A new Fortune 500 for the new economy

Change it we have. You can see how by reading down the list on the new 500 to the fourth company, Wal-Mart Stores. For four decades the Fortune 500 ranked the largest industrial companies in the United States. In 1956, we began publishing a separate list of nonindustrial companies. In 1983 it became a full scale Service 500, with companies grouped in several categories (banks, diversified services, life insurance companies, utilities, etc.), some ranked by revenues, others by assets. Companies that operated in both industrial and service sectors–General Electric, with its big television and financial services arms; PepsiCo, with its restaurants; AT&T, with its various manufacturing businesses; and so on–went onto the list that counted the majority of its revenues.

This year, for the first time, the Fortune 500 is a single list combining industrial and service businesses, ranked in size by revenues. A healthy respect for both customer satisfaction and public opinion requires us to declare the causes that impel us to alter it, and to alter it now.

The reason is simple, though its manifestations are profound: This is a new economy, undergoing a restructuring as rapid and deep as the Industrial Revolution of the last century. The large manufacturing corporation was a product of that earlier transformation. So were the big banks, insurers, transportation companies, retailers, and other nonindustrial corporations that grew up to serve the financial and marketing needs of the factories-much of this service sector subject to tight regulatory regimes that divided one type of business from another.

Those lines were always a bit blurry, and companies tried to cross them whenever they glimpsed a profit on the other side. Back in 1799, the Manhattan Co. wriggled through a legal loophole to turn a water business into the bank known today as Chase Manhattan. Over the years, companies migrated from one list to the other, mostly from industrial to service: RCA made the move in 1983, Liz Claiborne in 1993. Such moves were rare, though, and served to demonstrate the continuing value of separate industrial and service lists, and sublists within services. Industrial and service companies did different things. They rarely competed. Investors looked at them differently when evaluating management strategy or financial performance. Regulators held them to different standards–and required many service businesses to operate in rigidly defined markets.

Now Joshua has put his trumpet to his lips. In 1994 a showpiece industrial, General Electric, got 40% of its revenues from service businesses; by the old standard, if current trends continued, GE would move to the Service 500 before long, probably followed by IBM. Underlying these shifts is a change in the structure of corporate America, which Fortune has analyzed extensively in the past year. Says Dennis Beresford, chairman of the Financial Accounting Standards Board: “It’s becoming more common for large companies to be in both manufacturing and services, and also to operate relatively sophisticated financial services businesses.” The new economy has largely obliterated once valid distinctions between industrial and service businesses, and between services. Phone companies compete with broadcasters, software manufacturers offer personal-finance services, airlines sell mutual funds, automakers write insurance.

This massive reordering of business is caused by two powerful, mutually supporting forces: digitization and deregulation. In the last half-decade, the massive rollout of cheap computing power has allowed industries to chop apart traditional value chains–outsourcing work they used to do in-house, moving into territories once owned by other industries, and fuzzing up the line between manufacturing and service activities. At the same time, deregulation of transportation, telecommunications, energy, and financial services has changed the economics of those industries–in every case in the direction of making revenues, not assets, the best measure of size.

Look at manufacturing, undergoing a vast disintermediation as globalization, advances in logistics, computer-aided design, and warp-speed communication permit companies to outsource factory work–the very work that defined them in decades past. U.S. automakers today make fewer than half their parts; Chrysler outsources two-thirds. It’s an exaggeration, but not an outrageous one, to say that the Big Three are chiefly design studios and marketers. The increasing value of information–source of at least three-fourths of value-added in manufacturing, by the estimate of James Brian Quinn of the Tuck School at Dartmouth-has changed the nature of manufacturing. Shoemaker Nike makes no shoes; its work is research and development, design, marketing, and distribution-all services. Order a pair of custom Levi’s: Is this tailoring or manufactured duds?

