Marx on Enterprise Software

Maybe this is just a guess, but most Silicon Valley entrepreneurs are probably not particularly well-versed in their Marx. Marx may not seem relevant. But Marx wasn’t a socialist first and foremost (well, okay maybe he was — but he was a student of capitalism). And Marx has one theory that stuck with me: the horrifically phrased “tendency for the rate of profit to fall,” or the much better “declining rate of profit.”

In short, profits are vulnerable to competition: Competitors invest in efficiency, increasing their own profits, but in so doing cut into the total amount of profit available in a given sphere. Then their competitors respond, and the total amount of profit available declines inexorably.

Investments in enterprise software by businesses seem to fit this description. Software is a fixed capital investment that improves capital efficiency of existing corporations. Since I work in loyalty software that supports retail enterprises, this is something I think about a lot. Small changes in, say, shopper conversion at a retailer can drive huge improvements to the bottom line. Costs at a retailer are mostly fixed, and so incremental margin often goes straight to the bottom line. I’ve run the numbers many times for our clients: With fairly typical cost structures, 3-5% increase in marginal revenue can drive a 20-50% increase in total profits.

The issue is that this math only works for a single retailer rather than retail as a whole. Really good software can’t expand the total amount of retail spending in the United States, just steal market share. And if your competitors invest more than you, you’re pretty hosed. This has a name, by the way: a Red Queen’s Race. Marx would project that enterprise software would eat up a greater and greater share of retailer profit as part of the general race to improve competitive advantage through capital investment.

I was reminded of this by reading famous business school professor Clayton Christensen’s interview in Wired. He’s clearly stumbled upon the same insight, which is that within an industry the natural tendency (absent clear barriers to entry) is for the rate of profit to fall. He approaches it from a different perspective — “disruptive innovation,” the term we all love in technology, wherein a fundamentally new approach solves the same problem. For example, Redbox killing Blockbuster was disruptive: It devised a fundamentally new way to get DVDs into customer’s hands, rather than compete with Blockbuster over the established rental industry.

I would refer to this as a large and permanent gain in capital efficiency, a fancy term for “doing more with less.” Mature industries can’t compete with disruptors — they start with too high of an existing capital burden. Enterprise software helps businesses compete with others that share the same basic business model. But against a competitor starting with vastly better capital efficiency — think Amazon versus a mom-and-pop — there's nothing much to be done. The existing capital burdens on the legacy business model are too high.

Another way to view this is how Marc Andreesen famously phrased it: “Software is eating the world.” Intelligence in the form of code can render a lot of capital useless. Marx, Christensen, and Andreesen just have different takes on the same phenomenon.

What’s the point? Well, there’s nothing really prescriptive to be learned. Analytics technology can be very effective at what it does, which is improving your fixed capital efficiency through better shopper conversion, better inventory management, better supply chain optimization, and so on. It can improve your business a lot, and it’s not your problem if in so doing you’re cutting into the profitability of the industry as a whole. That’s kind of the defining characteristic of a Red Queen’s Race: You have to either participate or find a way to play a new game. Just a reminder that there's nothing new under the sun.

Except maybe there is. The defining characteristic of the Marxist/Christensenian model is a focus on capital investment and capital efficiency. Code has some maintenance costs (so do servers), but it doesn't depreciate the way fixed asset capital does. Perhaps the disruption of capital by software really only happens once. And then we really would be seeing something new under the sun.