Bill Gurley
Principal, Benchmark Capital

I was flattered when Bill invited me to speak at his conference. I've been a big fan of his for some time now. He asked me if I wanted to talk about venture capital but I said I'd rather talk about what inspires me as a venture capitalist, which is technology. The title of my presentation is IT is all that matters. The "IT" stands for Information Technology. A few people had come up to me asking, "what do you mean, "it" is all that matters?" So I just wanted to clarify that it stands for Information Technology [laughter].

In May of 2003, a gentleman named Nick Carr wrote an article in the Harvard Business Review titled, "IT Doesn't Matter." That, in fact, is the inspiration for the speech I'm about to give to you. Because he's not here to defend himself, I thought I'd read you his words, as opposed to me interpreting them because I might be a little bit biased against him. Nick says:

"I examine the evolution of information technology in business and show that it follows a pattern strikingly similar to earlier technologies like railroads and electric power. For a brief period, as they are being built into the infrastructure of commerce, these 'infrastructural technologies', as I call them, open opportunities for forward-looking companies to gain sustainable competitive advantages. But as their availability increases and their cost decreases-as they become ubiquitous-they become commodity inputs. From a strategic standpoint, they become invisible; they no longer matter. Seeing IT in this light reveals important new imperatives for the corporate management of information technology. In brief, executives need to shift their attention from IT opportunities to IT risks-from offense to defense."

To a venture capitalist who funds high tech companies, you might imagine that's quite an offensive statement. But I don't want you to mistake my profound conviction for defensiveness. I fundamentally believe that Nick Carr is not only wrong, he's way wrong. In fact, if companies follow his advice I would argue they're following a recipe for failure.

I want to start my talk by going way back to 1859 and Charles Darwin who released Origin of Species. My premise is that evolution is a wonderful model to think about how business works and how the economy works: species are competing in an ecosystem the same way that companies are competing in an ecosystem. Much of my talk will use evolution as a model for us to think about the importance of technology.

Just to start down that path, think about how the business world really is a competitive ecosystem. Companies, like species, are competing against one another. They have finite resources or inputs that they must compete with. Survival of the fittest is the rule that applies. Companies that lead and succeed will be able to grow and establish larger market shares. Companies that fail to do that will potentially starve or go extinct. To give the metaphor more detail, you can think of cash as oxygen or food in nature; or think about an accounting system as evolving to walk erect; or a call center as the evolution of an opposable thumb.

It's not actually that interesting to draw this correlation because it turns out that Darwin took his lead from earlier economists. For those of you who pay attention to detail, in Bill Miller's second quarter summary, he actually talked about the fact that Thomas Malthus was the original inspiration for Darwin to think about evolution. Malthus thought that the world was going to have a huge problem and everyone would go hungry because population growth would exceed the ability of mankind to produce enough food. He, like Nick Carr, didn't appreciate the role of technology enough because productivity circumvented the dire results he predicted. But he was the original inspiration: economics originally drove Darwin's thinking. Darwin was also an avid reader of Adam Smith. There's actually a very interesting similarity in that both Darwin and Adam Smith argued that the collective selfish behavior of the individual could lead to a stable and optimal overall system. One was talking about economics and the other about evolution but they were basically the same theory.

If we're going to talk about evolution we should also look to see what others have done since then. This gentleman is Richard Dawkins, famous for books like The Selfish Gene. He came up with a really interesting argument, which is that species evolve with their tools. A birds' nest, a beaver's dam, an ant hill-these are technologies being used by animals to increase their overall fitness. If you took these away and the species ability to know innately how to develop these types of things, they would have a lower fitness level and their chance of survival would drop. Dawkins also points out that people evolve with their tools as well. Between the caveman and the farmer with a tractor, who has a greater likelihood of survival? Who can more likely provide for themselves? The pathway of tool development leads through the automobile with its mechanic to the doctor with his MRI who can use his tools to actually extend the lives of other humans. It's interesting to see how these technologies get caught up in the fitness landscape of the individual. Take the doctor, remove his technologies, place him in the wild, and he has a lower fitness level than the caveman now. He has forgotten how to hunt, doesn't know what foods to eat, and surely can't walk around barefoot. Dawkins sums it up with this quote: "In the truest and most fundamental sense, human evolution is now inextricably bound with technological evolution."