In a word, manufacturing is dematerializing. We are witnessing, say Lehigh University professors Steven Goldman, Roger Nagel, and Kenneth Preiss, “the convergence of goods and services. It is forcing a reconceptualization of what we mean by the terms ‘production’ and ‘product.’ ” Quite suddenly, distinctions between manufacturing and service have become about as meaningless as battlefield lines in a guerrilla war.

The digital revolution has created an information industry that is a manufacturing-service hybrid, a fluid mix in which the same activity can be one, or the other, or both. Take computer software. Previously, Fortune listed Microsoft, Computer Associates International, and Oracle Systems on the Service 500, where the government’s Standard Industrial Classification puts it. The classification was sensible back when most programs were custom jobs written for mainframes by companies like Computer Sciences Corp., and when outfits like Control Data Corp. and Comshare sold time-sharing services. Today, most software is indisputably manufactured–you buy it in boxes. When the government revises the SIC code in 1997, software will probably be listed with manufacturing.

By then, however, software may be on its way back toward the service side. There is already brisk traffic in software that is never manufactured but instead is delivered over the Internet. That’s for starters, says Marc Sokol, vice president of product strategy for Computer Associates, the sixth-biggest company in computer and data services, which includes software. When the information superhighway is up and running, word processors, spreadsheets, and games will be set up on powerful central computers in a sort of information utility. Rather than trotting down to Egghead Software, buying a copy of Microsoft Word, and sticking it in a PC, a user will pay a small fee to use the application on the big machine- shades of the old time-sharing days. “Software will be pay-for-use,” Sokol predicts, “making it as much a service business as entertainment is.”

Many information businesses toggle between the industrial and service sectors. In 1989, Time Inc., Fortune’s parent company, an industrial because most of its revenue came from printed magazines and books, bought Warner Communications and created Time Warner. The new company appeared on the Service 500 because its sales came preponderantly from movies and cable TV. Nowadays, however, movie studios get more revenue selling videocassettes, a manufacturing business, than putting fannies in theater seats. Magazines, meanwhile, have begun appearing on online services–some of you are reading this on CompuServe. Technology exists to make compact disks on demand in stores, their digitized contents downloaded from a server; if that happens, does Tower Records become a manufacturer and Warner Music Group a service?

The point is, it doesn’t matter. Says CA’s Sokol: “The whole taxonomy has quickly become ludicrous.” IBM’s software business is nearly three times bigger than Microsoft. “Manufacturers” Big Blue and Digital Equipment bring in more revenue from consulting and processing services than “service companies” EDS, Andersen Consulting, and Computer Sciences Corp. combined. Until recently, the service arms of computer makers were appendages of the factories, dedicated to their own machines. In the last half-decade that changed. You can now run Microsoft applications on an IBM operating system in Compaq computers connected to a network designed by GM subsidiary EDS, and give Hewlett-Packard the contract to maintain the system. Ask Xerox to name its competitors, and you’ll hear, in addition to copier makers Canon, Eastman Kodak, Ricoh, and Sharp, names like Andersen Consulting, AT&T, EDS, Lotus, and Microsoft.

This isn’t to say that industry classifications don’t serve useful purposes, and Fortune ranks companies by industry in the tables that follow–not just the 500, but also the 500 next-biggest companies. In the larger scheme of things, however, the digital revolution has made the distinction between manufacturing and services increasingly theoretical: When industrial and service companies compete, they ought to be ranked against one another.

But ranked how? It would have been wrong to merge the lists unless the same measure of size and growth could be fairly applied across all industries–which was not true until very recently. When Fortune gave the Service 500 separate-but-equal status in 1983, it was divided into seven (later eight) industry groups “in order to compare like with like.” We explained: “In each category the primary ranking of companies is by a measure the industry commonly uses as an indication of relative size and growth.” Thus commercial and savings banks, financial services, insurance companies, and utilities were listed by the size of their assets, while diversified services, transportation, and retailing were ranked by sales, like the industrials. That once solid reasoning is suddenly wobbly, battered by the one-two punch of digitization and deregulation.

