Outlook 2001: can the new economy navigate rougher waters?

Puffed up with credit for the prosperity of the 1990’s, the new economy is entering its first slowdown, offering numerous efficiencies and injections of wealth to soften the pain.

But softening the pain will not be easy. This is the third or fourth new economy since the 19th century – each one offering a similar promise – and yet none could stop a persistent downturn, the New York Times on the Web reports.

That American enterprise has been changed by a set of new technologies is beyond doubt. Ever faster computers connected through high-speed networks or embedded in almost everything people use are putting their imprint on the nation, just as railroads once did, or the electric motor and the gasoline engine, or Eisenhower’s interstate highways.

Each enriched America, but could not arrest the endless cycles of a market system. And now the latest new economy – not just the dazzling dot-coms but the whole economy now that nearly every company is interlaced with computers – is caught in a slowdown.

Economic growth has decelerated since last June to half its earlier pace. Forecasters speak increasingly of the risks of a recession in 2001 that would end the longest expansion in the nation’s history.

New technology has never been a match for the forces that periodically overwhelm the economy: high interest rates, falling profits, shrinking consumer demand, plunging stock prices, too much debt, frightened lenders. All this is happening today.

Still, many corporate executives swear they will continue to invest in the innovations that define the new economy. If they are as good as their word, then their investments would buffer the economy, softening a recession.

“When innovation lowers costs by enough so that the return exceeds the cost of the investment, then you undertake the investment regardless of the business cycle,” said John Lipsky, chief economist at the Chase Manhattan Bank. But there is a caveat. “You don’t know ahead of time,” Mr. Lipsky said, “whether the return will be sufficient. Everyone is flying by the seats of their pants.”

No industry is closer to recession today than vehicle manufacturing. And yet DaimlerChrysler, despite shrinking profits, swears that it will continue to invest big sums in new technology.

One innovation getting under way will let DaimlerChrysler designers instantly know the changing cost of vehicles they are designing.

The dollar amounts might even be displayed like a digital clock on a computer screen alongside the evolving electronic design. Suppliers would also watch the design in progress and plan more efficiently to supply parts.

“We call it ‘fast car,’ and the investment will be major money; not billions but many, many millions,” said Gary Dilts, a senior vice president. “Developing a new vehicle costs $1 billion to $2 billion today,” he said, “and 20 to 30 percent of that cost is wasted now on the outdated information and inefficiencies we have in the system.”

Hundreds of companies say they have come to a similar conclusion. If the payoff is not as visible for some executives as it is for Mr. Dilts, then keeping up with competitors, even in a recession, is justification enough.

Home Depot and Land’s End, for example, are in the early stages of selling merchandise over the Internet, trying to satisfy consumers who before the age of the Internet were satisfied to shop in stores or through catalogues. These are still the main avenues.

“What we are hoping is that the Internet will get more people into the stores,” said Ron Griffin, a senior vice president at Home Depot. That means investing in stores – a new Home Depot opens every two days – and also in the Internet.

Fuel for growth: spending more to innovate

Capital spending surged in 1995, and that surge contributed mightily to the booming growth and prosperity of the late 1990’s. No area of this spending grew more rapidly than the outlay for computers, software, semiconductors and telecommunications equipment.

These items – the tools of information technology that define the new economy – represent 40 percent of capital spending today, up from 31 percent in 1995.

Since last summer, capital investment has grown much more slowly. Even so, spending for the tools of information technology has resisted the trend. While the rate of increase has slowed since last summer, it is still twice as fast as overall investment, despite the flameouts in the dot-com world.

That is not surprising. The new economy was never the handful of highly publicised and richly financed start-ups that appeared in such abundance to exploit the Internet. It was always the endless ways in which computers, software and communications gear were used to make any enterprise more efficient and less costly.

And now a slowdown, perhaps a recession, is testing this process at a critical stage. A transition is under way from Phase 1 of the new economy to Phase 2, as Kenneth G. McGee visualises the process.

