Mike Nobis saw how the financial crisis led his customers to postpone orders until the last minute, forcing his 100-year-old family printing business to work faster to deliver on time.
Instead of adding more people or machinery, he found the solution to the new business demands in a piece of software.
“We are investing a whole lot more in the software we are using so we can use less and less employees to do the exact same work,” said Nobis, president of JK Creative Printers & Mailing, of Quincy, Illinois, which produces items from business cards to catalogues.
Nobis’s strategy is being replicated at companies around the U.S., where investment in software is up 19 percent since the 2007 business-cycle peak, while spending on hard assets has slumped. Executives are taking less risk on physical assets such as computer hardware, machinery or warehouses, and using software to increase efficiency or reach customers on the Internet.
That shift has implications for the Federal Reserve. It suggests business spending may be less responsive to interest-rate policies, such as quantitative easing, aimed at encouraging investment in long-lived assets like structures, housing and equipment. Software purchases are typically financed out of cash on a month-to-month subscription basis, making the cost of borrowing less likely to influence the decision.
“Monetary policy is driven by the feeling that if you lower interest rates businesses will invest,” said Joe Kennedy, a senior fellow at the Information Technology and Innovation Foundation, a Washington research group. “There is an assumption that it will be on big, long-lasting projects.”
Given the cloudy economic outlook, still-high unemployment rates, and lack of policy consensus in Washington, “businesses are trying to avoid long-term bets on fixed assets,” he said.
Investment in non-residential structures such as stores and warehouses is down 18 percent since the fourth quarter of 2007, which marked the start of the recession. Spending on equipment of all kinds, from computer hardware to machinery, is up just 2.2 percent, according to data from the Bureau of Economic Analysis.
Corporate America’s focus on labor-saving, low-risk investment is turning into “a big worry” for the economy, said Julia Coronado, chief economist for North America at BNP Paribas in New York. “This technology is labor-saving capital investment; it doesn’t come with jobs. It doesn’t add capacity; it makes existing capacity more efficient.”
That will be one of the challenges confronting Janet Yellen, the nominee to succeed Fed Chairman Ben S. Bernanke when his term ends Jan. 31. Yellen, the current Fed vice chairman, is awaiting a Senate confirmation vote.
More investment in labor-saving information systems should show up in the form of higher productivity. It hasn’t, puzzling Fed officials. Productivity has grown at an average 0.8 percent annualized rate per quarter over the past three years, versus 3 percent in the decade through 2005.
Just why is “a riddle,” Dallas Fed President Richard Fisher told reporters after a speech in College Station, Texas, last week. “I’ve been discussing this with some of my colleagues.”
Fisher said “if you went out to any business and asked, where are you focusing your attention, it’s the IT revolution, just-in-time inventory management, working people longer, harder, lesser numbers of them. Something doesn’t square here.”
Fed officials, who hold a policy meeting Dec. 17-18, have kept the benchmark overnight lending rate near zero for five years while purchasing hundreds of billions of dollars of bonds to drive down longer-term rates and encourage spending and hiring. They have expressed confidence that those policies would speed economic growth and put slack capacity and labor to work more quickly.
They have been disappointed. In November 2011, Fed officials predicted the economy would grow 2.5 percent to 2.9 percent the following year, according to their central tendency estimates. Actual growth was 2 percent. Last December, they forecast growth for this year of 2.3 percent to 3 percent. Economists surveyed by Bloomberg project 2013 growth of 2 percent.
Allen Sinai, president of Decision Economics Inc. in New York, said traditional links between capital and job creation are breaking down. In the past, if a company built a plant or warehouse, it needed to add staff.
Now, the focus is on keeping investment in physical assets low while using conceptual capital such as software to better manage internal data or reach consumers on websites. Those types of investments may not generate the same amount of employment as a dollar spent on a new store, for example, and conceptual capital requires much higher skill levels to make and operate.
“Capital is not the capital it used to be,” Sinai said. “We are substituting a way of doing things. It is a different kind of capital,” one more focused on information than physical assets.
That helps explain why it’s taken more than four years since the end of the recession to bring the nation’s jobless rate down to 7 percent. Unemployment (USURTOT) reached that threshold last month, the lowest since November 2008, as employers added 203,000 workers.
Since the business cycle peak in December 2007, employment in computer systems and design has increased by 20 percent, while employment in construction has fallen by 22 percent.
