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The Dot Com Bubble Essay

The Dot-com Bubble or the Tech Bubble was a speculative bubble in the shares of early internet companies called “Dot-coms.” Soon after the 1987 stock market crash, global stock markets resumed their previous bull market trend, led by computer and other technology-related stocks that were traded on the new electronic NASDAQ stock exchange. By the early 1990s, personal computers were becoming increasingly common for both business and personal use. Now that computers were finally becoming reasonably priced and relatively user-friendly, they were no longer relegated to being the domain of geeky hobbyists. Personal computers had become genuinely useful business tools that granted their users a significant boost in productivity. Business applications were invented to help users with a variety of tasks from accounting to tax preparation to word processing. Computers also began to compete with television as a form of entertainment as PC video games entered the marketplace.

The operating system company Microsoft prospered enormously as almost every computer system sold had their software installed on it. During the 1990s, the U.S. computer industry decided to focus primarily upon computer software development instead of designing and manufacturing computer hardware. The reason for this focus was because computer software was a product with very high profit margins, unlike computer hardware. Software companies generated profits by selling licensed software, which costs very little to reproduce. Computer hardware, however, was rapidly becoming a commodity product or a product that is virtually indistinguishable from the product of any other competitor, which forces companies that are manufacturing such products to strongly compete on price.

Asian companies, with their low manufacturing costs, produced virtually all computer hardware components by the 1990s. Software, however, was protected as intellectual property with patents, which created a strong barrier to entry – a benefit that is highly sought after in business. Software companies’ stocks were very strong performers throughout the 1990s. Enthusiasm over the software business led to the creation of many small software startups, with a good portion of these fledgling companies being launched by college students in garages, paying their employees in as much pizza and soda as they desired. Practically every software startup hoped to become “the Next Microsoft”. Eventually, many of these startup companies attracted the attention of venture capitalists who were interested in financing the startups, taking them public and, hopefully, reaping massive profits.

By this point, startups began to pay their employees with company shares with the intention that the shares would become very valuable when company eventually went public. The majority of the software companies that were started during this era were located in Silicon Valley, near San Francisco, which became a technology Mecca. PCs became even more popular in the mid-1990s, when blockbuster PC games such as Sim City and Duke Nukem were launched and inspired many young people to become tech savvy. By the mid-1990s, the NASDAQ index of technology stocks was rising at an extremely fast pace, causing many tech-focused investors to become wealthy.

How the Internet Age Started

By 1994, the internet first became available to the general public. A primitive form of the internet called DARPANet had been around since 1969 and was created by government agencies as an efficient way to exchange scientific and military information to computers in different locations. During the mid-1990s, the internet had evolved as a way for people to communicate via email, use chat rooms and browse websites. Almost immediately, businesses saw the internet as a significant profit opportunity. America Online (AOL) made the internet available to the general public on a large scale. The Yahoo! search engine and internet portal was started in 1994 as a directory of websites. The retailer Amazon.com became the first online book retailer in 1994. EBay was started in 1995 as an online auction site.

As the internet became increasingly commercialized, many online businesses and their founders grew fantastically wealthy. Technology stocks continued to soar and created a very strong incentive for more technology companies to become publicly traded. Many early tech company shareholders, including employees, became millionaires overnight when their companies IPOd. Tech companies continued to pay their employees in stock options, which profited greatly as long as stocks maintained their strong upward trajectory. By the late 1990s, even some tech company secretaries had option portfolios valued in the millions, while several companies offered BMWs as a sign-on bonus for new employees! This was clearly an example of irrational exuberance.

How the Dot-com Bubble Inflated

The booming economy and stock market of the late 1990s inspired some economists to speculate that we were in a “New Economy” in which inflation was virtually nonexistent and where recessions were a relic of the past. According to this logic, the “Old Economy” represented traditional brick-and-morter businesses, which included sectors such as natural resources and retail stores. Some analysts even believed that corporate earnings and other financial data were not relevent for analyzing and investing in technology and internet-related stocks. From 1996 to 2000, the NASDAQ stock index exploded from 600 to 5,000 points. “Dot-com” companies run by people who were barely out of college were going public and raising hundreds of millions of dollars of capital.