For a generation or more, corporate America has bought computers and software and used them in-house for all sorts of processing once done by hand, or to operate in new, less costly ways. Now the investment is shifting outward, focused more on enhancing transactions among businesses and sales to consumers.

“The revolution that is happening is that the new economy is rapidly leaving the back office,” said Mr. McGee, a vice president at the Gartner Group, a research firm.

Whether this outward investment, so visible on the Internet, will be as effective as the in-house variety remains to be seen. Certainly in-house, the new economy has made progress.

Most of the spectacular productivity gains since 1995 have come in-house. Outward bound, there are more obstacles and, as a result, the payoff from the new economy technologies – particularly the Internet – is slower, executives say. That makes the investments involved more sensitive to an economic slowdown or recession.

In-house, computers talking to each other over high-speed networks have been particularly helpful – for example, in tracking shifts in sales and demand so that manufacturers or retailers do not overproduce or overstock and then have to cut back sharply, aggravating a recession.

Where the new technologies have really made a difference is in the production process itself, particularly in factories. The Timken Company, for example, a manufacturer of roller bearings, based in Canton, Ohio, uses computerised machinery to grind the bearings with greater precision and speed, thus reducing wastage and labour cost. Hundreds of companies report similar improvements.

But these are in-house achievements. The big gains in productivity and cost saving are expected to come with Phase 2, as companies increasingly use the new technologies to buy and sell to one another and, of course, to sell more to consumers.

For all the fascination with just these activities on the Internet, the surface is barely scratched. The Gartner Group expects business-to-consumer Internet sales in North America to rise to $143 billion in 2004 from only $30 billion this year, while business-to-business electronic commerce will jump to nearly $2.9 trillion in 2004 from a small $237 billion this year.

Traditional companies wrestle with the Internet

No company is second to Wal-Mart in using the new technologies. Rows of computers housed in a brick, armorylike building in Bentonville, Ark., Wal-Mart’s headquarters, have for years collected data on sales and inventory levels in Wal-Mart’s numerous stores and warehouses.

The information arrives not over the Internet, which did not exist when Wal-Mart installed its electronic data system, but over dedicated phone lines.

When the supply of some item runs low – dish towels in a St. Louis store, for example – the Wal-Mart computers are alerted electronically and generate an order, which then goes by e-mail message or fax to a towel maker, which delivers the merchandise and sends an invoice, also via the phone lines.

This is the essence of business-to-business commerce, which overshadows retail sales. The next big leap forward for the new economy is to put so-called B-2-B commerce on the Internet.

But Wal-Mart balks. The giant retailer has set up a Web site for the dish towel manufacturer, and for each of its other suppliers, so that they can see how their products are selling store-by-store and even at what price. But the suppliers cannot communicate with Wal-Mart through the Internet.

For the suppliers’ computers and Wal-Mart’s to talk to each other on the Internet requires a national agreement on a set of standards that in effect lets disparate computer systems understand each other.

Other companies, lacking Wal-Mart’s electronic sophistication, have costly supply operations, often involving a staff of purchasing agents, and the cost is an incentive to shift to the Internet.

But the investment involved in connecting disparate computer systems and in changing work practices is often daunting, and the going has been slow.

E-commerce – selling to consumers over the Internet – is similarly intended eventually to eliminate costly intermediaries, namely retail stores with all their sales people.

That is a radical change that is not even contemplated by the growing number of retailers selling directly to consumers over the Internet, Wal-Mart among them. The giant discounter has operated a Web site since 1996.

Theory lays out a clearer process. “It would seem to me,” said Kevin Stiroh, an economist at the Federal Reserve Bank of New York, “that you would have a transition period during which you would have both distribution channels – stores and Internet – operating simultaneously, which might not be the most efficient way to work, and then you would go to the channel that is the most efficient.”