Perspectives

1
Perspectives on Economic Growth
Roger Brinner, The Parthenon Group
2
Parthenon Economic Perspectives

• An Elusive Recovery
• Deflation?
• Temporarily Cheap Debt
• Growth Accelerants

3
War with Iraq Stalled the Recovery
Blue Chip 2003 Real GDP Outlook By Month of
Forecast
Implicit Current Estimate of Impact of Iraq
War Growth Cut by 1.25
Forecasts before War Fears
Forecasts cut as war moved to reality
Date Forecast Was Made Jan 2002 through Sept 2003
4
A Persistent Fed Boosted Housing to Offset
Business Weakness
Blue Chip 2003 Outlook By Month of Forecast
T-bill rate
Housing Starts
Date Forecast Was Made Jan 2002 through August
2003
5
Household Income Growth Has Remained
SolidFederal Tax Cuts Have Offset Other Income
Problems
6
Now, Equipment Spending is Set to Lead
History Forecast
Source US Bureau of Economic Analysis
Calendar Quarter
7
A More Upbeat Assessment of 2002 2003
Job Growth
Alternative Measures of Job Growth By Aug. 2003
Gain of 1.5 Million Jobs
Loss of 0.9 Million Jobs
NBER estimate of end of recession November 2001
8
Parthenon Economic Perspectives

• An Elusive Recovery
• Deflation?
• Temporarily Cheap Debt
• Growth Accelerants

9
Deflation Is Not Here Today, and Not Likely
TomorrowMost Aggregate Price Indexes Are Still
Rising
Wages
CPI
Deflatorfor GDP
10
For Consumers, Only Durables Prices Are
Falling, and..
Deflator for Consumer Services
Deflator forNondurables
Deflator for Consumer Durables
11
the Deflation in Consumer Durables Occurs in
the Quality-Adjusted Components of Cars,
Computers, and Software
New Autos
Furniture
Consumer Software
Computers
12
Parthenon Economic Perspectives

• An Elusive Recovery
• Deflation?
• Temporarily Cheap Debt
• Growth Accelerants

13
The Fed Will Raise Rates Significantly in a Year
Reacting, with a Lag as Always, to Job Growth
and Inflation
Employment Growth
Consumer Price Inflation
Fed Funds Rate
History Forecast
14
Pressures on Bond Market Yields Will Bring
Sharply Higher Costs of Long-Term Debt

EstimatedImpact/Change
Changes by 2004-5 Relative to 2002
Implied Level by 2004-5
10-year US Treasury in Late 2002-early 2003

4.0





Reversal of Investor Flight to Bonds
0.5 - 1.0
4.50 - 5.00
0.50 - 0.75
Fed Funds Increasing 150 - 200 Bp
5.00 - 5.75



Increase in Federal Deficit by 1 of GDP

0.5 - 0.75

5.50 - 6.50

15
Profits Will Continue to Rise as the Economy
Recovers Supporting a 12-month SP 500 target of
1200 vs 1000 today
ValueChain
Button
Pentagon
Sustainable Profit Growth is 6
400

HISTORY FORECAST

• Placeholder

350
300
250
BOOM-ERA mentality based on 14.9
EPS Trough-to-peak CAGR
Percent of Long-Term Average Value ('86-'95)
200
150
6.9 EPS peak-to-peak trend
GDP trend growth equals 5.4
100
4.5 EPS trough-to-trough trend
50
0
Mar-86
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Legend GDP SP 500 EPS
16
Parthenon Economic Perspectives

• An Elusive Recovery
• Deflation?
• Temporarily Cheap Debt
• Growth Accelerants

17
Growth AccelerantsTechnology Spending Impacts
of GDP Recovery Are Huge
18
High-Tech Capital Spending Recovering As
Predicted Last Year
Prior Forecast
Current Forecast
Prior Forecast
Current Forecast
History
Q1 01
Q1 00
Q1 99
Q1 02
Q1 03
Q1 04
Q1 05
Q4 05
19
Roger BrinnerExecutive Director And Chief
EconomistData Resources (DRI/McGraw-Hill)Prese
nted ToMicrosoft Corporation Executive Client
Summit Laguna Niguel, CaliforniaOctober 28,
1994
The Strong Links of High-Tech to the Economy Are
Long-Standing but Often Overlooked by the
Industry
Excerpts from a 1994 Discussion with Microsoft
Executives and Customers
Need-To-Know Economics For Computer And
Software Markets
20
Is Your Business Subject To The Business Cycle?

• One view
• No, sales growth is almost entirely keyed to
• Hot product introductions
• Technology breakthroughs
• Marketing and sales promotion efforts
• In other words, supply issues dominate

21
Is Your Business Subject To The Business Cycle?

• An Alternate View
• Yes, sales growth is very sensitive to
• My customers cash flows
• My prices relative to those of other solutions
  open to my customers
• The prices of hardware or software used in
  conjunction with my product
• In other words, demand issues are vital

22
Is Your Business Subject To The Business
Cycle?Computer Hardware Answer Yes
(Percent utilized)
(Percent change versus year ago)
23
Is Your Business Subject To The Business
Cycle?Software Answer Yes
Cashflow percent change versus year ago
Software Unit Sales percent change versus year
ago
24
Is Your Business Subject To The Business Cycle?