Many of these companies lacked clear business plans and even more had no earnings whatsoever to speak of. For example, Pets.com, which had intended to become an online pet products retailer, was losing money before it went public and raised billions of dollars. Numerous dot-com companies wasted millions of dollars on frivolous parties to celebrate their IPOs. There are even stories of dot-com employees who walked around their offices barefoot and played foosball and video games during the work day. At the peak of the dot-com bubble in 1999, it was said that a new millionaire was created every 60 seconds in Silicon Valley.

How the Dot-com Bubble Popped

By early 2000, reality started to sink in. Investors soon realized that the dot-com dream had devolved into a classic speculative bubble. Within months, the NASDAQ stock index crashed from 5,000 to 2,000. Hundreds of stocks such as Pet.com, which once had multi-billion dollar market capitalizations, were off the map as quickly as they appeared. Panic selling ensued as the stock market’s value plunged by trillions of dollars. The NASDAQ further plunged to 800 by 2002. One former high-flier, Microstrategy, slid from a lofty $3500 per share to a pitiful $4 per share. At this time, numerous accounting scandals came to light in which tech companies had artificially inflated their earnings. In 2001, the U.S. economy experienced a post dot-com bubble recession, which forced the Federal Reserve to repeatedly cut interest rates to stop the bleeding.

Hundreds of thousands of technology professionals lost their jobs and, if they had invested in tech stocks, lost a significant portion of their life savings. Needless to say, the New Economy theory was proven wrong and traditional economic principles still hold. What is sadly interesting is how bubbles will continue to occur in the future. When they do occur, foolish investors will continue to convince themselves that “this time is different!” The dotcom bubble started without the world wide web, and indeed in the beginning it didn’t even recognize the Internet as important. Once Al Gore began talking about the “information superhighway” in the early 1990s, however, the “big end of town” – Hollywood, Silicon Valley, telecommunications carriers, cable companies, and media conglomerates, all began investing.

Between April 1992 and July 1993 all of the major US business magazines had published major features on new communications and the “Information Superhighway”. It’s worth analyzing what these magazines and feature articles talked about. The first thing I noticed – not one of the feature articles I picked up mentioned the Internet. It wasn’t on the business horizon of this brave new converged world of Silicon Valley and Hollywood. They were more interested in interactive television.

Business Week’s July 12 1993 edition had a cover story “Media Mania… digital – interactive – multimedia – the rush is on”. Time Warner’s Gerard Levin talked of switching home televisions to “anything, anywhere”. Electronic books and magazines were about to change the world. Interactive TV would get to 20% of US homes by the turn of the century.

Gerard Levin was also in Newsweek’s edition of May 31 1993. The cover story was a zillion dollar industry. The dotcom indifference to the number of zeroes in monetary figures seems to have had its origins about this time. Levin was going to get his bank balances on TV. Couch potatoes would be able to individualise the endings of movies and select camera angles for sporting events. Intelligent agents in the refrigerator would tell the car to remember that it was out of milk. (Strangely, we are still talking about these things a decade later).

California Business in April 1992 had Silicon Valley meeting Hollywood in a 100 billion market as its cover story. And Forbes Magazine on April 13 1992 featured cable companies beating the phone companies to wire homes for the digital age. And touted the ultimate convergence device, where the television telephone and computer would merge in to a single intelligent box – a telecomputer.

Anyone reading all of this and missing the plot of the imminent arrival of the Internet could be completely forgiven. None of these articles gave the Internet a mention.

This helps us to realize that the Internet didn’t catalyse the dotcom bubble. It was merely latched on to as a vehicle when other avenues for investment did not appear to be going anywhere. The bubble was the second California Gold Rush and digital convergence before it became dotcom. The Dotcom mania was really about something that didn’t happen and didn’t have a dot anyway. Because many of the original dreams didn’t look like happening, the arrival of the World Wide Web and an attractive Internet caused all of the above parties to shift gear.

Prior to 1994, telecommunications companies were mainly interested in producing smarter phones, which would be like computers. It probably took another 10 years before we started to see the sort of developments they envisaged appearing in the mobile phone arena.

