How Technology is Changing the Way We Do Business
The Empire Club of Canada Addresses (Toronto, Canada), 1 Oct 2003, p. 42-54

McNealy, Scott, Speaker
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Elections. Hockey. Controversy. Innovation. The commoditization of technology. Corporate governance. The Financial Accounting Standards Board. SEC. Cash accounting. Personal investor responsibility. Regulation. Law enforcement. Keeping the market economy dynamic. Using information technology. Privacy. The computer industry.
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1 Oct 2003
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Scott McNealy
President and CEO, Sun Microsystems Inc.
Chairman: John C. Koopman
President, The Empire Club of Canada

Head Table Guests

Diane Francis, Editor-at-Large, National Post and Director, The Empire Club of Canada; Hanchu Chen, Grade 11 Student, North Toronto Collegiate Institute; Rabbi Perry Cohen, Facilitator, Teacher and Author; Manuel Pietra, President and CEO, The Descartes Systems Group Inc.; Robert L. Brooks, Senior Executive Vice-President, Treasury and Operations, Scotiabank and Past President, The Empire Club of Canada; Eugene V. Polistuk, Chairman and CEO, Celestica; Sharon Rudy, Vice-President, Spencer Stuart and Director, The Empire Club of Canada; Stephen Boisvert, President, Sun Microsystems Canada; Colleen Moorehead, CEO, E*TRADE Canada; and Steve Mahon, National Sales Manager, GE Access Canada.

Introduction by John Koopman

Reverend Sir, distinguished head table guests, past presidents, members and guests of the Empire Club of Canada, welcome to our luncheon.

In 1530 a Polish astronomer named Copernicus wrote a treatise entitled "On the Revolutions of the Celestial Orbs," which suggested that the earth might revolve around the sun. Copernicus was excommunicated for his heresy and he died a sad man. But he never doubted the veracity of his work.

In that terrible month of May 1940, when the bulk of the British Army was trapped on the beaches of Dunkirk, when it appeared that American Ambassador Joseph Kennedy might be successful in his bid to keep the United States out of the war, when England truly stood alone, when there was great pressure even within England for a negotiated settlement with Nazi Germany, Churchill never wavered in his belief in the ultimate triumph of the Britannic cause.

As Copernicus was to science and Churchill was to statecraft, Mr. McNealy is to the hi-tech world, because he is also quite sure of something. For the last 20 years there has been no one in the mercurial, volatile, capricious, and fickle hi-tech world who has had as consistent a message as Mr. McNealy.

For two decades he has been saying simply: "The network is the computer." Your laptop device is just a keyboard that accesses a network. Your programs and data are stored centrally. You can go to a phone anywhere in the world and make a phone call. In Mr. McNealy's world you will be able to go to a keyboard anywhere in the world and have access to your data and do your work.

Copernicus and Churchill had it easy. Predicting the development of the hi-tech world, where there are so many unknowns, Is an extremely perilous exercise.

In 1943 Tom Watson, the Chairman of IBM, said: "I think In the world there may be a market for five computers."

Steve Jobs and Wozniak went to Hewlett Packard with their first primitive computer. HP said: "Hey, we don't need you; you haven't finished college yet." Xerox did not understand the value of the GUI interface and essentially gave it away to Steve Jobs at Apple.

IBM single-handedly created Microsoft when it failed to grasp the value of the operating system.

Apple could have been the leading PC manufacturer today if John Scully had not made the nearly fatal mistake of failing to open up the Apple operating system.

Bill Gates and Microsoft missed the significance of the Internet. Mr. McNealy is recognized as one of the four horsemen of the Internet, not Bill Gates.

Tom Watson, John Scully and Bill Gates have all revised their opinions. Copernicus and Churchill never wavered, nor has Mr. McNealy.

