Dot-com bubble

The "dot-com bubble" (or sometimes the "I.T. bubble") was a speculative bubble covering roughly 1995–2001 (with a climax on March 10, 2000 with the NASDAQ peaking at 5132.52) during which stock markets in Western nations saw their value increase rapidly from growth in the new Internet sector and related fields. The period was marked by the founding (and, in many cases, spectacular failure) of a group of new Internet-based companies commonly referred to as dot-coms. A combination of rapidly increasing stock prices, individual speculation in stocks, and widely available venture capital created an exuberant environment in which many of these businesses dismissed standard business models, focusing on increasing market share at the expense of the bottom line.

Contents

The growth of the bubble

The venture capitalists saw record-setting rises in stock valuations of dot-com companies, 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. Although a number of these new entrepreneurs had realistic plans and administrative ability, most of them lacked these characteristics but were able to sell their ideas to investors because of the novelty of the dot-com concept.

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 expected that they could build enough brand awareness to charge profitable rates for their services later. The motto "get big fast" reflected this strategy.[1] During the loss period the companies relied on venture capital and especially initial public offerings of stock to pay their expenses. The novelty of these stocks, combined with the difficulty of valuing the companies, sent many stocks to dizzying heights and made the initial controllers of the company wildly rich on paper.

Historically, the dot-com boom can be seen as similar to a number of other technology-inspired booms of the past including railroads in the 1840s, automobiles and radio in the 1920s, transistor electronics in the 1950s, computer time-sharing in the 1960s, and home computers and biotechnology in the early 1980s.

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.

The dot-com model was inherently flawed: a vast number of companies all had the same business plan of monopolizing their respective sectors through network effects, and it was clear that even if the plan was sound, there could only be at most one network-effects winner in each sector, and therefore that most companies with this business plan would fail. In fact, many sectors could not support even one company powered entirely by network effects.

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.[2][3][4]

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. The phrase "Get large or get lost" was the wisdom of the day.[5] 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. 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 way that dot-coms sought to grow their customer base. 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 seventeen dot-com companies that each paid over two million dollars for a thirty-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 ten million dollars 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 in lieu 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, such as Cisco Systems, profited greatly from these projects.

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 (information-technology) industry, this quickly led to problems for small companies dependent on contracts from operators.

Thinning the herd

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 Federal Reserve had increased interest rates six times, and the runaway economy was beginning to lose speed. The dot-com bubble burst, numerically, on March 10, 2000, when the technology heavy NASDAQ Composite index[6] peaked at 5,048.62 (intra-day peak 5,132.52), more than double its value just a year before. 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. The findings, which declared Microsoft a monopoly, were widely expected in the weeks before their release on April 3.

One possible cause for the collapse of the NASDAQ (and all dotcoms) was massive, multi-billion dollar sell orders for major bellwether high tech stocks (Cisco, IBM, Dell, etc.) that happened by chance to be processed simultaneously on the Monday morning following the March 10 weekend. This selling resulted in the NASDAQ opening roughly four percentage points lower on Monday March 13 from 5,038 to 4,879—the greatest percentage 'pre-market' selloff for the entire year.

The massive initial batch of sell orders processed on Monday, March 13 triggered a chain reaction of selling that fed on itself as investors, funds, and institutions liquidated positions. In just six days the NASDAQ had lost nearly nine percent, falling from roughly 5,050 on March 10 to 4,580 on March 15.

Another reason may have been accelerated business spending in preparation for the Y2K switchover. Once New Year had passed without incident, businesses found themselves with all the equipment they needed for some time, and business spending quickly declined. This correlates quite closely to the peak of U.S. stock markets. The Dow Jones peaked on January 14, 2000 (closed at 11,722.98, with an intra-day peak of 11,750.28 and theoretical[7] peak of 11,908.50)[8] and the broader S&P 500 on March 24, 2000 (closed at 1,527.46, with an intra-day peak of 1,553.11);[9] while, even more dramatically the UK's FTSE 100 Index peaked at 6,950.60 on the last day of trading in 1999 (December 30). Hiring freezes, layoffs, and consolidations followed in several industries, especially in the dot-com sector.

The bursting of the bubble may also have been related to the poor results of Internet retailers following the 1999 Christmas season. This was the first unequivocal and public evidence that the "Get Big Fast" Internet strategy was flawed for most companies. These retailers' results were made public in March when annual and quarterly reports of public firms were released.

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 jokingly referred to these failed dot-coms as either "dot-bombs" or "dot-compost".

Aftermath

On January 11, 2000, America Online, a favorite of dot-com investors and pioneer of dial-up Internet access, acquired Time Warner, the world's largest media company.[10] 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, a symbol of the dominance of old industry during periods of technological growth.