TV and cable companies were into interactive television with 500 channels plus, interactivity, and video on demand. Choose your own angles for sports, choose you own plots for movies. Even Microsoft thought this was likely to be the main game, and Microsoft turned up at cable shows touting new navigation screens for the about-to-be 500 channel television set. However TV has been the couch potato of the digital age. It looks the same, largely does the same, as 10 years ago.

If TV is the couch potato of the digital age, the non-networked computer is not far behind. It really is hard to argue that computers as stand alone devices have improved much since, despite the engineering evidence of increased power and functionality. Personal computers remain as lousy and confusing as they were a decade ago. The last great advances in standalone computing were the mouse and Windows. Reliability does not seem to have improved. Speed for common tasks (such as opening a word processor) does not appear to be any faster, although some added functionality is available.

The networked computer however stands as the phenomena which has most affected our lives and caused changes. The shift of the computer from a computational to a communicating device is perhaps the most significant change of the information technology age so far. The growth of the Internet as a medium for connecting these communicating devices is, I suggest, the major change that happened.

And so the net grew. For the next five years we were to be bombarded with sometimes realistic and often unrealistic visions of the future; we heard of information superhighways, internet refrigerators and cars, knowledge economies, internet time and internet years, which were vastly different to any time known before, and the dotcom frenzy.

Not since the South Sea Island bubble in the 1700s had western economies experienced anything like the dotcom economic bubble. Suddenly everyone wanted a piece of the action; normally astute investors went crazy, and mums and dads added to the frenzy. For some, the dotcom era saw an amassing of great wealth. But almost overnight it disappeared during 2000 and 2001. The information age prophets of great things to come disappeared along with the monetary profits, and we all began to adjust to a more normal life, albeit one greatly enhanced by the large scale adoption of the Internet in western countries.

It may take a few years before we know how much wealth was lost in the dotcom era; some companies are still adjusting to post dotcom reality. But the losses are certainly in the billions, and with a few more years distance might be seen to be the major factor in the recent decline in the US economy. However dotcom is still too close to us to be able to fully understand .

Bubble growth

Venture capitalists saw record-setting growth as dot-com companies experienced meteoric rises in their stock prices and therefore moved faster and with less caution than usual, choosing to mitigate the risk by starting many contenders and letting the market decide which would succeed. The low interest rates in 1998–99 helped increase the start-up capital amounts. A canonical “dot-com” company’s business model relied on harnessing network effects by operating at a sustained net loss to build market share (or mind share). These companies offered their services or end product for free with the expectation that they could build enough brand awareness to charge profitable rates for their services later. The motto “get big fast” reflected this strategy.

Soaring stocks

In financial markets, a stock market bubble is a self-perpetuating rise or boom in the share prices of stocks of a particular industry. The term may be used with certainty only in retrospect when share prices have since crashed. A bubble occurs when speculators note the fast increase in value and decide to buy in anticipation of further rises, rather than because the shares are undervalued. Typically many companies thus become grossly overvalued. When the bubble “bursts,” the share prices fall dramatically, and many companies go out of business. American news media, including respected business publications such as Forbes and the Wall Street Journal, encouraged the public to invest in risky companies, despite many of the companies’ disregard for basic financial and even legal principles.[3] Andrew Smith [4] has argued that the Financial Industry’s handling of Initial Public offerings tended to benefit the banks and initial investors rather than the company itself.

This is because company staff were typically barred from reselling their shares for a lock-in period of 12 to 18 months and so did not benefit from the common pattern of a huge short-lived spike in the share price on the day of the launch. By contrast, the financiers and other initial investors were typically entitled to sell at the peak price, and so could immediately profit from short-term price rises. Smith argues that the high profitability of the IPOs to Wall Street was a significant factor the course of events of the bubble. He writes: “…But did the kids [the often young dotcom entrepreneurs] dupe the establishment by drawing them into fake companies, or did the establishment dupe the kids by introducing them to Mammon and charging a commission on it?” In spite of this, however, a few company founders made vast fortunes when their companies were bought out at an early stage in the dot-com stock market bubble. These early successes made the bubble even more buoyant. An unprecedented amount of personal investing occurred during the boom, and the press reported the phenomenon of people quitting their jobs to become full-time day traders.[5][6][7] [edit]

