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Wrap your brain around Nathan Myhrvold's theory of the exponential economy.

Baffled by the theory of relativity? Even stumped by Murphy's Law? Then hang on tight, because you need to understand Nathan Myhrvold's theory of the exponential economy. Formerly chief technology officer at Microsoft, Myhrvold, 42, is now CEO of Intellectual Ventures, a private entrepreneurial partnership in Bellevue, Washington.

Could you explain the exponential economy--slowly?

Nathan Myhrvold:Today, important technology-based commodities are going through enormous improvements in their price-performance ratio. [In English: As these things dramatically improve, you're paying less.] And I mean at a factor of a million or a billion, which is really unprecedented.

For instance, the first trains ran at about 10 miles per hour. Soon, they got up to 20 miles per hour. Today, trains go about 50 miles an hour, and a few go 250. Well, [25 times faster] is not a big factor change in all of train history. Looking forward, the economy of the 21st century is going to be all about these giant exponential changes.

How can a technology-rooted business put this knowledge to use?

Myhrvold:You need to figure out which areas of your industry are going through exponential change. Not every technology changes dramatically. For instance, hard disks have gone through exponential changes, but floppy discs [haven't].

Some people can't comprehend the power of the industry. I remember in 1990 predicting that in 2000, there would be computers operating in gigahertz. Even people at Microsoft were saying, "What could we possibly use a gigahertz processor for? And who would want it?" You have to have vision and the courage to believe it. And that's not easy, because many of these innovations create pretty nonsensical predictions.

At the same time, not every pie-in-the-sky prediction will come true. You have to sort through the crazy answers that seem right vs. the crazy answers that are just crazy.

And entrepreneurs who aren't involved in an exponential economy-are they destined to become museum pieces?

Myhrvold: Restaurants and other economies that aren't exponential aren't going anywhere, but as exponential economies become more and more relevant, it's going to be harder for [nonexponential] entrepreneurs to ignore them. If you look ahead 10 or 20 years, the Internet and PCs will be as important to Coca-Cola's marketing strategies as television is and has been. You've got to be aware of these issues, no matter what business you're in.

This story appears in the February 2002 issue of Entrepreneur. Subscribe »