The 20th century company acquired capital assets (property, plant and equipment); employed a large, low skilled secondary workforce to produce things with that PPE; and employed a small, high skilled primary workforce to manage both the secondary workforce and administrate the PPE. By comparison, the 21st century company rents infrastructure - commercial space, cloud services, computers - and both employs and contracts knowledge workers who collaborate on solving problems.
I want to focus on the capital rather than the labor aspect of this. Unlike its 20th century predecessor, the modern company is capital-light. Companies don’t own the tools their employees use, they rent them (e.g., spreadsheet software) or buy a tool and the right to rent the tenancy when certain capabilities are used (e.g., machine tools with subscribable capabilities). 21st century companies do raise capital, but it is used primarily as a buffer to absorb losses during the startup years.
As I’ve written before, industrial firms - largely 20th century firms - are under investor pressure to look more like their 21st century counterparts. The (post-startup) 21st century firm has both scale and recurring revenue yielding very attractive margins and cash flows that, because they are light on fixed assets, result in higher returns to investors. For a 20th century firm to make this transition requires balance sheet and income statement restructuring. The balance sheet transformation is straightforward: sell buildings and pay rent to use them; contract for logistics services rather than own and operate a fleet of trucks. The income statement is much harder to change: if you make machines, the biggest bulge in the top line still comes from moving machines. Still, OEMs are trying to sell subscriptions to services on the machines they make, promising revenues in the low double digits of machine sales.
For a 20th century firm to change its income statement requires customer cooperation. That cooperation is not immediately forthcoming.
The OEM value prop to the machine owner/operator consists of at least two parts. One is that the owner/operator only pays for machine capabilities when they’re needed. Another is that subscribable capabilities can overcome the difficulties of replacing skilled labor.
The prior is obvious, but to a lot of owner/operators of dubious value: the 20th century mindset doesn’t equate a machine tool with a mobile phone, a device on which you pay to install and use apps.
The latter is a structural problem of labor markets. Plenty of firms in construction and manufacturing rely on older machine tools. They rely on skilled labor to use those machines in an expert fashion. These are not knowledge workers in the contemporary sense, but laborers skilled at using the machines, operating them efficiently, effectively, and responsibly. In expert hands, those machines will get the job done quickly, safely, and without damage to the machine itself. As that population of experts ages out, the firms dependent on them are finding it difficult to hire replacement employees. The latter OEM value prop amounts to shifting capability from the operator to the machine itself, which makes it easier for the owner/operator to source (hire and replace) labor. Theoretically, the machine owner/operator should be willing to pay to rent machine capabilities as the difference between the total compensation for an expert and the total compensation for an employee who is not, and will likely never be, an expert.
For the owner/operator, it means the machine is now both balance sheet and income statement phenomenon (beyond MRO costs). Again, theoretically this isn’t a problem as long as the cost of renting machine capabilities is less than the difference in employee compensation between expert and technician. But everybody knows that rents rise, and the owner/operator has less control over OEM fees than it does over negotiating employee comp. When the cost of renting the capability is not sanitized by the compensation gap, supplementing balance sheet with income statement impact requires that the owner/operator have (a) pricing power to be able to pass those costs onto customers or (b) taking the hit on its own margins. Neither are particularly attractive options.
Which points to another unattractive thing about substituting machine capability for employee skill: a greater dependence on the OEM for capability. There’s a fable that a former CEO of Nokia told of the Finnish boy who was outdoors in winter and cold, and discovered he could warm himself by wetting his pants. This, of course, is only effective for a short while and has undesirable consequences. The lack of skill development among employees - and in fact, a limitation on ever developing those skills because of the convenience of reaching for the subscribable capability - increases dependence of the owner/operator on the capability from the OEM. That gifts the OEM a lot of pricing power over the owner/operator.
Consider commercial agriculture. Suppose that the subscription price to use the software to optimize planting and fertilizing is indexed to the cost of seed and fertilizer. Suppose seed and fertilizer consumption is more effective by 25%, so the OEM charges the farmer a metered rate up to the 25% of the total volume the farmer would have made without the software times the current market price for seeds and fertilizer. Within the narrow definition of that subscription transaction, the economics seem to be fine, but systemically they work against the 20th century farmer. Seed and fertilizer companies will increase prices to compensate for the loss of volume. OEMs can increase the subscription fee as a percentage of savings within a +/- x% or so band to capture more of the farmer’s savings. The bottom line is, any savings will not accrue to the farmer. Worse still, if after all of this, commodity prices are soft, the farmer is screwed. Not out of business, but dependent on economic rescue. (Food security being up there as a national priority with energy security and financial security means governments will pump money into farms just as they often own petroleum companies and always bail out their banking system.)
For OEM subscriptions to truly take off, the owner/operator has to become a 21st century business. In our ag example, in the absolute form, that means putting seed and fertilizer out to bid with the winner agreeing to sell at cost and taking a cut of the yield; contracting to an ag operations firm that brings their own machines and personnel; and of course, leasing both land and buildings. In this case, the value prop of subscriptions is not to the farmer, but to the service provider with the equipment performing farm operations.
Admittedly this is a bit extreme. But it is not far fetched. Boeing doesn’t make what it sells… although that hasn’t turned out according to plan and for the time being they’re undoing that by purchasing the manufacturing business they spun out. Ok, bad example. A better example is Apple, which also does not make what it sells, and that has been quite successful. So, similar to how Apple reminds every new owner/operator upon unboxing a product, this soybean - the product of the seed, fertilizer, pesticide; of the choice of land on which it was grown; of the cultivation, irrigation, spraying and harvesting; of the storage and transportation - was Designed by Farmer Bob in Kansas.
The point is, there’s a mismatch of 20th century OEMs trying to synthesize and export a 21st century business model onto 20th century owner/operators. At present, it’s not a natural fit for either.
And by the way, just as this applies to manufacturing and agriculture, it also applies to households. We’re seeing the groundswell of a transition from owning to renting. While automobile leases have been around for years, interest rates and excessive property values are forcing would-be first time buyers into renting, possibly forever. An entire property industry is being built around this possibility. An “ownerless” society is far more inclined - and far better prepared - to manage a myriad of subscriptions than an “ownership” society is. This transition suggests automakers will gradually find it easier to sell subscriptions to things beyond satellite radio.
We’ve come a long way since the 1970s when the courts ruled households didn’t have to rent a phone from Ma Bell but could buy a telephone outright and plug it into the AT&T network. Since landline telephones lasted decades, ownership of the tool freed up income that had previously been committed to a subscription for a phone. Today, of course, AT&T (among others) has effectively found their way back to that model.
Turns out it was back to the future all along. It isn’t so much that the future is digital. It’s that it is asset light.