In Mr. McNealy's world Microsoft's vision of the desktop PC as the centre of the computing paradigm has no place. Bill Gates and Microsoft are accordingly not fond of Mr. McNealy's vision. In Sun's battle with Redmond, its fortunes have been up and they have been down. Just a few months ago the magazine Wired ran an aggressive storey entitled "McNealy's Last Stand." But there are an ebb and a flow to every good battle, and smart money does not bet against Mr. Scott McNealy.

As for Mr. McNealy's provocative opinion about the future of the industry, Churchill once said: "You have enemies? Good. That means you have stood up for something, sometime in your life."

Mr. McNealy obtained an MBA from Stanford. In 1982 Mr. McNealy co-founded Sun, which is an acronym for Stanford University Networks. This makes Mr. McNealy that rarest of ducks--an MBA who has actually created something. "Sixty Minutes" has called him one of the most influential businessmen in America.

Ladies and gentlemen, please join me in welcoming Mr. Scott McNealy, the Chairman and Chief Executive Officer of Sun Microsystems, to the podium of the Empire Club of Canada.

Scott McNealy

Thank you John. Rabbi Cohen, all the distinguished guests, it is great to be here. It's always fun to get hold of a microphone on national TV and actually have my stuff show up on a Web site forever, so I'm pretty excited about this. It makes me nervous, not about speaking but what I might say.

There is a lot to talk about and I tried to jot down a few topics. I have lots of enemies because I have a lot of attitudes and perspectives. I thought I would talk about a list of subjects. I'll race through them and maybe if we have time for a question-and-answer session, I'd love to do that. If not, you can always send me e-mail. Everybody else does.

There are elections, hockey, corporate governance, the economy, monetary policy, computer battles and privacy. Those are all interesting topics that I thought I could touch on.

First of all with respect to elections I guess you are having one tomorrow. We've got some candidates from California we would be happy to donate if you're short.

With respect to hockey, we are a little bummed out. You took Owen Nolan from us. Go Sharks. They're coming back this year.

I think John actually fairly represented my perspective and that is I don't want to walk across the beach and not make footprints. That's just not fun. It's kind of boring. I don't enjoy controversy. I just think controversy is necessary in a market economy. I think you need to have winners and losers. You need to have people taking different perspectives. I don't believe you can make money, which is a wonderful by-product of a market economy of a capitalist society, without having a controversial strategy because if your strategy is not controversial everybody will do it. If everybody agrees it is the right thing to do, everybody will do it and then you will have no differentiation. It is kind of like going to a job interview and being asked why you should be hired and you say that you can breathe. That's just not going to get you the job. You have to have a differentiated strategy that will give you some pricing power out there.

I named my first kid Maverick to give you an idea of where I come from. In case you're wondering, Dakota, Colt and Scout were the other ones. They're all cars from Detroit and kind of western weird.

Our view is that you have got to have a controversial strategy. The real hard part of the controversial strategy is being correct. It is easy being controversial. If you don't get that part right then you have a big problem. Our strategy has always been controversial. It's probably as controversial now as it has ever been, but we think basic fundamentals around open interfaces like sharing are critical and that's what we are doing. We think that we will continue to win the network computing model, everything connected to the network in the utility model, as John happily described. You don't put a nuclear power plant in everybody's home. That's not a good idea. And you don't put a super-user personal mainframe in every user's control unless you want viruses in administration and all those other things.

The other piece that we believe in is innovation. I love it when people use the word commodity about the technology industry because that's conventional wisdom. They talk about the commoditization of technology. I love it when people say that. It makes me feel good that we're investing 15 per cent of sales in R&D and inventing new next-generation network computing technologies. People will say: "Don't even bother, don't try, we're commoditizing all this stuff."

Coca Cola is a commodity. They introduced new Coke a while back. Remember that one. It didn't work so they went back and re-introduced Coca Cola Classic. Can you imagine: "I don't like my new UltraSpark 3 computer. I think I'll go back and re-introduce UltraSpark 2." It doesn't work like that. Can you imagine a 10-year-old computer? Would you go out and buy a 10-year-old computer? Think about how quickly we are evolving and innovating.