Before we get to how this applies to business, I'd like to talk about sports. On the screen you see two different types of tennis rackets. One of them was around for about 100 years-the good old wooden tennis racquet. It was the state-of-the-art for a very long time. About twenty years ago they developed an oversized graphite racquet. Ironically it was made for the amateurs. Somewhere along the way the amateurs must have started beating the professionals because the oversized racquet became the only racquet. In fact, you can't get a wooden racquet today except maybe on eBay. And so in 1991 Bjorn Borg, who had been out of the market for nine years, decided he was going to make a comeback. He had missed the shift that had gone on in the technological landscape. So he ambled back onto the court with his wooden racquet. I found this great article that had been written by a tennis analyst about this experience. She said, "he looked like one of King Arthur's knights on a Connecticut Yankee's backyard court. Young, powerful Paladins battled one another on the red clay of Monte Carlo, blasting serves with the latest generation of oversized wide-body rackets. And there was Borg stepping onto the clay, pigeon-toed as ever, dangling from his right hand a black wood anachronism. He never had a chance. Although he was still in top physical condition, his shots looked ludicrously soft, floating lazily across the net before taking a beating from his opponent's oversized racquet." Six months later Bjorn Borg went on in a major tournament to win a quarter final. He was using an oversized racquet at the time. So using last generations technology had become a baseline in that sport. Technology had changed the landscape forever.

On the screen is Curt Schilling, pitcher for the Arizona Diamondbacks. I don't know if many of you know this, but Curt took it upon himself to film ten years of himself pitching against different batters. The teams didn't do this sort of thing, so he hired the staff-the cameramen and editors-and ended up with all of his pitches on CD-ROMs which he carries with him. Sometimes they show him in the dugout with his laptop open watching these pitches. He's evaluating, before he goes up against a batter, each time he as pitched against that batter. He knows what their weaknesses and strengths are and what kinds of pitches might work or not work against them. As many of you may know, he was co-MVP of the World Series in 2001. How did teams deal with this? The San Francisco Giants hired a Chief Information Officer. They now have a CIO! They installed nine cameras with different angles and now they digitally encode every batting attempt in their park so that their batters can view every single bat that they've had against a particular pitcher. Competition is leading to more and more money being spent on technology. Now there are about ten ball clubs that are putting in the same system. I guarantee that the rest of them will install them as well, but they won't be gaining a competitive advantage. They'll be keeping up with the Jones' and they won't have a choice.

Tomorrow you get to hear from Paul dePodesta who will talk about the Oakland A's. If any of you have read Moneyball, it's a wonderful book. I'm not going to steal his thunder but I'll note one thing. If you look at the bottom of the front cover of the book it says, "the art of winning an unfair game." If you look at the title of his speech tomorrow, it's "the SCIENCE of winning an unfair game." These guys clearly use technology to gain an advantage.

Businesses evolve with their tools as well. Companies that use technologies first and effectively will gain competitive advantage. Others are forced to play catch-up and yet others will try to get by without doing anything. They're going to step out on the court with the old wooden racquet. If you think about it, many technologies are now baseline requirements for businesses. You wouldn't think about starting a retail business without a point-of-sale system. You can't imagine starting a bank without financial systems. The customer's expectations are too high at this point. There are a few small businesses where this may not be true, but for the vast majority technology is a requirement. Even in our venture capital firm, we have a small headcount but 15% of our staff is in IT. Our LP's expect all of our reports to be on the web where they can get to them. Every person I work with expects me to have my email on me at all times. It's just an expectation in the industry and if we failed to deliver those things we'd be below par and ineffective as a competitor. And the key think I want to leave you with from the first part of this presentation is that technologies are the real weapons of business. These are the things that companies try to use to differentiate themselves from one another.