• Links to the economy can be clarified by
  statistical analysis.
• Unit sales of software respond as follows
• A 1 rise in corporate cashflow translates into a
  2 rise in sales within 12 months
• In addition to this cycle, unit sales growth has
  averaged 15 per year from 1987-93
• A 1 decline in hardware prices translates into a
  1 gain in unit software sales

25
Is Your Business Subject To The Business Cycle?
Personal Computer Software Millions of units,
seasonally adjusted
26
Another Decade of Data Confirms the Patterns1-
2 - 3 for Software Growth1 GDP Growth gt 2
Cash Flow Growth gt 3 Software Growth
Actual Software Purchases

• Software Spending Responses
• Per Percentage Point Change in Key Drivers
• 1.7 software gain
• per 1 corporate cash flow increase
• 0.3 software gain
• per 1 hardware price decline
• 2.0 software gain
• per 1 software price decline
• The responses are gradual, taking 2-3 years to
  fully mature

Purchases Explained by Model (87-03)
First Quarter
27
Information Industry Employment Trails Spending
Communication, Computer and Software Spending
(left axis)
History Forecast
Information Industry Employment (right axis)
Jobs
Info Capex
Spending and Jobs Fell to Early 1999 Levels
28
Recent History and Annual Outlook
29
Growth AccelerantsBeyond the Rising Economic
Tide
Revenue Rejuvenation Strategies
Long-Term Opportunities
Close-In Opportunities
Product Development
Sales Force Optimization
Full PotentialTM Pricing
New Markets
30
Indicators of Pricing Opportunities
How well do you understand your pricing
opportunities?
Need to know
Disagree
Agree

• Macro-Economic Factors
• Global competitors are suffering from a weak
  dollar
• Excess industry capacity was removed during the
  recession
• Demand shows signs of recovery
• Industry/Company Dynamics
• Net realization of pricing actions is below
  expectations
• Competitors have traditionally followed a
  leaders price increase
• Customers do not curtail purchases when
  confronted with an industry-wide price increase
• Price discrimination can be exercised across
  customer segments
• Your company has a cost advantage relative to
  major competitors
• Customer Behavior
• Service and quality differentiate your products
• Price is not the 1 determinant of your
  customers purchase decision
• Customer switching costs are high
• Internal Processes
• Discounting discipline has been lost
• Managers and sales lack adequate, organized
  market information

31
Pricing Is The Grossly Neglected Orphan of Profit
Management

• What is the value of the test to the test-takers?
• What is preventing me from charging the full
  value, rather than my cost or my traditional
  price?

• The Payoff
• Pricing has far greater leverage on profits
• Price discrimination is far superior
• Price leadership has to be established
• Careful statistical analysis will provide a
  compelling fact base

32
Case Study Information ProviderOverview

• Leading provider of information services needed
  to understand how it might use its position to
  maintain price leadership through changing prices
  and enhancing product features

Situation

• Performed customer research to determine relative
  performance of competing offerings vs. customer
  needs
• Determined sensitivity of customer to various
  changes in price level and structure through
  econometric modeling
• Tracked competitor pricing dynamics over time to
  determine price leadership

Parthenon Actions
33
Case Study Information ProviderInitial
Hypotheses / Analytical Framework
Revenue and Profits Can Be Increased Through
Pricing Tactics
Price Structure Can Be Modified To Boost Revenue
and Profit
Price Increases (on Certain Products or Customer
Segments) will Boost Revenue and Profit
Relative pricing between products can be used to
optimize revenue
Appropriate use of volume discounts can optimize
revenue
Product bundling and alternative pricing formats
can drive incremental volume
Add-On products / services can be charged for
Customers will accept price increases
Competitors will match price increases
Limited potential to substitute another product
Product has high value to customers
Price is not principal purchase criteria
Competitors have historically been price followers
Competitor profitability is low
34
Case Study Information ProviderCompetitive
Response

• Analyzing competitive response to price increases
  can inform views of future reactions
• Our clients main competitor had a clear history
  of following our clients price increases, and
  even dropped prices on one product to match our
  price

Historical Price Increases
Client Prices
Competitors Prices
Client Prod 1
Competitor Prod 1
Unit Prices in Dollars (disguised)
Client Prod 2
Competitor Prod 2
Competitor Prod 3
Client Prod 4
Competitor Prod 4
1997
1998
1999
2000
2001
35
Case Study Information Provider Transaction
Discipline and Exceptions

• Minimizing revenue impact of exceptions can be a
  large and fast source of revenue improvements
• Segmenting sales and discounting history can
  uncover best sales practices to help field sales
  reps adhere to new policies

Observed Customer Discounts Negotiated
Volume Discount Schedule Actual Negotiated
Discounts