Nowhere has it landed harder than in telecommunications. Following the breakup of AT&T in 1984, it made sense to list Ma Bell, largely unregulated, with diversified service companies (ranked by sales), while her offspring stayed behind on the utilities list. There they were ranked by assets because regulators pegged their profits to a rate of return on assets.

The distinction is fading as fast as a tan line in September. First, in the past year the three big long-distance companies have either begun or announced plans to begin invading the Baby Bells’ local monopolies. Tit for tat, the Bell operating companies are clawing at regulations that stay them from selling long-distance service. Joseph Kraemer, head of the communications consulting practice at EDS, predicts they will win, on average, 30% of originating long-distance traffic. Second, the Bell operating companies are entering other unregulated markets. In 1993, for example, Bell Atlantic won the right to send video over its network. According to Raymond Smith, CEO of Bell Atlantic: “Five years ago about 55% of our business was not subject to competition. Today that number is only 15% to 20%.” That’s for residential dial tone–where competition is coming fast. Everybody is drinking from the same revenue streams.

In a historic decision, three of the seven Baby Bells–Ameritech, Bell Atlantic, and US West–changed accounting systems to reflect the new reality. In 1993 and 1994 they abandoned Financial Accounting Standard 71, “Accounting for the Effects of Certain Types of Regulation,” and began keeping their books by rules used by unregulated businesses. FAS 71 lets utilities depreciate assets over a long time period, reflecting their regulated rates of return. Bell Atlantic’s telephone poles, for example, were written off over 35 years, AT&T’s over just 15. As a result of the accounting change, in 1994 Bell Atlantic wrote down 11.1% of its assets, a total of $3.6 billion. Says Smith: “Each and every one of the Bell operating companies will do the same thing. It doesn’t change the revenues. But you can no longer measure our size by our assets.”

Other utilities are starting down the same road. In California, Pacific Gas & Electric and Southern California Edison purchase between a quarter and a third of the power they sell. If PG&E needs more kilowatts, don’t figure on its adding to its asset base: “New power plant projects,” the company told stockholders last year, “will be increasingly undertaken by IPPs [independent power producers] rather than utilities.” Though nonutility power generation is still a small business, the independents’ capacity is growing ten times faster than the utilities’. In 1992, Congress opened competition in wholesale electricity markets. Says Richard Priory, president of Duke Power (1994 revenues: $4.5 billion): “Corporations can buy power from anybody they want to–it’s the big thing in our industry these days.” Result: Ranking utilities’ size by assets, Priory says, “doesn’t pass the snicker test.” Gas and electric utilities still adhere to regulatory accounting, but FASB Chairman Beresford says: “That case gets more difficult to make every year. Ten years from now, I suspect, we’ll see relatively few, if any, using it.”

Digitization and deregulation–which created a gigantic information industry out of computers, telecommunications, and entertainment–have had a similar effect on finance. Banking, insurance, and other financial companies are converging into a financial services mega-industry-sharing an unstable border with the information behemoth. Says Richard Kovacevich, CEO of Norwest Corp., the nation’s tenth-biggest commercial bank (1994 gross revenues: $6 billion): “The banking industry is dead, and we should bury it. We are part of the financial services industry.” Laura Estes, who runs the 401(k) and rollover IRA business for Aetna Life, says: “Everybody is going after the money in everybody else’s pocket. My competition is mutual funds and banks.”

Want FDIC-insured savings? You can get it from a bank–or from American Express or Merrill Lynch. Unhappy with your Fidelity Investments mutual fund? Bank of New York will take your business, as will American Airlines or John Hancock. Banks and insurance companies make nearly a quarter of new mutual fund sales. Want to make a financial services executive sweat? Say “Microsoft.” The software giant plans to acquire Intuit (makerof Quicken personal finance software), establish an online network (20% owned by Tele-Communications Inc., the largest cable TV company), and hook up with Visa for electronic payment services. Killen & Associates, a Palo Alto research firm, projects that Microsoft will. reap $2 billion in financial services revenue by 2000, competing with AT&T, BankAmerica, Citicorp, Deluxe, EDS, First USA, and GE, among others.

