quo? We have a few viewpoints below on how to mitigate the negative effects of IT-hoarding:

• Despite the competitive obstacle posed by the tech titans, investors can target emerging companies and startups with strong network effects--meaning those companies whose products and services increase in value as more people use those products and services. Unsurprisingly, many of the largest tech companies have been able to exploit this, such as Facebook’s social networking platform.
• A startup’s management can also be supremely important--in early stage companies in particular, investors often invest on the basis of a strong management team even if the company’s product is problematic or has yet to launch. Notably, according to the World Management Survey, smaller companies are consistently worse run than their larger peers.
• Moreover, much of the competitive advantage associated with the tech titans comes down to the strength of their technologies. The larger firms are better at protecting their competitive advantages with patents. To the extent possible, investors may want to target startups who are early developers of a new technology and have effectively utilized IP laws to maintain their edge.
• Along the lines of patent protection, early adoption of new technologies may also be critical in solidifying a startup’s future prosperity. For example, reporting by the McKinsey Global Institute indicates that early adopters of AI may have already gained “an insurmountable advantage” over slower competitors.

While it may be difficult to find startup investments with all of the characteristics above, investors may also benefit from legislative action in the future, as governments consider IP and antitrust policies meant to alleviate the effects of IT-hoarding.

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• Large Companies Increasingly Comfortable with Startups as Business Partners
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