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Dot-Coms: From Deified to Demonized

Too much euphoria on the upside has now given way to too much pessimism on the downside. It was wrong to hold the dot-coms in such esteem in 1999, but it is equally wrong to find them at such fault in 2001. These Internet companies disrupted tradition and spurred established companies to create new business strategies and models. Now traditional companies of all sizes are understanding and exploiting business on the Net. Many of these firms lost significant market share to the dot-coms, at least initially. But smart ones watched them attentively and adopted some of their innovative entrepreneurial practices.

Indeed, at the 2001 annual meetings of the American Economic Association, Stanford economics professor Robert E. Hall argued that the dot-com stock market boom was not an irrational bubble, but a rational assessment of the prospects for their future earnings, given the knowledge at the time.6 Contesting the work of Robert Shiller (and others), cited earlier, Hall believes that stock prices move rationally with the expectation of future returns. In other words, the stock market operates on the principle of registering the properly discounted value of the future cash that shareholders expect to receive. Cash-flow growth is the key to understanding the movement in the market. Hall states that it is "illogical to condemn astronomical price-earnings ratios as plainly irrational without investigating the prospects for growth in future earnings."7

Hall joined the ranks of those who have highlighted the enormous value of intangibles for many of today's companies, especially for the technology users such as insurance companies, banks, and business-service firms. There is a strong association between the use of computers and software and the value of these intangibles imbedded in stock valuations. Companies that have a significant "body of technical and organizational know-how"—types of property Hall calls "e-capital"8—have the highest imbedded intangible-capital valuations. Industries with low levels of intangibles—and, therefore, rationally low price-earnings multiples—include utilities, oil and gas extraction, primary metals, and airlines.

Unlike Shiller, Hall sees the stock-market boom of the 1990s as eminently consistent with the rational evaluation by investors of future returns; indeed, often investors were too cautious in their forecasts. He used Microsoft as an example of a firm that had immense and rational value owing to knowledge and proprietary technological savvy. The growth rate of cash earned by such tech leaders and innovators has been phenomenal. According to Hall, "A dollar invested in Microsoft stock in 1990 resulted in a claim on $1.38 in after-tax earnings in 2000 alone. Obviously the market in 1990 guessed absurdly low about Microsoft's cash-flow growth."9

Hall argues that the main reason why stocks of new Internet companies soared to wild valuations in the first instance was because investors initially believed that only the start-ups would be able to adjust nimbly enough to harness the productivity-enhancing powers of the Internet. Most investors and analysts thought that old-line companies would lack the creativity and imagination, not to mention adaptability, to take the lead online. When Old Economy companies surprised everyone by showing they could effectively compete with the dot-coms, investors realized their mistake, painfully. It became obvious, finally, that the benefits of IT breakthroughs were accruing to the big shots as well, not just to the brash new dot-com start-ups with untried and unorthodox—and most importantly, unprofitable—business models. Valuations suddenly appeared ridiculously high for the start-ups and their stocks plunged—helped along, to be sure, by their extraordinary cash-burn rates and the Fed-induced drying up of cheap capital. This along with the meltdown in the telecom stocks triggered a cyclical slowdown in the economy, which, as we have seen, spiraled throughout the tech sector and the stock market in general.

Smart traditional companies embraced the Net and digitized their business models and processes to leverage the Net in every aspect of their businesses faster than originally expected. They began to garner the benefits in terms of rising revenues relatively quickly. Their contribution to the revenue and job growth in the New Economy far exceeds that of the dot-coms.

The dot-com bubble may have burst, but the New Economy is far from dead. The New Economy was always about productivity gains and innovation, and it still is. Old Economy companies have embraced the Internet and enhanced their economic performance. Dot-coms are a relatively small part of the New Economy, never representing more than 9.6 percent of revenues, according to a recent study co-authored by Andrew Whinston, a professor at the University of Texas.10 But the dot-coms have played an important role and will continue to do so.

In the foreword to this book, business strategist Don Tapscott makes a compelling argument that the dot-com fireworks distracted the attention of financial media and business schools from a much larger economic transformation that was precipitated by the Internet: the demise of the vertically integrated corporation. Vertically integrated companies perform a host of functions beyond their core competencies. Functions such as sales, marketing, service, design, and human resources have traditionally been performed in-house because the time, expense, hassle, and risk of partnering with other companies that specialized in such services outweighed the benefits.

With the Internet's arrival, this is no longer the case. Companies can focus on what they do best and partner with other companies to do the rest, using the Internet as the means to coordinate and collaborate their energies. Business webs that allow partners to provide different goods and services are developing throughout the economy. These include sites such as CharlesSchwab.com, LendingTree.com, Travelocity.com, and Siebel.com. Many projects are starting to be executed in much the same manner as a Hollywood movie is produced. The producer, director, screenwriters, actors, cinematographer, and stage hands come together, work intensely, produce a film, and then disband to collaborate with different people on the next film. The ability to identify, bring together, and orchestrate the energies of many disparate entities will distinguish the winners in tomorrow's economy.

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