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Through the Looking Glass

The editor of Inc. Technology explains why small companies use technology to look like the big guys and vice versa.
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Large companies and small companies use technology to mimic each other. Who's getting the bigger payoff?

American Express and Maurice Badler Fine Jewelry, a small New York retailer, face the same challenge when they plan a direct-mail promotion: making sure the expensive bait isn't wasted on prospects who aren't likely to nibble. But the two companies are in the same bind for opposite reasons. Badler, a small company, doesn't have a huge customer base from which to cull prime targets for its high-priced jewelry catalogs. American Express, on the other hand, has too much information. Its millions of customers represent all possible combinations of economic status, location, and buying preferences. How can it sift through all the data to find just those customers ripe for, say, a Caribbean-vacation package promotion?

The solution for both companies is technology. Badler purchases demographic databases, which are loaded onto PCs and then searched for households that can afford its offerings. The result is average revenue per order of about $1,000 -- more than five times what an average catalog order brings in -- plus a $15 profit per catalog that places Badler's catalog among the most profitable of U.S. consumer catalogs.

American Express, meanwhile, dumps its vast sea of customer information into powerful mainframes that churn through the data to pull out the names of customers who, for instance, live in cold-weather climates, have charged airplane tickets to vacation areas, and have a few thousand bucks in available credit.

Companies of all sizes have turned to information technology to become more effective. But small companies and large companies invest in technology to overcome different obstacles. Small companies want to erase the advantages big businesses have always had: large national or even international sales forces that can call on tens of thousands of customers; armies of managers that can bring vast stores of market research and expertise to bear on product development and marketing decisions; highly automated factories that produce goods at the lowest possible cost; and horizontal integration that makes it possible to offer a broad range of products and services.

And large companies? They're using technology to cut through the layers of personnel that isolate top managers from the action in the real world and bog decision making down to the point where markets change faster than plans can be implemented. And they're using technology to offer more customized personal service.

Put simply, small business and big business are fighting a looking-glass war to see which can better use technology to act like the other while continuing to retain its "natural" advantages. An organization that combines the sophistication and muscle of a giant company with the nimbleness and personality of a tiny company would be formidable indeed.

Consider two more examples:

( Fisher Marantz Renfro Stone Inc., a small New York architectural-lighting design firm, didn't have the staff to send out designers to clients to review preliminary designs -- common practice in larger firms. So the company set up an audio-conferencing and on-line document-sharing system that allows designers and customers miles apart to look at, discuss, and modify blueprints on a computer screen.

( GTE's expertise is distributed over 106,000 employees in 29 states and nine foreign countries. But a manager looking for insight into a customer can often put a finger on exactly the right information by firing up a "groupware" program that gathers up, organizes, and makes accessible all the different information that's available on the company's computer network.

Both sides claim to have won skirmishes. But who's winning the war to get more out of technology?

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Who Wins on the Flexibility Front?
Erik Brynjolfsson, an MIT Sloan School of Management professor who has been analyzing the relationship between information technology and productivity, reasons that if smaller companies have an edge in profiting from technology, then large companies would find that as they reduce their size they would get more out of technology and thrive. The result, he predicts, would be a Darwinian shrinkage in average company size.

Well, that's exactly what's happening. Brynjolfsson's research found a strong correlation between the growth in the 1980s in the U.S. manufacturing sector's information-technology investment and a decrease of 20% in the average number of employees in industrial companies. One of the reasons, says Brynjolfsson, is that smaller manufacturing companies are in a better position to use technology to turn out products in smaller, faster, more customized runs, an edge that is increasingly proving decisive. Large Fortune 1,000 companies shrink to get the same benefits from technology as their smaller competitors.

Economist Stephen Roach, at New York investment bank Morgan Stanley Co., has taken a similar look at service companies. He notes that a near $1- trillion investment in information technology by U.S. service industries in the 1980s failed to increase productivity. It wasn't until the 1990s, when large service companies began to shed employees, that productivity gains turned up. Presumably the reason is that smaller companies can better put technology to use by offering more flexible services more efficiently. The figures again suggest that the smaller the company, the larger the payoff.

It's not hard to see why. Consider the movie industry, where a small production company like Pixar Animation Studios relies on small bands of programmers armed with computer-animation tools rather than on the legions of actors, crews, and conventional animators that a large studio would have unleashed -- and ends up producing last year's runaway hit Toy Story. If computer animation becomes the standard means of producing movies, most studios are going to get smaller. Perhaps, then, downsizing isn't so much about the replacement of workers by automation as it is about companies driving toward the smaller scales at which automation works best.