Let me talk about a couple of issues that are really grinding on me and will probably get me into a lot of trouble. Corporate governance is one. There are a lot of fashion statements going on and right now CEOs are not in fashion. They were a few years back but they didn't deserve the celebrity status they got then and they certainly don't deserve the corporate governance nightmares that we have going on right now.

There are two key issues. Sarbanes-0xley is one of the most damaging buckets of sand in the gears of the market economy that we've ever voted 98 to nothing on in Washington. This basically is your full body strip search of every company, whether or not there is any suspicion of wrongdoing. The amount of "turtling" as I call it--just going into a shell and getting conservative; not taking the risks and doing what the dynamic market economy needs that's going on in corporate America and wherever else we touch is unbelievable. It is a disaster. You'll never be able to identify the cost of that particular piece of legislation and I challenge anybody to tell me that the Securities Exchange Commission (SEC) filings and the annual report and income statement are any more clear, trustworthy, transparent or useful now than they were a year and a half ago before we all started spending five to 10 million dollars minimum each, as public companies, to complete these documents. It is a disaster and I can't believe shareholders haven't gone nuts. This is an accounting full employment act backed by the lawyers and supported by the judges.

I don't know why anybody would join a board of directors any more. If you have made money, if you are smart or both, you would not join a board and you certainly wouldn't join an audit committee. I think the level of corporate governance is going to plummet as all the smart accomplished and wealthy folks don't go on boards. I don't think that is a good thing. I don't think that will improve corporate governance.

The next statement on corporate governance that I would like to make is that the Financial Accounting Standards Board (FASB), SEC and accountants have gone absolutely whacko on us. I'm a Stanford MBA and I went to most of my classes, including the accounting courses. I can't read annual reports, income statements and SEC filings any more. They are absolutely undecipherable. General Electric (GE) is doing one of the most wonderful jobs of trying to put its reports in English but try reading the GE reports. And they're doing better than anybody I can think of out there. Just try and understand them.

What we need to do is to move way from the FASB world and move back to cash accounting. Everybody in this room can read a cheque book. Everybody can read what cheques were written and what cheques were received, what the bank accounts are for a company and what their future cash obligations will be (both in and out) over the next 40 years. If we lay that all out with strict cash accounting and let the analysts do the analyzing and the investors do the guessing and stop putting the CEOs and the accountants in charge of making judgments we'd all be a lot better off.

I spend all day trying to close the books and making judgments on whether we should've written up or down our tax credit asset on our books. I then have to decide how much to depreciate versus expense and then I have to decide how much to put on the books as an asset versus reserve. I have to decide how long to depreciate and what the book values of different things are. That is the amount of judgment that the CEO is forced to make on the books and then we get threatened with handcuffs when we make a wrong judgment. It creates an immense amount of "turtling" in our corporate and industrial boardrooms around the world. I think that's bad for the economy.

Cash accounting. Let the investors and analysts do the work. Don't make the CEO guess. I don't hear people talking about that, but again it doesn't take a lot of audit expertise to audit how much you have in the chequing account and to verify that contracts are accurately reflected in the reports in terms of cash commitments out and in for a company.

Instead of making reserves on receivables and saying I want to put on a reserve of 3 per cent, I'd much rather publish how many receivables I have that are 30 days or less, 45 days, 60 days. I'd like to publish the names of every company that owes me money over 90 days. That would be way more information for the investor about who's not paying and what my chances are of collecting, than some random 2 per cent reserve that I put on my receivables and I take all judgment away from me and put that judgment in the hands of the investor who has to take personal responsibility.

Speaking of personal investor responsibility, how many people who invested in Enron actually read all of their

annual reports and SEC filings? How many do you think? Of those who did read them how many understood them? Of all of those folks, how many do you feel sorry for?