Free spending

According to dot-com theory, an Internet company’s survival depended on expanding its customer base as rapidly as possible, even if it produced large annual losses. For instance, Google and Amazon did not see any profit in their first years. Amazon was spending on expanding customer base and alerting people to its existence and Google was busy spending on creating more powerful machine capacity to serve its expanding search engine.[citation needed] The phrase “Get large or get lost” was the wisdom of the day.[8] At the height of the boom, it was possible for a promising dot-com to make an initial public offering (IPO) of its stock and raise a substantial amount of money even though it had never made a profit — or, in some cases, earned any revenue whatsoever.[citation needed] In such a situation, a company’s lifespan was measured by its burn rate: that is, the rate at which a non-profitable company lacking a viable business model ran through its capital served as the metric.

Public awareness campaigns were one of the ways in which dot-coms sought to expand their customer bases. These included television ads, print ads, and targeting of professional sporting events. Many dot-coms named themselves with onomatopoeic nonsense words that they hoped would be memorable and not easily confused with a competitor. Super Bowl XXXIV in January 2000 featured 17 dot-com companies that each paid over $2 million for a 30-second spot. By contrast, in January 2001, just three dot-coms bought advertising spots during Super Bowl XXXV. In a similar vein, CBS-backed iWon.com gave away $10 million to a lucky contestant on an April 15, 2000 half-hour primetime special that was broadcast on CBS. Not surprisingly, the “growth over profits” mentality and the aura of “new economy” invincibility led some companies to engage in lavish internal spending, such as elaborate business facilities and luxury vacations for employees.

Executives and employees who were paid with stock options instead of cash became instant millionaires when the company made its initial public offering; many invested their new wealth into yet more dot-coms. Cities all over the United States sought to become the “next Silicon Valley” by building network-enabled office space to attract Internet entrepreneurs. Communication providers, convinced that the future economy would require ubiquitous broadband access, went deeply into debt to improve their networks with high-speed equipment and fiber optic cables. Companies that produced network equipment like Nortel Networks were irrevocably damaged by such over-extension; Nortel declared bankruptcy in early 2009. Companies like Cisco, which did not have any production facilities, but bought from other manufacturers, were able to leave quickly and actually do well from the situation as the bubble burst and products were sold cheaply.

In the struggle to become a technology hub, many cities and states used tax money to fund technology conference centers, advanced infrastructure, and created favorable business and tax law to encourage development of the dot com industry in their locale. Virginia’s “Technology Corridor” is a prime example of this activity. Large quantities of high speed fiber links were laid, and the State and local governments gave tax exemptions to technology firms. Many of these buildings could be viewed along I-495, after the burst, as vacant office buildings. Similarly, in Europe the vast amounts of cash the mobile operators spent on 3G licences in Germany, Italy, and the United Kingdom, for example, led them into deep debt.

The investments were far out of proportion to both their current and projected cash flow, but this was not publicly acknowledged until as late as 2001 and 2002. Due to the highly networked nature of the IT industry, this quickly led to problems for small companies dependent on contracts from operators. One example is of a then Finnish mobile network company Sonera, which paid huge sums in German broadband auction then dubbed as 3G licenses. 3rd generation networks however took years to catch on and Sonera ended up as a part of TeliaSonera, then simply Telia.

The bubble bursts

The technology-heavy NASDAQ Composite index peaked at 5,048 in March 2000, reflecting the high point of the dot-com bubble. Over 1999 and early 2000, the U.S. Federal Reserve increased interest rates six times,[9] and the economy began to lose speed. The dot-com bubble burst, numerically, on Friday, March 10, 2000, when the technology heavy NASDAQ Composite index, peaked at 5,048.62 (intra-day peak 5,132.52), more than double its value just a year before.[10] The NASDAQ fell slightly after that, but this was attributed to correction by most market analysts; the actual reversal and subsequent bear market may have been triggered by the adverse findings of fact in the United States v. Microsoft case which was being heard in federal court.[citation needed] The findings, which declared Microsoft a monopoly, were widely expected in the weeks before their release on April 3.[citation needed] The following day, April 4, the NASDAQ fell from 4,283 points to 3,649 and rebounded back to 4,223, forming an intraday chart that looked like a stretched V.