Here are a few examples. The first one is Nextel, which evolved from McCaw Cellular. Here is a business that is highly competitive and capital intensive. It's not necessarily a great business but Nextel had a proprietary data network with a single supplier (Motorola). And so everyone else was on either GSM or CDMA and everyone was giving them a hard time about their network. Well it turns out that their network supported a single feature, "push to talk." It makes the phones work like walkie-talkies. It turns out that feature is fairly interesting to companies that have work forces like delivery or support work forces. They like the real time multi-user communication. Because of that they're the only wireless carrier that can sell to corporations with corporate contracts and these corporations churn less. All of a sudden a single technological advantage separates Nextel from the competition in a highly competitive business. Guess what technology all the other wireless companies are spending money on in start-ups right now? They're trying to put "push to talk" on top of GSM. And it's not about ROI. They don't have a choice. They have to do it because the competitive bar just went up in business.

That's a technology business. What about a lazier business technologically? Well take used cars for example. In 1996 Wayne Huizenga started AutoNation. In five years he becomes the largest seller of used cars in America with $15 billion in sales, 30,000 employees and about 276 dealerships. And when the Internet came along, he didn't run and hide. He knew it was important. He put all his listings out there. But guess what? He's not the leading seller of used cars today. Does anyone know who is? You're right, it's eBay. They launched their used car effort in the year 2000 and according to Morgan Stanley, by Q2 of 02 they took over the lead. In used cars, technology matters.

Airlines. Herb Kelleher is the CEO of Southwest. They've had an amazing run. Since 1971 they've had 30 years of profitability. Their market cap usually swamps all the other airlines-not individually but combined. When the Internet came along, Southwest got out in place first. They very quickly had 50% of their transactions online and lowered their cost per transaction from $6 to $1. Along comes Jet Blue and David Neeleman. Here's a guy who sold an airline to Herb Kelleher and copied all of his tricks. But he took it one step further. He put DirectTV in every seat. He went 100% ticketless from day one. And most incredibly, he eliminated call centers in his cost structure by leveraging the Internet and allowing every single one of his call agents to work from their homes. If you call JetBlue you actually get someone in their home. Since they went public a few years ago they outperformed Southwest stock.

This next story is about booksellers. Here are Steve and Leonard Riggio, Barnes & Noble. By 1995 they had consolidated the retail business and become a national leader. They were starting to have huge leverage against the publishers. They should have been able to use that to have a huge advantage going online but they didn't. Along came Mr. Bezos, who will speak to you tomorrow. This guy was an executive on Wall Street. He picked books because it was the best item he could think of to sell online. The Barnes & Noble philosophy held that people wanted to hang around and browse in bookstores. But Amazon's market cap is now 10x that of Barnes or Borders.

Other leading companies are innovative with technology. I find it hard to buy into Nick Carr's premise when you look across the landscape and see that the leading companies are leading from a technology standpoint. Dell built millions of products a quarter to individual order. The amount of IT systems that you need to keep track of every single item like that is gargantuan. It's a huge investment. In fact, eight years after the world realized this model was better, the competitors haven't been able to rebuild this thing. They can't imitate what Dell has built. FedEx tracks millions of transactions a day. A few days ago someone in my office was able to register to get an email from FedEx when any recipients of her packages had signed for them. Everyone else is going to have to do that. You can now track your package at every single step along the way. Imagine if the business you were in had that type of transparency to the customer. That's a cost of doing business. Cemex is a Mexico City-based manufacturer of cement. They use GPS and linear programming to optimize their truck schedule. In doing so, they reduce the time they can deliver a load of cement from three hours to 30 minutes. Now they guarantee 30-minute delivery for every order. Everyone who competes with them now has to live up to that premise. Walmart is driving all the innovation in RFID which is wireless inventory systems. They're out telling their suppliers they're going to have to go in this direction. Qualcomm and Charles Schwab, both leaders in their industries are frequent buyers from our start-ups. They come to us and ask to see what our companies are doing so they can understand where they might have an opportunity to gain a competitive advantage.