The other thing is we don't need any more regulation. We just need law enforcement. The laws are all there. If you do fraud you go to jail. The real mistake here was not that crooks will be crooks because crooks will always be crooks. It is that the law enforcement didn't step in before the politicians overregulated and that's a real tragedy.

Now the reason why I think we need to keep the market economy dynamic is because of what's going on with our economy-and technology is to blame. Technology has absolutely changed productivity. I had a conversation with Alan Greenspan a long time ago. Have you noticed the amazing GDP growth we've had in all of these economies with no inflation and rising unemployment? Information technology through distance learning and the pricing power that the Internet puts in the hands of the user is unbelievable. The shrinking of the supply chain, the auditing and the instantaneous response means we don't forecast any more. We respond to what has happened in the last six hours. That is how businesses are run today because of the speed and the power of the networks. We are now able to use information technology--digitizing, automating, and remote controlling.

One great example was the 35 or 45 thousand piano players who were in front of the silent movie theatres playing piano. One day they figured out how to put sound on the film and all we needed was one piano player.

That kind of transformation should and will eventually, if the government doesn't get in the way, happen everywhere in massive and wonderful ways. And it is a good thing. This unemployment thing is a good thing, because these people have brains and we can apply them to all of the things that do need to be done as opposed to make-work jobs.

In Sacramento they have somebody sitting on a chair pushing the Otis elevator buttons. That's for full employment and it is a huge waste of a brain--an absolute huge waste of a brain. We need to move people out of these jobs that can be automated and remote-controlled and move them into actual value-add jobs.

I tried to explain to Greenspan that the issue was not fighting inflation but rather making sure we have the dynamics of this new economy in place. If you notice what's happened to monetary policy right now, he is pulling all these levers and nothing works. It doesn't help because the other problem is we have kind of lost national monetary policy sovereignty. The world economy and the global markets have all fused into one. In the old days you used to have kind of physical country border moats around your monetary policy. Nowadays the water just runs wherever and you try and splash it out of your area and it just kind of rushes in from all 12 corners of your borders.

The job just doesn't matter like it used to. It will be less of an issue. Japan's interest rates have run at zero or 1 per cent forever and it hasn't changed anything over there. It now has to do more with regulation and social economic policy than fiscal or monetary policy. I think the politicians need to start taking a different look at what makes economies work. The old dials and knobs don't work like they used to.

Another topic is privacy and this is one that with technology always gets everybody all bent out of shape. I have some fairly strong opinions on privacy and how our technology is impacting it. The biggest issue everybody states is that they are worried about their privacy. I would imagine Canada is somewhere between Europe and the U.S. The U.S. doesn't worry about it as much and doesn't regulate it as much. Europe is paranoid and absolutely scared to death of its government. It is more scared to death of its government than it is of the bad guys it seems. People say: "Isn't it scary to have my information electronic or digitized?"

I have made this statement many times and it keeps getting reported so I am going to live with this one until I die. You have no privacy. Get over it. You have never had privacy. Privacy is a thing about anonymity versus appropriate availability of your personal information. I have a belief that anonymity breeds irresponsibility. Absolute anonymity breeds irresponsibility almost for sure.

I challenged an audience a while back. Imagine you could spend the next three weeks invisible. You might, unless you're a very disciplined person, live your life a little differently for those three weeks. Stop thinking about it. But when you get that anonymity you are not necessarily going to live the same as if there were repercussions or consequences to your actions.

I think the physical world has just as much if not more opportunities to be anonymous and it is actually harder to protect yourself against anonymous invisible activities than it is in the virtual world. In the virtual world you can encrypt everything. Compare mail and e-mail. My mailbox is 3,000 miles away on a publicly available street in a tin box with a tin door. I take 8.5 in. by 11 in. sheets of paper in English, unencrypted, fold them up and put them in a paper-thin envelope, seal it with spit and give it to the U.S. government. It has a ship-to and a ship-from address right on the front and it goes anywhere. It is sitting there and there's no surveillance, no monitoring, no encryption, no audit trail. Look at the challenge they had trying to track down the person who put Anthrax in the envelope. They haven't tracked that person down yet. It is a fairly anonymous way of doing it.