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Whose Culture Embraces Technology?
That smaller companies seem to be getting more out of technology than larger companies probably reflects, at least in part, a difference in attitude between small and large companies. Small companies tend to apply technology to augment their existing capabilities -- to raise speed and quality on the factory floor, for example, or to get a better handle on who their customers are. But large companies seem obsessed with increasing the efficiency of existing performance -- to provide the same services with fewer employees, for example, or to cut out layers of managers without impairing decision making. In the end big companies may reduce their costs, but they don't turn out better products or service. We see large retailers install inventory-management systems that improve inventory turns and eliminate stocking clerks, without worrying about who's going to answer customers' questions. And we see large car-rental agencies rely on bus-based computers to allow them to shorten the time they need to keep a car on hand waiting for a customer -- as they also eliminate the employees who check customers in -- without considering the fact that customers finance those efficiencies by cooling their heels curbside in a bus.

Cultural differences between large and small companies may also account for the relative difficulty large companies have in using computers to their advantage. New technology pays off especially well when people are prepared to change their work habits around it. But behavior at larger companies is often so hierarchical and ingrained that it prevents that sort of worker flexibility. There's a story about GE chairman and CEO James Welsh, who once chewed out managers for spending too much time polishing their E-mail notes, thus wasting the speed and interactivity computer networks can promote. How did the managers respond? Well, they continued to polish their notes, but then they took the time to go back and insert typos and other mistakes to give their E-mail that dashed-off quality Welsh was after.

But where large companies are most at a disadvantage is in the nature of the technology itself. Big companies' biggest problem? They're stuck with mainframes.

It's not a question of hardware cost. Large companies have an edge there -- they pay less per wired-up employee for computer hardware, thanks to economies of scale. Big companies negotiate substantial discounts from PC vendors, and mainframes are actually cheaper per user than PCs. Similar economies apply to network hardware and to phone-line costs.

Too bad for large companies that hardware costs account for only about 15% of the total costs of running desktop computers. Software and administrative costs eat up the rest, and here the picture from a bigger company's point of view isn't pretty. Smaller businesses of almost any sort can pick up off-the-shelf, often industry-specific, software packages to handle accounting, sales, marketing, personnel, and distribution functions. Costs range from a few hundred dollars for a basic database or accounting package -- which can be more than enough for a tiny business -- to $50,000 or so for a highly sophisticated package aimed at midsize companies. Armed with basic programs, the average growing company can almost immediately start analyzing its customers, paring down inventory, producing slick marketing literature, and doing whatever else it takes to narrow the gap between it and its larger competitors.

But generic software for large companies simply doesn't exist at any price for many applications. Chrysler can't go out and pick up software for running a giant car manufacturer. And the software packages that are available for big companies, like accounting and personnel packages, often don't fill the bill anyway. That's because large companies typically have thousands of well-defined work processes that have evolved over decades and that involve tens of thousands of employees. The only alternative is to build application programs from scratch, at costs that can easily reach tens of millions of dollars. Even worse, the software needed to run a large company is so complex that it isn't uncommon for a company to abandon a program out of despair of ever debugging it -- after spending years and millions on it. BankAmerica and Pacific Gas and Electric are among the hundreds of organizations that have written off runaway software projects.

According to Jim Johnson of the Standish Group International, in Dennis, Mass., large businesses and government agencies spent about $81 billion on canceled software projects in 1995. And in 1994 Standish found that only 9% of large-company software projects are completed on time and on budget, and those that are completed have an average of 42% of the originally proposed features and functions. Small companies, on the other hand, complete 78% of their software projects, and those have at least 74% of their promised features and functions.

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Who Can Adapt to Change Faster?
Then there's the task of updating software to meet business requirements that are changing ever faster. Smaller companies usually just throw out the old package and replace it with something state of the art, usually at considerably less cost than the previous version.

But rebuilding a huge homegrown system from scratch takes too long, so large companies try to patch up the old one, at tremendous cost and usually with little success. Forrester Research, in Cambridge, Mass., found that only 14% of Fortune 1,000 information-systems executives even try to claim that their core computer applications are flexible enough for business-process change. One simple example: now that many giant companies have invested millions in setting up Lotus Notes groupware on proprietary networks, smaller companies are finding they can achieve essentially the same capabilities for a fraction of the cost with programs that work over the Internet.

