By John Merrells

Overload, 9(43):, June 2001

Economical Thoughts

I've always been interested in economics. My brother, rather uncharitably, says I've always been interested in money. If it hadn't been for my inability to string together a dozen misspelled words into a sentence I probably would have taken a degree in economics or business instead of computer science. However, my interest has lingered, and been reapplied.

Economics is hard to define, beyond that which economists think about. Most succinctly it might be expressed as the allocation of scarce resources, and the distribution of their product. Engineers mostly address the allocation of scarce resources. Marketing, sales, and business development specialists deal with the distribution of the product of those resources.

Engineers make economic decisions every day. There are alternative solutions to every problem, and many factors in deciding between them. Some technical: correctness, extensibility, reliability, performance, and scalability. Some economic: build or buy, sub-contract, or re-factor existing code. Typical questions from project management are: How much risk does each solution introduce to the project? Are there complementary actions that would mitigate that risk? Should we just make it work for now, and try to get it redone later? Should we build a generic solution that can be applied to variants of this problem? What other tasks are dependent upon the successful completion of this task? Which engineers could easily complete this task, and which engineers are actually available to work on it?

An engineering team enters into a contract with the product definition team to deliver a specified product, consuming a certain amount of resource. The resources consumed by a software engineering project are mostly intangible, being the time of professionals with a certain breadth and depth of skill. Tangible resources, such as a comfortable office space, machines, and tools, are less significant. In economic theory these resources are known as capital. The engineering brains are intellectual capital, and their environment is physical capital. Both of which can be bought with financial capital.

The reason that my thoughts recently have turned to economics, rather than software engineering, is that the economic climate in Silicon Valley has changed. For the past few years the scarce resource has been intellectual capital, now it has returned to being financial capital.

The technology stock market boom of the past five years made huge amounts of financial capital available incredibly cheaply. Venture capitalists, the gatekeepers of financial capital for startup companies, were fighting over each other to invest larger and larger sums. As the cost of capital tended towards zero the large infrastructure vendors extended cheap credit with lenient terms to the startups in return for stock. For example: Lucent extended $10bn in credit to telecom dotcoms. Intel took equity stakes in 450 of its customers, which at its peak was worth $10bn. Now its books don't look quite so good. BT overextended itself to win 3G licenses and have had to oust their CEO, cancel their dividend, sell their valuable foreign holdings, and ask their shareholders to stump up five billon pounds to pay down their debt.

The collapse of the technology stock sector has snapped the cost of capital back to traditional levels. The existing venture capital funds have been crushed, and the new funds are being held on the sidelines until the debris settles.

Large companies are refocusing their businesses, taking the opportunity to clear out some of the dead wood and fat that they'd taken on in the boom.

Small companies, seeking their seed or first rounds of funding, are having some success. A couple of million dollars is still small change to the VCs, and the chance to be in at the ground floor of the next big thing is too tempting for them to miss out on.

The beginning of the downturn was generally regarded with disappointment, but also with some relief that the madness was finally over. The daily commute in and around San Francisco and San Jose has eased significantly. The proliferation of unviable businesses had soaked up valuable resources causing a scarcity of office space, and engineering and management talent. But the downturn always cuts deeper than you'd like. Some perfectly reasonable businesses are struggling through capital starvation.

Medium sized companies that were raising their capital by spinning a visionary yarn were brought up short when the game changed. Those funded in 1999 and 2000 are having a very hard time raising their 2nd or 3rd rounds. Up until December last year company officers were being pushed to spend heavily to gain first mover advantage and to grow employee headcount. They've burnt through $30m shooting for the moon and have few real customers to show for it. Asking the venture capitalists for another $20m on blind faith doesn't fly any more. The only thing that counts now is real revenue from signed, deployed, and referencable customers.

As engineers we love the invention, design, and implementation of new things, but what it takes to get those things built requires an appreciation of economics. Spare a thought for the economics of engineering. From the microeconomics of your engineering team; to the macroeconomics of who is paying for your project and why.


'Startup', Jerry Kaplan, Penguin.

'The nudist on the late shift', Po Bronson, Broadway.

'Introduction to Economics', John Craven, Blackwell.

'The New New Thing', Michael Lewis, Penguin.

'Crossing the Chasm', Geoffrey Moore, Harper Perennial.

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