Sunday, July 7, 2024

High-Risk and Low-Risk Approaches to Technology Capex Both Can be Dangerous

It is by no means unusual that financial analysts worry about artificial intelligence capital investments on the financial performance of firms making those investments. Such concerns continue to be raised even for successful firms including Amazon and Meta--and other firms--that are spending heavily on AI capabilities without a clear and demonstrable early financial return. 


But there always are tensions between "high-risk; high-reward" gambits and "low-risk; low-reward" behaviors that can lead to "low risk; disastrous reward" outcomes. That might be particularly true in any technology-driven industry or business where technology-led disruption is possible.


In large part, that is an understandable between people who get paid to monitor quarterly financial performance and those who can--or must--take a longer view, including industry leaders, researchers, scientists or public policy advocates, 


Leaders who advocate for significant investments often view it as a "once-in-a-generation opportunity" to gain a competitive edge or maintain market dominance. On the other hand, investors and financial analysts typically are wary of overinvestment without clear short-term returns.


Even within each firm, one normally expects more caution from financial executives; more enthusiasm (or at least support for higher investment) from line of business or strategy executives. 


So there are recurring tensions around overinvestment, investment “bubbles” or failed implementations of new technology. In fact, in many cases, there has been at least temporary “overinvestment” in new technologies, which might be hard to distinguish from the typical “many flowers blooming” early startups to eventual consolidation we see in any new market. 


Technology

Era

Period of Overinvestment

Outcomes

Railways

1840s

Railway Mania (1845-1847)

Market crash, numerous bankruptcies

Electricity

1880s-1890s

War of Currents

Consolidation of electric companies

Automobiles

1910s-1920s

Auto industry boom

Market saturation, Great Depression

Radio

1920s

Radio boom

Consolidation, formation of major networks

Personal Computers

1980s

PC boom

Market saturation, industry shakeout

Internet

1990s

Dot-com bubble (1995-2000)

NASDAQ crash, numerous dot-com failures

Renewable Energy

2000s-2010s

Clean tech boom

Bankruptcies (Solyndra), market consolidation

Cryptocurrencies

2010s-2020s

Crypto boom

Market volatility, regulatory scrutiny

AI

2020s-present

Ongoing AI boom

Likely to see similar patterns


Enterprise leaders always must be alert for new technology potential to revolutionize industries, create new products or services, and allow some adopters to possibly gain a new competitive edge. They fear falling behind if they don't invest early.


Tech enthusiasts and early adopters frequently are among those who are likewise optimistic about investments in new technology, as are venture capitalists, who see the potential for high returns on investment as the technology gains traction.


But overinvestment, wasted investment and excesses also are part of the history of new technology innovation. 


Venture capitalists also routinely expect they might lose money, or possibly break even or make a slight profit, on seven out of 10 such investments. 


Technology

Era

Proponents' View

Skeptics' View

Internet

1990s

Revolutionary communication and commerce platform

Overhyped "dot-com bubble"

Cloud Computing

2000s-2010s

Transformative for business operations and scalability

Security concerns and loss of control

Mobile

2000s-2010s

New paradigm for consumer engagement

Limited functionality compared to desktops

Social Media

2000s-2010s

Unprecedented user engagement and data collection

Unproven monetization strategies

Blockchain

2010s-2020s

Disruptive for finance and data management

Speculative technology with limited practical applications

5G

2010s-2020s

Enabling technology for IoT and smart cities

High infrastructure costs with uncertain ROI


Nor are those examples limited to today’s information and communication technologies. Indeed, overinvestment has been characteristic of many infrastructure-dependent technologies in the past. 



technology

Era

Period of Overinvestment

Outcome

Canals

Early 1800s

Canal Mania (1790s-1830s)

Many canals became unprofitable due to competition from railroads; financial losses and bankruptcies

Telegraph

Mid-1800s

Rapid expansion (1840s-1860s)

Market consolidation, with many companies failing or merging; eventual displacement by the telephone

Railroads

Mid-1800s

Railway Mania (1840s-1850s)

Market crash, numerous bankruptcies; led to more regulated and sustainable growth

Telephone

Late 1800s

Telephone boom (1880s-1890s)

Overbuilding and financial strain; eventual consolidation into major companies like AT&T

Internet Apps

Late 1990s

Dot-com bubble (1995-2000)

“Internet bubble” and dot-com crash


The point is that financial analysts have reason to be skeptical of excessive investments while investors and business leaders must make bets in hopes of profiting from the innovations. Perhaps only VCs routinely expect to fail often, as part of the process. But technologists also know that up to 70 percent of technology projects fail. 


And virtually all investors and startups believe they will succeed, despite the obvious historical evidence that many to most new firms will eventually fail, or be consolidated into larger entities. So even if some see AI investment as a “bubble waiting to burst,” others see a necessity to invest heavily. 


Will there be overinvestment and failed implementations? Almost certainly. We might reasonably expect failure rates up to 70 percent for AI projects, as that would be expected for information technology projects overall. 


But is there danger in no investment or too-slow investment? Also almost certainly, in at least some cases. Even if 70 percent of implementations do not create value, we are left with the near-certainty that up to 30 percent will do so, and that at least a few of those implementations could deliver extensive or disruptive value. 


We might also note that within each large enterprise, there likewise are roles that tend to incorporate more risk, and those that seek to minimize risk. 


Innovation specialists; business development roles; product managers and venture investment officials might routinely have to advocate for high-risk and high-reward investments. 


Other roles lean towards risk aversion, including compliance officers; financial roles; line of business managers and legal staff. 


We might tend to agree that, in any technology-driven business, the biggest risk is not taking any risk. When technology enables rapid change, perhaps the only strategy that is guaranteed to fail is “not taking risks." 


Financial analysts are virtually required to raise issues about large capex or high debt to support new initiatives. Business leaders in technology-driven industries also are virtually required to make big and risky decisions rather routinely. 


Financial analysts are required to assess quarterly financial performance. But business leaders of technology-driven  businesses also must make big decisions of a longer-term nature that are, of necessity, risky. 


It’s a tough balancing act.


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