Some observers claim that large companies' software woes are quickly becoming a thing of the past as even the biggest organizations move away from hard-to-program mainframes to PC-based computing. But reports of the death of the mainframe have been greatly exaggerated. A study conducted by Sentry Market Research, in Westborough, Mass., shows that though the percentage of large-company computer-processing power coming from mainframes has dropped steadily from 80% in 1992, it still comprises 50%. Only one-third of large companies have as much as a single strategic PC-based application in place, and 40% haven't even begun the process of moving mainframe applications to PC-oriented systems. Large-company programming departments are so backed up with requests to fix or build systems that they're running two years behind -- essentially the same size backlog those departments were carrying six years ago.

Not that PCs will solve large companies' software problems if and when they finally do take over from mainframes. Forrester found that the ancillary costs of running PCs -- that is, the nonhardware and software costs associated with management, support, downtime, training, coworker assistance, and recovery from crashes -- increase dramatically per PC with the number of PCs linked together in an application. For a 5,000-PC application, for example, those other costs come out to $9,000 per PC, or 75% of the $12,000 total cost of operating each PC. The study goes so far as to conclude that reliable, mission-critical PC-based applications are simply cost-prohibitive in large companies.

Forrester also found that only 5% of Fortune 1,000 executives expected the move to PC-based information systems to improve customer satisfaction. In contrast, two-thirds of Inc. Technology readers polled last year indicated that improved customer service was an expected benefit of their information-technology investments.

Large and small companies don't seem far apart in how much they spend on technology as a percentage of revenues -- 3% to 5%, according to a recent study by the GartnerGroup, in Stamford, Conn. The difference seems to be that most of a large company's investment pays for programming and administrative overhead, while the small company's computing dollar usually buys high-performance software.

Of course, there are plenty of exceptions. Some large companies have managed to develop relatively flexible systems aimed at improving customer satisfaction. Citibank, for example, has long been a leader in the financial-services industry, providing consumers with better access to services and information through such innovations as automated teller machines, PC-based home banking, and automated phone credit-card management.

That's not necessarily bad news for small companies. In fact, it holds out hope that smart small companies can continue to find ways -- even in the face of rapid growth that promises to convert them into larger companies -- to avoid outmoded legacy systems and rigid work structures.

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Who Wins on the World Wide Web?
If computers have helped smaller companies cut many large-company advantages down to size, the World Wide Web may well decimate those advantages. In television advertising, for example, a giant company can afford a lavish commercial during the Super Bowl, while a small company is more likely to have to settle for a spot between late-night Godzilla movies on a local cable station. Similar disparities apply to print advertising and, to a lesser extent, to direct-marketing efforts.

But in the world of the Web, an ingeniously applied $20,000 from a three-person business can permanently stake out a jazzy, captivating site that can compete on an equal footing with a Fortune 50 company's $3-million effort. Indeed, to judge by Web offerings so far, small companies are setting the standards for sites that keep on-line viewers clicking. Check out the site of chocolate big gun Godiva Chocolatier (http://www.godiva. com). Compare it to the $1,500 site of up-and-coming Esther Price Candies (http://www.covesoft.com/esther).

What we see happening on the Web shouldn't surprise us. The Web's nascent culture prizes the new, the fast-changing, the creative, and the original -- all qualities we'd expect from smaller rather than larger companies. But never has small business had such an opportunity to capitalize on those qualities. The effect of the Web is analogous to a local, independent hardware dealer's suddenly being able to open a giant store alongside every Sears in the world.

In the looking-glass war smaller businesses clearly have the advantage. But will that advantage last? It's hard to say. Right now there are no hot technologies in sight that favor big, slow-moving companies, as mainframe computing once did. Perhaps one of the biggest competitive threats facing small companies is large companies that downsize so aggressively -- spurred on by the advantages of smaller-scale technology -- that they literally become small companies, the way dying giant stars shrink to long-lived nuggets of glowing gas. It remains to be seen if those "white dwarf" companies retain too much of their big-company baggage to use technology as effectively as smaller companies do. For now, at least, small companies need only press their advantage.

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David H. Freedman (david_freedman @incmag.com) is editor of Inc. Technology and Inc. Online. Research assistance for this article was provided by Sarah Schafer.


WHO'S WINNING THE LOOKING-GLASS WAR?

Benefit of technology Who wins? Why? What can big companies do?
Customized products Small companies Require smaller runs Reorganize around smaller units
Better service Small companies Cultural constraints Force cultural change and shift focus from replacement to service
Ability to react to change Small companies Complexity of giant systems Move to PC-based systems
Productivity Small companies Have much less development Shrink overhead than large companies
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Last updated: May 15, 1996

DAVID H. FREEDMAN

A Boston-based contributing editor, Freedman is the co-author of A Perfect Mess, which examines the useful role of disorder in daily life, business, and science.




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