It was actually very easy to justify the valuations of many (but not all) internet companies in the first "bubble" although not by naive net present value calculations. The key is to model scaling up as a call option on a future larger version of the firm; you only get the larger version if your company ends up valuable. With a standard checking account type model the only ways to increase value are to increase cash flows or decrease your discount rate, but with an option other avenues become available.
For example, the lower the strike price of the option, the more valuable. So Webvan = enormous initial outlay = high strike price = bad, whereas two college kids in the Yscraper = low strike = good. Another way to increase the value of an option, and I think this is the critical one for the first boom, is to increase the uncertainty of the value of the underlying asset i.e. the hypothetical larger version of the company. In the boom, that uncertainty was huge, we will all be buying pet food online next year, will Google manage all commerce of any kind in five, etc.
So, interestingly, the very fact the wisdom of the crowd had no clue what Web 1.0 business should be worth may have driven the high valuations in the first place.
In the second boom it appears 1. Strikes are lower, 2. Uncertainty is lower = affect on valuations is ambiguous. That's basically the conclusion of article as well as I see it, just approached from a different viewpoint.
Maybe it wasn't so much the business ideas as the greed that made the bubble burst. Most bubblers just wasted so much money on consultants etc., which really wasn't necessary. Since I heard this time around people are more careful, maybe this bubble won't burst.
Besides, I remember Ray Kurzweill writing that the Bubble wasn't really a bubble. The companies that really created value created so much value that they compensated for the ones that went bankrupt.
Besides, I remember Ray Kurzweill [sic] writing that the Bubble wasn't really a bubble. The companies that really created value created so much value that they compensated for the ones that went bankrupt.
Sure, overall the whole Internet thing has created a lot of actual value, and this is evidenced by the fact that the recession that followed was pretty mild. But it's still true that it was a bubble in the sense that companies were being invested in with little to no actual value, with unworkable business schemes, and a "hemorrhage money now, make billions later!" mentality. The perception was that the Internet was a money-generating panacea, all you had to do was open a site with a .com suffix, like RoofShingles2U.com, and you'd automatically put all roofing salesmen out of business and corner the roof shingle market.
A bubble can only be identified definitively in hindsight i.e. after it has burst. If it doesn't burst then its just industry growth.
I think the lessons were learnt the first time around and because the stakes are now comparatively very low the chances we are now currently in a bubble seem remote.
Still, there was one clear and strong sign of a bubble before it collapsed: most public dot-coms gave zero dividends, or actually a tiny symbolic sum close to zero. That was a signal for any smart investor to make money now and run away.
More to the point, most public dot-coms had zero earnings, which is even more of a signal for the smart investor to take the money and run. Over the long run, stock prices track earnings. Zero earnings = zero stock price.
Not exactly. Dividends is what attracts investors (well, real and smart investors), while stock prices is a measure of people's desire to have shares, as well as their sympathy towards that company.
In other words, stock price is a matter of auction, while dividends is a better indicator of whether your company can make money or not.
Dividends don't mean that much: Microsoft in its dominant years (when they had 40%-plus margins and were raking in the cash) never paid a dividend (they did so only recently).
Growth companies do not pay dividends, as a rule. The fact that these companies were having trouble getting anywhere near profits -- that was indeed a real problem. (Also, the fact that they were public at all was a real problem for them, since public investors want profits sooner than later.)
This second bubble was made possible by better web programming tools and languages -- everyone becomes a PHP/MySQL programmer nowadays. These tools weren't that affordable in 1990's.
Technology made many things easier, like copying books and music, automating everyone's tasks, etc. But it also made programming itself a lot easier. Programming improves everyone's lives and it improves itself too. So bubbles are inevitable (as well as inevitable are some oscillations).
Sorry, I didn't mean "affordable" exactly in terms of money. The tools became much easier to use, which means a better learning curve, which means saving programmer's time, which means money.
Seven years later, we're now clearly in the throes of another dot-com bubble. You might argue that the new bubble has been in effect since mid-2006, but the signs are absolutely unmistakable now. The job market for software developers is every bit as hyper-competitive as it was in 1999. The idea that you can found a company on the internet-- and make money-- is taken seriously now. There's a new one every week.
I dunno...I think the first bubble was a boom through 95, 96, and 97. Netscape, Yahoo, Amazon, Craigslist, EBay all had real products that made money and changed how people did business. It didn't get to be bubblicious until about 1998, when people started getting venture funding for pet stores.
It was right around 97 that people started crying "bubble!", and I think that we're at about the same point in the economic cycle that we were then. Tail end of the midcycle phase. Assuming the housing bust doesn't tank the economy, the real bubble years are still ahead.
If we are in the midcycle phase, it's still a good time to start a company. Capital's not flowing freely enough that anyone can get funded, so those who bootstrap good ideas now stand to profit handsomely when money managers seek to pull all their capital out of the failing real estate market and into the stock and startup market.
It's not time to worry until VCs start giving out $15M to any idiot with a business plan. You don't want to be that idiot.
The fine point here is: there is a difference between a boom and a bubble. Boom == increase in activity supported by actual innovation. Bubble == increase in activity based on marketing fluff or other unsustainable models.
PG talks quite a lot about this kind of thing; in particular, he points out that a boom can sustain for as long as there is innovation (wealth-creation) to support it, and that there is no reason the economy can't support, say, 1000 people working on startups rather than 1000 people working for IBM.
Ok, isn't Web 2.0 a similar marketing fluff? I understand with all similarities it's not the same. I'm sure it is much better now, but add one more new factor, like the failure of Windows Vista for example, and you may have that critical mass for a new collapse.
"add one more new factor, like the failure of Windows Vista for example, and you may have that critical mass for a new collapse"
Forgive me, but I don't see the connection. How would the failure of Windows Vista do anything but help applications that run on the web? I can imagine some large things that could hurt this boom (economic collapse, maybe), but nothing small.
Web 2.0 has a lot of hype right now, but that doesn't make it marketing fluff. There is real substance here (and real profits, real innovation, and real users).
In contrast: here is a quick story about a company that I interviewed with in 1998. I don't remember the name; they were located South of Market in a really nice loft with lots of brick, glass, and chrome. Free lunch every day, free beverages, lots of perks. The business model: we are going to get your website's customers to fill out surveys. You are going to pay us for this. We will get the customers to fill out surveys by rewarding them with frequent-flier miles. I remember three things about this company, years later: how nice their loft was, how stupid and convoluted their business model was, and how arrogant they seemed to be about it. They acted like they were already a success.
In contrast, btw, the startup I did join was operating out of a cluttered office in Palo Alto that they'd got a really good deal on. Junk was everywhere, and the Founder/CEO asked me if I minded. I told him, "hey, it looks like a real startup." That company is still in business today. Frequent-Flier-Miles-for-Surveys, Inc: not so much.
For example, the lower the strike price of the option, the more valuable. So Webvan = enormous initial outlay = high strike price = bad, whereas two college kids in the Yscraper = low strike = good. Another way to increase the value of an option, and I think this is the critical one for the first boom, is to increase the uncertainty of the value of the underlying asset i.e. the hypothetical larger version of the company. In the boom, that uncertainty was huge, we will all be buying pet food online next year, will Google manage all commerce of any kind in five, etc.
So, interestingly, the very fact the wisdom of the crowd had no clue what Web 1.0 business should be worth may have driven the high valuations in the first place.
In the second boom it appears 1. Strikes are lower, 2. Uncertainty is lower = affect on valuations is ambiguous. That's basically the conclusion of article as well as I see it, just approached from a different viewpoint.