Consultants at McKinsey & Co. analyzed the convergence in personal financial services in a just completed study. Says Lenny Mendonca, who directed it: “What used to be regulatory-defined positions are now defined by what consumers need.” That goes for the wholesale side too, Mendonca says. Banks, brokerages, and insurance companies all want to offer one-stop shopping. This logic drove Mellon Bank to acquire Dreyfus last year. Says CEO Frank Cahouet: “We have more than 3-1/2 million customers, and we’re trying to provide them with all the logical products.” Regulations-such as the Glass-Steagall Act, which bars banks from underwriting securities and which most observers expect will be repealed or gutted shortly–may slow the convergence but cannot stop it. Says Mendonca: “Glass-Steagall is largely irrelevant already if you have a smart team of lawyers.”

The convergence in financial services played a critical role in Fortune’s decision to merge the industrial and service lists and do a new ranking based on sales and revenues. First, nontraditional rivalries among financial services companies now mean that “to compare like with like” one must look beyond SIC codes. In small Midwestern towns, the rival that Norwest most often bumps up against is a brokerage firm, Edward D. Jones. Just 5% of Norwest’s profits come from banking relationships with big companies (vs. 75% a decade ago). Says CEO Kovacevich: “It’s absurd to compare us to Morgan Guaranty. Morgan and Bankers Trust are more like Morgan Stanley and Salomon [which appeared on the diversified financial companies list] than they are like us.”

Second, assets have become a less important measure of financial companies’ size and growth. Says uber-accountant Beresford: “When I started auditing banks in 1970, everybody was pushing to enhance the size of their balance sheets. These days they’re doing just the opposite.” They’re going after revenues, whether from loans or, increasingly, from fees. A third of large banks’ revenues derive from non-interest sources, such as data processing, sales of securitized assets like mortgages, and service fees; these produced less than a quarter of big-bank revenue in 1982.

Says Mendonca: “The game of financial intermediation”–accepting money from Peter and investing it with Paul–“is no longer won by having the intermediated assets on your balance sheet.” For example, the assets produced by the hottest insurance products- variable life and annuities–belong to policyholders, usually in the form of mutual funds; the insurer manages them for a fee, and what counts is premium income. The Equitable administers third-party assets worth more than twice as much as the company’s own hoard.

Let us not overstate the rate and extent of these changes. GE’s chief financial officer, Dennis Dammerman, notes that in some GE Capital businesses–aircraft and railcar leasing, for example–owned assets generate the revenues, rather than vice versa. For them assets may be the truest measure of size. Mellon’s Frank Cahouet says: “It’s not quite time to toss away the distinctions [among financial services companies], but it’s coming. I think you’re a couple of years away.”

Maybe so, for banks; maybe a couple of years ago for computers and software. Epochs flow into one another, like the seasons. There may be shirtsleeve days in February and snowstorms in April, but there comes a day when the sun crosses the equator, and we say a new spring has begun. For the royalty of corporate America, that day has come.

Ladies and gents: for the new economy, the Fortune 500.

The 500’s top ten this year

1. General Motors
1994 revenue in millions: $154,951

2. Ford Motor
$128,439

3. Exxon
$101,459

4. Wal-Mart Stores
$83,412

5. AT&T
$75,094

6. General Electric
$64,687

7. IBM
$64,052

8. Mobil
$59,621

9. Sears Roebuck
$54,559

10. Philip Morris
$53,776

And last year

1. General Motors
1993 revenue in millions: 138,220

2. Ford Motor
$108,521

3. Exxon
$99,504

4. IBM
$62,716

5. General Electric
$61,558

6. Mobil
$57,077

7. Philip Morris
$50,621

8. Chrysler
$43,600

9. Texaco
$35,185

10. Du Pont
$33, 364