On March 20, 2000, after the NASDAQ had lost more than 10 percent from its peak, financial magazine Barron’s shocked the market with its cover story “Burning Up”. Sean Parker stated: “During the next 12 months, scores of highflying Internet upstarts will have used up all their cash. If they can’t scare up any more, they may be in for a savage shakeout. An exclusive survey of the likely losers.” The article pointed out: “America’s 371 publicly traded Internet companies have grown to the point that they are collectively valued at $1.3 trillion, which amounts to about 8% of the entire U.S. stock market.”[11] By 2001, the bubble was deflating at full speed. A majority of the dot-coms ceased trading after burning through their venture capital, many having never made a ″net″ profit. Investors often referred to these failed dot-coms as “dot-bombs.”[citation needed]

Aftermath

See also: Early 2000s recession

On January 11, 2001, America Online, a favorite of dot-com investors and pioneer of dial-up Internet access, merged with Time Warner, the world’s largest media company, in the second-largest M&A transaction worldwide.[12] The transaction has been described as “the worst in history”.[13] Within two years, boardroom disagreements drove out both of the CEOs who made the deal, and in October 2003 AOL Time Warner dropped “AOL” from its name. Several communication companies could not weather the financial burden and were forced to file for bankruptcy. One of the more significant players, WorldCom, was found practicing illegal accounting practices to exaggerate its profits on a yearly basis. WorldCom’s stock price fell drastically when this information went public, and it eventually filed the third-largest corporate bankruptcy in U.S. history. Other examples include NorthPoint Communications, Global Crossing, JDS Uniphase, XO Communications, and Covad Communications.

Companies such as Nortel, Cisco and Corning were at a disadvantage because they relied on infrastructure that was never developed which caused the stock of Corning to drop significantly. Many dot-coms ran out of capital and were acquired or liquidated; the domain names were picked up by old-economy competitors or domain name investors. Several companies and their executives were accused or convicted of fraud for misusing shareholders’ money, and the U.S. Securities and Exchange Commission fined top investment firms like Citigroup and Merrill Lynch millions of dollars for misleading investors. Various supporting industries, such as advertising and shipping, scaled back their operations as demand for their services fell. A few large dot-com companies, such as Amazon.com and eBay, survived the turmoil and appear assured of long-term survival, while others such as Google have become industry-dominating mega-firms.

The stock market crash of 2000–2002 caused the loss of $5 trillion in the market value of companies from March 2000 to October 2002.[14] The 9/11 terrorist destruction of the World Trade Center’s Twin Towers, killing almost 700 employees of Cantor-Fitzgerald, accelerated the stock market drop; the NYSE suspended trading for four sessions. When trading resumed, some of it was transacted in temporary new locations. More in-depth analysis shows that 90% of the dot-coms companies survived through 2004.[15] With this, it is safe to assume that the assets lost from the Stock Market do not directly link to the closing of firms. More importantly, however, it can be concluded that even companies who were categorized as the “small players” were adequate enough to endure the destruction of the financial market during 2000-2002.[16] Additionally, retail investors who felt burned by the burst transitioned their investment portfolios to more cautious positions.

Nevertheless, laid-off technology experts, such as computer programmers, found a glutted job market. University degree programs for computer-related careers saw a noticeable drop in new students. Anecdotes of unemployed programmers going back to school to become accountants or lawyers were common. Turning to the long-term legacy of the bubble, Fred Wilson (financier), who was a venture capitalist during it, said:[4] “A friend of mine has a great line. He says ‘Nothing important has ever been built without irrational exuberance’.

Meaning that you need some of this mania to cause investors to open up their pocketbooks and finance the building of the railroads or the automobile or aerospace industry or whatever. And in this case, much of the capital invested was lost, but also much of it was invested in a very high throughput backbone for the Internet, and lots of software that works, and databases and server structure. All that stuff has allowed what we have today, which has changed all our lives….that’s what all this speculative mania built.”


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