You can't get at my I box unless you have my job card, know my password, know where to go, how to get through firewalls and how to get around the sniffers and snoopers and all the rest of it in the audit trail. It is very difficult to do. If you are smart enough to be able to do that you can probably make more money doing something useful than reading my e-mails. There are enough deterrents in that. By the way if it is encrypted, if you can crack the code, the National Security Agency will pay you way more than you can believe.

The opportunity to go on-line creates nice audit trails. You have no privacy. Somebody has your medical records; somebody has your financial records. All of those places exist. All of those documents exist probably in a file cabinet unencrypted, unlocked, and have you ever noticed the security in a hospital? Put on a doctor's gown and a mask and you can go anywhere. Do you think your medical records are safe? Unfortunately your medical records if they are not on-line are not available to you when you need them in an emergency.

Your cell phone has an answering machine. Remember the old days when you had an answering machine. You would always keep it at home because you wanted those private. Do you really think people want to listen to your answering machine messages? Think about it. Now that you have a cell phone a corporation handles your messages. It is appropriate handling though. I think it was absolutely appropriate that the day after 9/11 there were 12 FBI agents in the Sabre airline reservation system seeing where everyone of us travelled on the airplane. That was not an invasion of privacy. If we didn't have those audit trails and those electronic records we couldn't have tracked folks down. So I think privacy is a big issue.

I will spend two minutes on the computer industry and then turn it over to John. The world is changing. Every data centre on the planet is unique. Walk into your data centre and then try and find one anywhere else on the planet that's like yours. They are unique custom jalopies. There are 10 times too many employees in our industry charging 10 times too much revenue for the current computing power.

Imagine if everybody who flew on an airplane built their own custom airplane out of spare parts and multi-vendor components and assembled them in a hangar at home in their spare time and said: "Hey, do you want to fly to Chicago with me?" That's what we've done. Can you imagine no two airplanes being alike? That is what we've done in the data centres. The world is going to move away from making its own custom airplanes. Right now they are asking IBM to come in and pay them a bunch of cash. They say: "IBM, buy my hangar, buy my custom jalopy airplanes and buy all my mechanics and FAA crash analysts." IBM makes its money back in years three to 10 of their contract by buying complete airplanes. We are driving the industry to eventually just renting a seat on the airplane. You do that every time you get in your browser, get out of your company firewall, go out onto the Internet and use gift-wrapped software available on a Web site from eBay or Amazon or or E*TRADE or whatever.

That's the way the world's going to work. You are going to stop buying software. You are going to use it. You are going to stop buying computers. You're going to use them in the same way you don't buy telephone switches and nuclear power plants and you don't operate the Hoover Dam. My boys are going to grow up someday and say: "Daddy, did you really own a computer?" Did you have a well in the back yard? How old are you Daddy?" So stay tuned.

Sun is actually very well-positioned for that new world. Much better positioned than General and Motors which is what I call Intel and Microsoft and very different from IBM which is a company of mechanics. So there you have it--a quick synopsis of the computer industry.

John said I have a lot of enemies but I have a lot of friends too. Thank you all.

The appreciation of the meeting was expressed by Sharon Rudy, Vice-President, Spencer Stuart and Director, The Empire Club of Canada.

Scott McNealy, President and CEO, Sun Microsystems Inc. and John C. Koopman, Vice-President, Spencer Stuart and President, The Empire Club of Canada.

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How Technology is Changing the Way We Do Business

Elections. Hockey. Controversy. Innovation. The commoditization of technology. Corporate governance. The Financial Accounting Standards Board. SEC. Cash accounting. Personal investor responsibility. Regulation. Law enforcement. Keeping the market economy dynamic. Using information technology. Privacy. The computer industry.