The internet was being thought of as an economy and not a channel in the economy. The events of 2000 signaled the end of the internet bubble and marked the start of a real digital transformation in the economy.
People mainly jumped on the internet bandwagon because of its fashionability. The internet is providing a powerful new business infrastructure, a universal information system for handling the transactions of the economy while bringing about radical new efficiencies to both buyers and sellers of goods and services.
One problem with the dot.com phenomenon was that it was mainly concerned with business-to-consumer retailing. Despite the crash of 2000, the internet still changes everything. Can a business function today without a telephone or fax machine? The Internet too is fundamentally reshaping businesses, the information systems that run them and the industries in which they compete.
In this new economy, gaining market share was considered key because of the benefits of network effects. In addition, a large customer base was needed to cover the high fixed costs often associated with doing business. Profitability was a second concern, and Netscape was one of the first of many Internet companies to go public without positive earnings. Some companies deliberately operated at losses because it was essential to spend a lot early to gain market share, which would translate at a later point into profitability.
There were dissenting voices, warning that this was just a period of irrational exuberance and the making of a classic stock market bubble. Investors should have paid attention to these voices but instead they chose to buy into the concept as evidenced by the values given to several loss-making dot-com companies.
There tends to be an information gap between investors and companies. Investors usually do not have enough information to determine the good investments from the bad. And companies do not usually have the infrastructure and know-how to directly receive capital from investors. Therefore, both parties rely on intermediaries to help them make these decisions. These intermediaries include accountants, lawyers, regulatory bodies, investment banks, venture capitalists, money management firms and the media.
The implications of the Internet crash were far reaching. Many companies that needed to raise capital for investment found the capital markets suddenly shut to them. Millions of investors saw a large portion of their savings evaporate. This phenomenon was a likely contributor to the drop in consumer confidence that took place in late 2000 and early 2001. In addition, the actual decease in wealth threatened to dampen consumer spending. These factors, along with an overall showing of the US economy, threatened to put the US into recession for the first time in over 10 years. But it could also be argued that there were benefits of this era and that investment in the technology sector positioned the US to be the world leader in the future.
In the early stages of development, key intermediaries such as venture capitalists sought to provide a high rate of return to their investors for the associated risk. This was typically accomplished by selling their stake in their portfolio companies either to the public through an IPO or to another company in trade sales. Entrepreneurs relied on investment bank underwriters in the actual process of doing an initial public offering. These bankers were paid a commission based on the amount of money that the company manages to raise in its offering, typically 7 percent.
In the aftermath of the dot-com crash, many tried to pinpoint whose fault it was that the whole bubble occurred in the first place. Sell-side analysts came under attack in the media as did some venture capitalists, investment bankers and the accounting industry. They were all at fault because of the hype they placed in what should have been noted in the beginning as a fad.
Palepu, K., Healy, P. & Bernard, V. (2004). Business Analysis & Valuation: Using Financial Statements. Ohio: Southwestern-Thomson Learning.