Several communication companies, burdened with unredeemable debts from their expansion projects, sold their assets for cash or filed for bankruptcy. WorldCom, the largest of these, was found to have used illegal accounting practices to overstate its profits by billions of dollars. The company's stock crashed when these irregularities were revealed, and within days it filed the largest corporate bankruptcy in U.S. history. Other examples include NorthPoint Communications, Global Crossing, JDS Uniphase, XO Communications, and Covad Communications. Demand for the new high-speed infrastructure never materialized, and it became dark fiber.

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.

The Dot-com bubble crash wiped out $5 trillion in market value of technology companies from March 2000 to October 2002.[11]

Recent research suggests, however, that as many as 50% of the dot-coms survived through 2004, reflecting two facts: the destruction of public market wealth did not necessarily correspond to firm closings, and second, that most of the dot-coms were small players who were able to weather the financial markets storm.[12]

Nevertheless, laid-off technology experts, such as computer programmers, found a glutted job market. In the U.S., International outsourcing and the recently allowed increase of skilled visa "guest workers" (e.g., those participating in the U.S. H-1B visa program) exacerbated the situation[13]. 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.

Some believe the crash of the dot-com bubble contributed to the housing bubble in the U.S. Yale economist Robert Shiller said in 2005, “Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors. These days, the only thing that comes close to real estate as a national obsession is poker.”[14]

List of companies significant to the bubble

For discussion and a list of dot-com companies outside the scope of the dot-com bubble, see Dot-com company.

See also

Terminology

Media

Venture Capital

Further reading

References

  1. ↑ Spector, Robert (2000). amazon.com: Get Big Fast. ISBN 0066620414. 
  2. ↑ Kadlec, Daniel (1999-08-09). "Day Trading: It's a Brutal World". Time. http://www.time.com/time/magazine/article/0,9171,991726,00.html. Retrieved on 2007-10-09. 
  3. ↑ Johns, Ray (1999-03-04). "Daytrader Trend". Online Newshour: Forum. PBS. Retrieved on 2007-10-09.
  4. ↑ Cringely, Robert X. (1999-12-16). "There's a Sucker Born Every 60,000 Milliseconds". I, Cringely. PBS. Retrieved on 2007-10-09.
  5. ↑ How to Start a Startup
  6. ↑ Index Chart
  7. ↑ Theoretical Dow Jones Index
  8. ↑ ^DJI: Historical Prices for DOW JONES INDUSTRIAL AVERAGE IN - Yahoo! Finance
  9. ↑ ^GSPC: Historical Prices for S&P 500 INDEX,RTH - Yahoo! Finance
  10. ↑ "Top Mergers & Acquisitions (M&A) Deals" (2007-03-28). Retrieved on 2007-05-05.
  11. ↑ Will dotcom bubble burst again? / QCTimes.com
  12. ↑ Goldfarb, Brent D., Kirsch, David and Miller, David A., "Was There Too Little Entry During the Dot Com Era?" (April 24, 2006). Robert H. Smith School Research Paper No. RHS 06-029 Available at SSRN: http://ssrn.com/abstract=871210
  13. ↑ [1] "Indian Companies Abusing U.S. H-1B, L-1 Laws: A Study Ruining American Economy & Society - Dampening Recovery. SAN FRANCISCO: Jan 23, 2004 (PNS) - According to a research by Professor Ron Hira of Rochester Institute of Technology, India companies are abusing the temporary work visas by making a heave [sic] use of H-1B and L-1. The Indian companies have come under scrutiny their abuse practices which have accelerated shift of tech work to India causing anxiety and resentment among American work force."
  14. ↑ Jonathan R. Laing (2005-06-20). "The Bubble's New Home". Barron's Magazine.
  15. ↑ INTERNATIONAL BUSINESS; Fashionmall.com Swoops In for the Boo.com Fire Sale - New York Times
  16. ↑ Top 10 dot-com flops - CNET.com
  17. ↑ Historical prices of EDIG stock
  18. ↑ EToys: Stock Went From Hot to Shot - Brief Article | Los Angeles Business Journal | Find Articles at BNET.com
  19. ↑ eToys to shut down Web site March 8 - Feb. 26, 2001
  20. ↑ Another One Bites the Dust - FreeInternet.com Files for Bankruptcy - Addlebrain.com
  21. ↑ InternetNews Realtime IT News – Freeinternet.com Scores User Surge
  22. ↑ ISP-Planet - News - Freei Files for Bankruptcy
  23. ↑ BW Online | September 14, 2000 | Hotmail's Creator Is Starting Up Again, and Again, and
  24. ↑ Microsoft buys Hotmail - CNET News.com
  25. ↑ 25.0 25.1 http://seattletimes.nwsource.com/art/news/business/infospace/infospaceTimelineDay1_2_intro.swf
  26. ↑ Abigail Goldman (2002-12-06). "Mattel Settles Shareholders Lawsuit For $122 Million". Los Angeles Times.
  27. ↑ http://www.xcelera.com/investor4.html#q2 Xcelera's FAQ's

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