Productivity cycle, Software and The “(small)big data” Arms Race

How the economic machine works- http://bit.ly/1bkw3i1

Above is a link to one of the best sources that explains how the economic machine works by Ray Dalio. If you don’t know him I would advise anyone who care about their money to follow his work. He’s the founder and Chief Investment Officer of the largest hedge fund in the world, Bridgewater Associates.

I was watching this recently and I started to think about how the current long-term productivity cycle is shaping how both individuals and companies think about innovation and value creation.

Before I jump in I want to make a confession. I left the hedge fund world a few months back to focus on “tech” startups knowing that with the current productivity cycle the risk-return scenario was pretty great. Although I liked the flat structure and “entrepreneurial” environment at a hedge fund, I got some advice from a close friend which I took to heart; “You can only take significant risk when you’re young. When you have kids and settle down it becomes difficult to move around and be all-in. I would do this if I was your age.” (he has 3 kids, I think) This combined with knowing that the needle won’t move anytime soon in the investment business I made the decision to make a leap into the startup world.

Ok, so now getting back to the topic. Ask anyone, including Ray Dalio and you’ll realize that we’re in a long-term productivity cycle right now or how the media puts it,“the lost decade.” This was brought about by the long-term debt cycle, which recently burst and the result was famously known as the “great recession.” Now to get out of this is a process, which is long and tedious (who can we blame but ourselves), but it goes from productivity growth (currently in it) followed by income growth and credit growth (this is how the economy works, just ask Ray).

The word “startups” get thrown around a lot. But ultimately technology is what drives innovation and productivity, period (ask any economist). Specifically, I believe that the startups challenging the status-quo with the power of software (2.0) will drive the productivity cycle. And yes, I know Marc Andreessen famously said, “software is eating the world” but I wanted to take a mix of an economics and technological approach.

I believe software 2.0 will impact the world going forward in three ways.

One is the proliferation of e-commerce and cloud computing. Yes Amazon and Google is part of it, but I’m talking about companies focusing on specific verticals that are changing the way things are done. Vertical focused e-retailer’s are flipping the idea of the store front (Bonobos, BaubleBar, Warby Parker etc.), which reduces the cost of inventory. If you look at any of the (-)aaS companies, most of them specialize in a specific vertical. They all provide new ways of doing the traditional things like shopping, marketing, document creation, storage etc. at a much better price, which creates a lot of value for corporations and individuals alike.

Second, I think software is enabling the next hardware revolution. Yes, 3D printing is cool also, but I am talking about the internet-of-things. Devices that have powerful software integrated into them which enables them to be connected to the internet, both to monitor and collect data.

Third is the most meaningful and what all three boils down to, which is “big data.” Yes I said it. It’s thrown all around the tech blogs and media like it’s the next big thing and I usually don’t take anything in the media seriously, but I do believe “big (small)data” is the next big thing.

Let’s take a step back for a minute and think about why this is true. The use of data to make better decisions started on wall street at least a couple of decades back with the proliferation of “quants.” (D.E Shaw, Jim Simmons, George Soros etc.) The reason why “data” was so effective on wall street was because ultimately if you take out all the noise it’s all a numbers game. And I don’t mean shuffling around numbers, but I mean literally every transaction came down to a number and quants took these numbers and crunched them to make better decisions. Over the past few decades wall street has been in an “arms race” to improve efficiency through technology and data, which ultimately came to a breaking point when a handful of High Frequency Trading firms went under recently. But ask anyone on the street and no one can deny the benefit of this arms race.

Now this is starting to spread to other parts of the economy and the upcoming “data revolution” will be powered by the numbers created through the use of software. This time the data will create efficiency which results in companies and individuals making better decisions rather than front-running your competitors (aren’t we all front-running someone). There will be two types of data collected. One is transaction related data on the buying and selling activities of individuals and corporations (at the end of the day aren’t we all just buying and selling something). The second is personal data, which is the numbers created from connected devices that could monitor your health, your car, your home, your kids…your pets?……even your employees? The collection and crunching of these numbers can lead to better decision making because if you can market a product to someone who has a high likelihood of buying that product, then as a company you’re saving money and as an individual you’re saving time (also money). On a personal level individuals can make better health decisions for themselves, their kids and attend to a problem in their house or car before it causes significant damage.

My belief is that the productivity cycle will be driven by both startups and startup mentality. Why? The reason why the current cycle takes so long is because we leveraged up the old ways of doing things as much as we could and basically milked the cow until it can produce no more milk. Now the question becomes, where does the new growth come from? I think the current cycle will be driven by startups that out innovate their larger peers and figure out new ways of doing things. And I think this will largely be done by software enabled innovations outputting enough data to make any meaningful improvements in the way things are done. We see signs of this with the proliferation of startups and large companies either forming venture funds for investments or their own startup labs/innovation centers (Amex, Samsung, Intel, Walmart, Target, JP Morgan, Novartis etc.). As much assets the F500 possesses, I don’t see these companies surviving this cycle w/o first incorporating innovation and value creation through software and preparing themselves to take advantage of the coming “data revolution.”

Now in all fairness to Marc Andreessen, I do agree that software is taking over a large part of the world, but there are bigger economical forces at work here. I believe our current productivity cycle will be driven by the benefit achieved from software which will lead us into a “data revolution” and hopefully into income growth, then credit growth and ultimately GDP growth.

In a follow up post I will write about how structural unemployment can hinder the productivity growth w/o immigration and education reform.