Dot-com bubble

Dot-com bubble

The "dot-com boom" was a speculative bubble covering roughly 1995–2001 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. The bursting of the dot-com bubble marked the beginning of a relatively mild yet rather lengthy early 2000s recession in the developed world.

The bubble builds

The venture capitalists saw record-setting rises in stock valuation of these and other similar companies, and therefore moved faster and with less caution than usual, choosing to hedge 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.

An annual event started in 1995, the Webby Awards, working to recognize the best websites on the Internet. The event was typically an extravaganza held annually in San Francisco, California, near the heart of Silicon Valley. The ceremonies mirrored the flashy dot-com lifestyle with costumed guests, modern dancers, and faux-paparazzi to make guests feel important. The event peaked in 2001 with thousands in attendance. In 2002 it was a more somber event with only several hundred guests and little of the excess of the late 1990s. In 2003 the awards were reduced to a virtual event because many of the nominees could not fly to San Francisco due primarily to corporate belt-tightening and fear of losing their jobs. The 2005 and 2006 editions were held in New York City.

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 late 1990s boom in technology dot-com company stocks is a good example of a bubble, which burst in the Spring of 2000 and through 2001 .

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.[citation needed]

In spite of this, 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. Stories of people quitting their jobs to become full-time day traders, while not representative, were common in the press.

Free spending
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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. 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, even any revenues. 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 runs through its capital served as the measuring stick.

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 $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, 30-minute primetime special that aired 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 blown out of proportion regardless of whether seen in the context of their current or projected future cash flow, but this fact 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 in March 2000, reflecting the high point of the dot-com bubble.
The technology-heavy NASDAQ Composite index peaked 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 [1] 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) were 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 10th weekend. This selling resulted in the NASDAQ opening roughly four percentage points lower on Monday March 13 from 5038 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 three days the NASDAQ had lost nearly nine percent, falling from roughly 5050 on March 10th to 4580 on March 15th.

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 peak of 11,908.50)[2] and the broader S&P 500 on March 24, 2000 (closed at 1,527.46, with an intra-day peak of 1,553.11)[3]; 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's deflation was running full speed. A majority of the dot-coms ceased trading after burning through their venture capital, often without ever making a net profit. Investors often jokingly referred to these failed dot-coms as either "dot-bombs" or "dot-compost".

[edit] 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. 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. The acquisition thus became a symbol of the dot-coms' challenge to "old economy" companies and the old economy's ultimate survival. The revolutionary optimism of the boom faded, and analysts once again recognized the relevance of traditional business thinking.

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 accounting tricks 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. Some analysts believe that there is so much dark fiber worldwide that only a small percentage of it will be "lit" in the decades to come.

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 to have a good chance of long-term survival.

Recent research suggests, however, that as much as 50% of 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.

Nevertheless, laid-off technology experts, such as computer programmers, found a glutted job market. 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. 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" (from Barron's Magazine's article "The Bubble's New Home", 20 June 2005).

In September 2005, The Economist referred to discussion of "Web 2.0", accompanied by rumors that Microsoft was considering buying America Online (AOL), as "Bubble 2.0".[4]

In 2006, some speculated that a new dot-com bubble might be at hand, citing the acquisition of Intermix Media (owner of MySpace) by News Corporation, Skype by eBay and YouTube by Google as well as the possible acquisition of Facebook by Yahoo.