The experience of Nobis, the printer, shows how a change in corporate behavior drove his company to make an investment in information, not people or machinery.
As the recession deepened in 2008, Nobis noticed his customers were holding on to cash as long as possible. When they finally decided to do a print job, they needed it immediately. Such short-term demands can throw a printing operation into chaos because the process involves a chain of separate tasks from designing to printing to binding.
Nobis said his new software was able to manage the workflow, and push some jobs ahead of others so all operators could see how their schedules and tasks were adjusting. It also automatically managed his inventory of paper.
“Our pressman, all our bindery people, they have monitors at their stations and the software walks them through their process and plans their day for them,” said Nobis. “We had 36 employees; now we are down to 28, and we produce a whole lot more.”
The software boom hasn’t been accompanied by a corresponding rise in computer hardware investment. Spending on information processing equipment is up 3.9 percent since the 2007 business cycle peak. Some companies already have hardware on site. Others access existing server capacity through cloud-computing companies like Amazon Web Services, a unit of Seattle-based Amazon.com Inc. (AMZN:US)
The ISE Cloud Computing index, which tracks 39 companies such as Rackspace Hosting Inc. and VMware Inc. that can benefit from growth in the cloud-computing market, is up 33 percent over the past 12 months, compared with a 28 percent gain for the Standard & Poor’s 500 stock index.
In effect, many companies are purchasing computer hardware as a service rather than sinking their own cash into servers. Ed Anderson, a former executive at Microsoft Corp.’s cloud-services unit, says that makes sense for the same reason that businesses purchase electricity or telecommunications services instead of owning a phone company or a power company.
Cloud computing allows companies or individuals to access storage and applications online on public or private networks.
The use of the cloud hasn’t led to a big pickup in hardware purchases because the companies that provide those services are finding ways to juggle capacity with “elastic software that lets you share those servers across immense utilization rates,” said Anderson, who is now research director at Stamford, Connecticut-based Gartner Inc.
When Mihnea Stoian and his partners decided to start Luevo.com, a 10-month-old crowd-funding website for fashion designers, their main investment was in software. Their hardware needs were met in part via the cloud by Amazon Web Services, and Heroku Inc., a unit of San Francisco-based Salesforce.com Inc. Luevo.com’s capital expenditure on hardware was practically zero, he said.
A decade ago, scraping money together to buy servers and hire technicians was “the largest stumbling block” for a start-up, said Stoian, who is based in Toronto. “Now it is the one thing they really don’t have to worry about.”
Mobile computing is also driving expenditures on software as retailers rush to capture online customers who may now be looking at their products on a tablet, a phone or a desktop.
Abercrombie & Fitch
Billy May, a group vice president in charge of New Albany, Ohio-based Abercrombie & Fitch Co. (ANF:US)’s digital strategy, said about half the company’s Internet traffic arrives through mobile devices.
The company’s domestic store count fell to 912 in 2012 from 1,068 in 2009. While the company doesn’t break out software expenditures, May said the company is increasing its investments in electronic commerce.
E-commerce is shaping up as a bright spot in this year’s holiday sales season. Online sales on last week’s Cyber Monday rose 21 percent from 2012, according to International Business Machines Corp. Retailers catering to smartphone and tablet users benefited the most, with mobile traffic accounting for 32 percent of site visits, a 45 percent gain from last year.
Compared with physical assets, “the economics are superior” in digital selling venues, said May. “Customers are loyal to brands and seek a seamless relationship” as they shop in stores, or at their desks, or on their smart phones.
“Historically, investment in technology was seen as a cost center,” he said. “In today’s dynamic marketplace, those aren’t costs. They are assets” as retailers learn more about what their customers like and want and shape their offerings to them.
Other retailers are also stepping up their software investments. Staples Inc., the world’s largest office supplies chain based in Framingham, Massachusetts, started Velocity Lab in December last year, a new team dedicated to improving the company’s electronic commerce. Target Corp., the second-largest U.S. discount retailer, opened an innovation center in San Francisco.
“The 20th century was about rearranging material; now the economy is about rearranging bits of information,” said Daniel Castro, a senior analyst at the Information Technology and Innovation Foundation. “The value added is how to generate intelligence and knowledge out of data. That is what we are seeing in the growth in software spending.”
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