At the intersection of technology, finance and the Pacific Rim.

Friday, May 12, 2006

On wednesday I spoke of the importance of understanding the cycles of a business. It is only then that you will be able to feel the rhythm of a company or industry. And there are many such cycles to understand. Let me review a few of them with you:

Industry cycles: These are often demand/supply cycles and we see them most often where supply comes into the market in "big chunks" and where there is little differentiation of product. Examples would include LCD panel production, long distance fiber optic line capacity and semiconductors. The "chunkiness" results in a lot of burps in the industry--though demand continues to grow, the chunks of supply that come onstream outstrip the ability of the end market to absorb. What happens then is what we see in everyday life--15 inch LCD screens give way to 17 inch; 256mb DRAMS give way 512 mbs and prices drop like a rock. Eventually this supply overcapacity gets corrected as companies no longer have the capacity to re-invest--their profits are replaced by red ink--and either they lack the cash or their stock price considerations act as a brake on further investment. Supply then tightens and profits return. The length of the cycle will vary in accordance with the time it takes to add capacity in the industry.

In the semiconductor business this can be as long as 9-12 months to build the fab and an additional 6-9 months to fill the fab with equipment. We have been waiting for four years for an upturn in the backbone telecom industry--those companies that provide backbone lines to corporations and other telecom providers. It has not materialized because these companies laid a lot of dark fiber during the bubble period which can be readily lit and come online--so supply is easily replenished even though demand keeps doubling every year (or less a period) for "bit" demand. Eventually the dark fiber will all be lit and we will be back to the days of shortages--and prices will go up. But when is the magical question and there have been a lot of predictions with a lot of false starts.

Working Capital Cycle: The working capital cycle in a sense is closely related to the above supply demand cycle. As you know, the working capital cycle refers to the conversion of inventory (work in process production and post-production) into receivables and finally into cash. The cycle has become shorter and shorter over time--with management innovations such as just in time inventory management and demand pull inventory systems, which force the vendor to hold inventory. Also (and importantly) better supply chain management tools and software have contributed to the compression of this cycle.

Despite these improvements, the working capital disruptions will still flare up from time to time. Intel, for example, this quarter saw a significant build in inventory which had the effect of depressing margins and revenue. In the disk drive business, recessions in the industry are caused by over-supply which usually shows with too much inventory in the channel. Remember we say that high tech inventory is like sashimi--it declines rapidly in value with time. This only contributes to further pricing pressures in the market. In enterprise software, the time to be wary of the working capital cycle is during new product introductions--the accounts receivable balance is a sure sign of the quality of the product--dissatisfied customers don't pay.

So if you want to know the general health of the industry, watch the supply-demand cycle and the working capital cycle--especially inventory. I will comment later on the other cycles that we see in IT.


Blogger euzine said...

WOW, I think this is a really cool idea that you opened a blog for the IT class. As a religious fan of you, I'll drop by as often as possible, and try to contribute!

2:36 PM  
Blogger bayu said...

A Professor's blog, this is new for me and very interesting way to have a feedback from your class. Thank you Professor, I'm really lookin' forward for this blog.
Well, IT industry (or I can say semiconductor) does moving very fast and sometimes we didn't realize it. I think less than 2 years a go, I upgraded my notebook RAM from 128 to 256 which is at that time, it was so expensive. And with 256 in my notebook its quite enough for browsing and using some softwares. But nowadays, many software/program (or even games!) requires 512 RAM or more, which is I have to think twice before I install it =(
I was wondering, what will happen in the next 3 or 5 years..?? We never know how fast does the IT growth now on..

4:35 PM  
Blogger LeftBack said...

Ok, I'm in (not an easy task for a foreigner ~ the log-in instructions were all in Korean).

Cycle times have become so crucial to the competitive advantage of businesses that the move to collapse cycle times has spawned a new industry. Business Process Management (BPM) accelerates business processes by computerizing them and automating decision points where applicable.


7:34 PM  
Blogger ky choi said...

Thanks for your message to remind me of the past session and give me one more thought.

All the Best!!!

9:39 PM  
Blogger Do Kim ngan said...

Well, no wonder we are in an IT industry analysis and management class, it is a good chance for everybody to acess to new way of exploiting high technology.

By the way, I think that the business cycle for a semicondutor product is quite short (about 6 months to 1 year). When IT companies produce these products, they produce in a large quantity. However, with the disruptive technology, the new products will take over the place of the old one. For example, today, so many people use 512RAM or even larger and almost no one use the lower type. But I have never heard of a supply surplus of IT products.
I just want to ask where are these out of date products going? Or, the firms already estimate the demand in the market? How could they do that?

10:37 PM  
Blogger Do Kim ngan said...

By the way, professor, I can blog in just because I have my own block before :))

10:40 PM  
Blogger Jinwoo IM said...

I read articles about Intel. After reading Intel articles you gave me, I can understand better what you wrote in this article.

Although I am not acquaint at reading financial statements, I keep trying to do that. I hope that my ability to comprehend those articles will be improved in the near future.

Thank you for making this precious space.

9:09 PM  

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