I find it hard once again to believe Nick Carr's theory when the leaders are taking these kinds of actions. The data also creates a problem for his thesis. From 1960 to 2002, technology as a percentage of CapEx has gone from 15% to 50%. So clearly, companies feel a need to spend money on all this technology. It's hard to believe as a massive group that they're all behaving irrationally.

But one of the reasons that people are skeptical about technology is because it is extremely frustrating. A lot of people suffer with technology. There are numerous comic strips written about how horrible technology is. Companies have problems with technology. The Wall Street Journal reported in 1998 that 42% of corporate IT projects were abandoned before completion and 50% failed to meet expectations. There is a lot of failure inherent in the system. But I urge you once again to think about evolution. Most mutations lead to a negative fitness, not a positive one. Only a few lead to a positive one and they force the landscape to change. The failure of individual projects is not significant or indicative of the claim that all IT expenditures are bad.

Here are a couple of failed IT expenditures. The one on the screen is from 1997 and is about Dell stopping their SAP implementation. It turns out that Dell was running their accounting system on Tandem computers and Compaq bought Tandem and Dell had to get off of the systems because it send a bad signal to its customers. But when they tried to use off-the-shelf software on top of their business model, it didn't fit. They could have adjusted their business model to the software-which is, ironically, what a lot of companies do-but they chose instead to abandon the project.

Here's one from 2001 that's a little worse. Nike missed its numbers and blamed it on i2 Technologies. That was the high point of i2's stock price: they're at about a penny now. They fell 22% the day that Nike made this announcement. This was a first: I had never seen a company blame one of their IT vendors for missing a quarter. But why did Nike put themselves in that position? Why was it important for them to spend $20M on an inventory system? They were forced to because that's what the industry was demanding.

This article came out only a few weeks ago: UPS invests $30M in IT to speed package delivery. They claim the technology will provide UPS with a distinct competitive advantage. But a spokesman from FedEx said that they already use similar systems. FedEx is saying "we already got one of those." And so it goes.

If you think about this in more detail, you run into the Red Queen Effect. The idea comes from the book Through the Looking Glass where the Red Queen says that you have to run as fast as you can just to stay in place and if you want to get somewhere else you have to run twice as fast. This is what IT spending is all about. Everybody is trying to get a competitive advantage yet at the same time they're trying to catch up if they have to. This creates a system where you are constantly moving and most are moving just to stay caught up.

You only need a few leaders who have successful, positive ROI projects to force the whole industry to come along. You don't need the aggregate expenditures to matter. Everyone else will be forced to play catch-up with the leaders or they risk extinction. For every Dell there is an Acer, AST or NEC that wasn't able to come along. That doesn't mean they didn't keep trying to invest in systems to keep themselves current. For every Walmart there's a Kmart.

, you can't choose not to play. This is Nick Carr's strategy. He wants you to walk out there with that wooden tennis racquet. And you're going to get your head handed to you. I actually had a chance to meet with Nick and we shared a panel together on this very topic. I realize that one of the big differences between my thinking and his wasn't in the overall picture but in his definition of the importance of marginal competitive advantage. We were talking about Sabre and he said, "you know Sabre only had an eight-year technological advantage." I said, "what in the world makes you put the word 'only' in that sentence?" Eight years for a business advantage is like everything we strive to achieve. It was at that moment that I realized the problem with Nick's argument. I told him, "somehow I picture you in the late 1700's talking to the Native American Indians saying 'look I understand that you have these bows and arrows and they have those guns, and that's a bit of a disadvantage. But you know guns are really expensive right now and they're hard to come by. If you wait about ten or fifteen years, they're going to be a lot cheaper and abundant and you can get them then. Don't worry about it.'" I think that's what he's telling companies to do and it's a huge mistake.

