The Value Proposition: IT and the utopian fallacy

It's commonly claimed that the Internet age empowers individuals and small firms, creating opportunities for all and improving the distribution of wealth.

For the small number of entrepreneurs who have managed to make a quick buck out of the dot-com gold rush, that claim is probably justified.

But at a macro level, it's no more than a myth.

In its recent anti-competition defence, Microsoft claimed that there were hundreds of small software companies springing up to compete with it, implying that the start-up costs were small and the pickings easy.

Strassmann has long questioned these assumptions. He recently analysed the figures available in the UK to see if the utopian view can be justified. It can't.

To follow the argument, you first need to understand Strassmann's definition of Knowledge Capital (KC) as the value of the notional pool of capital that creates Economic Added-Value (EVA) for a company.

EVA is an established accountant's term, acknowledged to be a good measure of the value a company creates for its shareholders. If you take the accounting profits and take away the return that investors would reasonably expect at current interest rates, what is left is Economic Added-Value. EVA is a real figure representing the returns that good management, ideas, efficient systems, and so on create for investors.

If you take the EVA figure and divide by the current cost of capital interest rate, you arrive at a monetary figure for Knowledge Capital. Knowledge Capital is the value generating assets of the business that include know-how, ideas, databases, good will and all the other assets that investors are really interested in.

Traditionally, banks calculated the asset value of a company based on all the dead things like plant, machinery, company cars and buildings. If you are a capital intensive manufacturer making everyday products that approach is fine, but for an information intensive firm Strassmann's KC valuation is far more relevant. Let's put some concrete numbers in here.

In the UK for 1998, the total KC for 1,506 PLCs was £1,654bn. Just 19 firms each had at least £10bn, and as a group held £1,489bn - 90 per cent of the total. The information economy is clearly enabling the successful few to amass phenomenal wealth.

The shake-out of the dot-coms, mergers of financial organisations and increasing dominance of global megaliths will increase this concentration of wealth. Far from enabling distribution of wealth to smaller competitors, the Internet provides a vehicle for the rich and powerful to control larger markets with lower overheads and to create even greater profits.

Microsoft can be used to further illustrate the trend. The global software industry in 1998 generated profits of $12bn. Microsoft accounted for $7.7bn - 65 per cent of the total. Another 331 firms accounted for about $9bn and 280 lost nearly $5bn. Surely the US government was right to question whether Microsoft has healthy competition.

Business-to-business Internet systems, such as the one recently announced by Commerce One/Oracle, show how the small number of automobile manufacturers that currently dominate the market will concentrate wealth by eliminating the middle men and small-fry in their supply chain.

Business-to-business initiatives allow the dominant players in an industry to increase profits and in the process to eliminate many of the smaller suppliers which can't compete with their economies of scale. Small local suppliers will be replaced by foreign giants who can now find global markets to justify the levels of investment in the state-of-the-art machinery needed to build cheaper product.

For information intensive operations such as software, media entertainment, communications and finance, the traditional industrial checks to growth do not apply. They don't need large plant and buildings, armies of cheap labour or efficient transport systems to underpin growth.

Their products can be moved easily around the world, crossing boundaries with impunity and more often than not will be delivered down a telephone cable. Growth and concentration of power can now be total, the only restriction being the number of people in the world online.

When one company controls your communications link, the entertainment you access, the software systems you run and the shopping channel you use to buy the groceries, it's not the authorities you need to fear. As the UK government pushes for increasing use of the Internet in all aspects of our lives, it will eventually find that tax collection, law, justice and detection of crime will be controlled by a global corporation answerable on to its shareholders with a registered office in tax-free cyberspace.

If you think this view is over the top look closely at the outsourcing deals that allow companies such as EDS to run the UK tax system.

** If you would like to know more about Butler Group's Strassmann assessment services, please visit the http://www.ButlerGroup.com Web site or e-mail Jonathan.Stephenson@ButlerGroup.com.