Brains vs. Brawn
Commoditized products have been rising in value faster than products made from intellectual capital. That will change.
(Fortune magazine) -- I have long held that brainpower trumps all economically - that intellectual capital is the most reliable way to wealth, for a person or a company. But sometimes even brilliance can't outperform the brute force of giant economic trends, and that has been a major theme of the past several years - much to my surprise.
The recent easing of commodity prices only highlights how strongly they've risen recently. With all the attention they've been getting, I had suspected we were missing a countertrend: the even stronger rise in value of brands, technology, copyrights, and other purely human products. A simple way of testing this hypothesis was available. For a column in March 2000, I calculated the price per pound of several products along a spectrum of brainpower intensiveness, and the results were even more dramatic than I had supposed. At the low end of the scale, the most commoditized product, hot-rolled steel, sold for 19 cents a pound. At the high end, the distilled essence of brainpower, Intel's most advanced chip (a Pentium III 800MHz microprocessor) sold for $42,893 a pound. I've just revisited that list to see how the comparisons have held up.
Result: They haven't held up very well. The true commodities on the list, steel and gold, have risen hugely, about 170% each. But almost none of the more intellectually endowed products are up nearly that much. The closest contender is Viagra, the price of which varies widely at online pharmacies; at $20 a pill, it's up 150% since 2000.
Other forms of intellectual capital haven't fared as well. Hermès scarves sold for $275 in 2000 and now cost $375, up just 36%, or less than 4% a year compounded, barely beating inflation. As for Intel's top-of-the-line chip, that Pentium III sold for $851, while the new Core 2 Duo Extreme Edition chip sells for $1,000 - a far more advanced processor, yet it costs only about 18% more.
A couple of brainpower exemplars have actually declined in price. A recent megahit movie in a nicely packaged two-DVD set has fallen from $35 (Saving Private Ryan in 2000) to $23 (this year's Iron Man). Most surprisingly, a Mercedes-Benz E-Class four-door sedan, combining technology and brand strength, was $78,445 eight years ago; the current model, fully loaded, is about $75,000, and its base price is just $61,900.
So let's review. The closer a product is to the dirt from which it came, the more its price has risen, while if it has been upgraded and sweated over by hundreds of Ph.D. engineers, it's lucky just to have held steady. What on earth is happening?
A few things. A large trend of the past 20 years has been not just increasing demand for advanced products, pushing prices up, but also an increasing supply of them - and the brainpower behind them - pushing prices down. Intel (INTC, Fortune 500) and AMD (AMD, Fortune 500) hire the smartest engineers from around the world, assigning them to create higher performance at lower cost, and they do it. A major reason that a Mercedes costs less than it used to is competition from brilliantly designed Lexuses. Some realms of intellectual property, like brand building, require little capital - so as opportunities in Asia blossom for a top-end brand like Hermès, competitors rush in as well.
In commodities, by contrast, global growth has increased demand a lot faster than supply. That's because ramping up supply - finding and opening new wells and mines, building giant refineries - takes loads of capital and time. But demand grows fast, as fast as emerging Info Age economies. The resulting imbalances have pushed prices to the sky.
Thus commodity bulls like Jim Rogers have been spectacularly right for the past several years and may be so for years to come. Yet ultimately, in their lumbering way, commodities will behave like commodities. As supply and demand ponderously equilibrate, prices eventually will barely cover costs, the most ambitious capital projects will prove unwise, and the zip will go out of the share prices. That's the definition of a commodity business.
A smart investor can make money by playing once-a-generation trends in commodities. But a smart businessperson can always innovate, create a new brand, build a better product. The game never stands still, but neither does it lead to an inevitable conclusion. That's why I'm still betting on brainpower.