If technology is a weapon, that makes Bill Gates and Larry Ellison arms merchants. They're the ones selling picks and axes to the gold miners. I would argue that's not a bad place to be. The positives include a continuing big growth in technology-expenditures on technology as a percentage of CapEx might grow from 50% to 77% or 80%. The negatives are that the arms merchants have competitors too; the Red Queen Effect applies to tech companies as well.

Ironically, I was walking through the casino this morning thinking that there were a lot of slot machines around, and was that really necessary. It struck me that I should check something out. I downloaded a comparative chart of the big gaming companies. Sure enough, Mandalay Bay was the leading stock performer of the past four years. But there's another stock on here that's higher: IGT (International Gaming Technology). They sell the slot machines. They're the arms merchant to the business.

There are even other technologies that intersect with business in a more profound way. This isn't a single company getting an advantage but technologies that change whole industries. eBay has done this to flea markets, asset disposition and is now attacking used cars and tickets. What's going on in digital media is unbelievable. An MP3 player is handheld and has 40GB of memory. Five years from now, this same size device will be able to hold every song in production. There are only 260,000 CD's that are active at any one moment in time. Ten years from now you'll probably be able to fit that on a Compact Flash card. I don't know what these industries will do. There are 300 million PC's out there that act as CD copying devices. If the music companies sit or run and hide or try to play defensively with technology, this stuff is going to blow them up. More recently telecommunications has been exploding with innovations. Check out skype.com. It's a peer-to-peer client written by the folks who wrote KaZaA. I frequently do business calls with our overseas offices for free and it's very high quality. All of our start-ups are starting to use it as a primary means for interacting with their sales forces and customers. I don't know what is going to happen, but it will be revolutionary and if you sit around and ignore it you won't get anywhere.

Another big trend over the next ten years will be offshore white-collar job migration. The Internet and technologies that exist make it very easy to shift jobs offshore. Every one of our software or development companies has software teams in India or Pakistan or Russia. Call centers are being developed in India where they're teaching people how to have a phony Southern accent so they can answer the phone for companies over here in America. The US will have a hard time dealing with this. We will experience rapid white-collar job migration moving offshore.

You get someone who has the financial disciplines of a Warren Buffett but is open minded and embracing of what's going on on the technology front. These guys have made a lot of money on stocks like Nokia and eBay. These are names that Buffett would have never owned.

I want to wrap up by taking another look at something that Dawkins said just to reinforce the point I'm making. "Taken to its natural conclusion, Dawkins's idea suggests that humankind is really co-evolving with its artifacts; genes that can't cope with that new reality will not survive into future millennia." I believe that not only applies to species but to businesses and investors as well. If I leave you with anything it would be these simple points. (1) Evolution is a model or decent metaphor to think about business, and companies evolve with their tools. (2) technologies are business weapons, but there are no guarantees. (3) You can't choose not to play without risking extinction-heading out onto the field with a wooden racquet is a really bad idea.

Q: How can you really separate effective CEO decision making from the use of technology. That is, in most of your examples it is a CEO and his team effectively using newly available technologies to create competitive advantage. So if IT is all that matters, does leadership still matter?

A: Certainly the title is an attempt to drive home a point relative to Mr. Carr, but if you remember back in my presentation I talked about technologies being used first and effectively. I didn't spend a lot of time on it, but the "effectively" part is extremely critical. Here's an example. I was invited to speak to a group of Levi's executives about eight years ago. They had spent $30M on automated distribution warehouse center. One pair of jeans could come in one side and exit the other side very quickly. But they had no idea how much inventory was in the channel or in the stores, so it was a kind of useless piece of technology. It had no effect on business. I agree with you 100%. Unless you implement technology in a way that is smart and reinforces a competitive advantage of a business, then you won't get anywhere. Of course, managers and great decision-making matter.

Q: Can you talk about how digital technology makes quality unimportant or at least less important and how this affects consumer electronics.

A: Let me give everyone a little bit of backdrop on this. I wrote a newsletter recently that talked about the digitization of the consumer electronics industry. It turns out that the majority of feature set that's going into digital products has now been reduced to a single semi-conductor chip. It's very easy for anybody to get a hold of these chips and assemble them. In fact the three leading companies will give you reference designs on how to combine the chips. There's a huge trend now where digital products can be delivered by anybody. You'll see PC vendors jumping into the game and house brands emerging. The value of distribution will go way up. How does quality go away? When you have analog products there's a continuum of quality. Once you go digital, the product typically either works or it doesn't. The function set of a DVD player is rather rudimentary. There's nothing you can do better than the next guy. So you can go to Walmart and buy a DVD player for $38 from a Chinese distributor and a Taiwanese manufacturer. You will see prices on consumer electronics go way down, the power of distribution go way up, and the power of some of the brands you're used to seeing struggle.

Q: Does the fact that IT is all that matters mean that technology companies are good investments? How has Silicon Valley changed since the late 1990's debacle?

A: I think that technology companies are great investments. I had one slide on this topic. I think they have an advantage from a growth perspective. They are also taking advantage of a trend that is going to drive corporate expenditures for a long time. That said, there is more uncertainty. You also see that technology companies that fall from grace have a really hard time getting back.

You'd be very surprised, I think, at how Silicon Valley dealt with the bubble crash. Entrepreneurism is so innate in Silicon Valley that people didn't just give up and look for a job. They kind of sucked it up and dealt with the new reality. I spend a lot of time in other markets where start-ups are less of the overall fabric. I those areas you had more people complaining. But I have found the valley to be rather resilient. A lot of opportunists left town. Things are picking up again.

Q: It seems that the pace of innovation is starting to pick up. True or False?

A: Hard for me to say. When the economy popped, the willingness of corporations to spend on IT stopped for a period of time. We had such overinvestment in capacity that they needed to take a breath and figure it all out. On the margin it may look like it's picking up again.

Q: Does technology level the playing field between big and small firms or does technology give larger companies more of a competitive advantage?

A: That's a tough question. I think that technologies that are more dislocating like VoIP-Skype has ten employees and it's very easy for them to sell free long distance and upsell by running ads. They can do that. It's very hard for MCI to think about doing that because they have such a huge infrastructure. In a market that's more staid, I don't know that it gives small companies enough of an advantage to overcome some of the other factors. Clearly, Barnes & Noble if they had implemented properly could have done a lot to stave off Amazon.

Q: Given the high failure rate of projects, isn't it more effective to be a fast follower of more successful mutations?

A: Yes, Dell takes that argument a lot of times. The subtlety is in the details. How fast do you fast follow? Are you the third guy with the graphite over-sized racquet? Maybe there's a middle ground where you watch what's going on and don't get so much on the bleeding edge that you're tripping over yourself. But you have to be nimble and willing to move very quickly if you want to get those advantages.

Q: What industries or industry leaders are most vulnerable to technology innovation? Do you believe the US is behind the curve in things like telecom and technology?

A: The entertainment industry and the telecom industry are the most susceptible to technology innovation right now. It's funny, I think a lot of people believe we got behind in the wireless space and as recently as this year, Verizon and Sprint are actually getting ahead of European carriers in terms of driving value from additional services. Certainly we are way behind Asia in terms of driving broadband penetration. There's only 22% penetration in the US. There's 70% in Korea. As a result, there are all these things happening in the Internet in Korea that aren't happening here. In both Japan and Korea, the government has spent a huge amount on digital infrastructure. It's not clear that there's an answer for us to get where they are because they're doing some things that are pretty abrupt. I don't know that US tax dollars will be spent on technology infrastructure anytime soon.