The Dot-Com Crash: the winners and the losers (Jerry Gao)
On March 13 2018, the Nasdaq reached its record high of 7637, gaining almost three thousand points over the past two years. Such sharp increase in the composite index of information technology stocks raised questions regarding as to whether an internet bubble was slowly building up or not, which reminded people of the appalling Dot-Com bubble burst in the late 1990s.
The Dot-Com Bubble formed mainly due to the following reasons. First, the release of the Mosaic Web Browser in the late 1980s made the internet much more accessible to the public. As a result, the number of internet users in the US nearly tripled from 15% to around 45%. Such increase made people think of the Internet as the future. At the same time, Congress passed the Tax Payer Relief Act of 1997, freeing up capitals for the middle class. In addition, the steady declining interest rate from the Reagan era also encouraged investments. Investors poured in billions of dollars to finance these growing internet-based startups.
Soon, people became over-optimistic. Since the Internet was a new concept, many people started their e-commerce businesses with very little business experience. Therefore, a large part of the society’s wealth flowed into the hands of inexperienced business executives, and three major problems emerged. First, web retailers over-invested in warehouses and infrastructure. This became a burden as they failed to turn these physical assets into profits. Second, according to Professor Anitesh Barua from UT Austin, most Dot-Com companies were not great at logistics and supply-chain management. Consequently, they could not always deliver their products to their customers quickly and efficiently. In addition, customer-acquisition was both a time consuming and a wasteful process. Some Dot-Com companies like Pets.com invested massively in commercials and failed to convert that spending into profits.
The story of “Pets.com” was a classic example of how companies failed due to their flawed business models during the Dot-Com bubble. Like most other companies, Pets.com had a wildly popular IPO from which the company raised 82 million dollars. However, instead of trying to come up with a profitable business plan, the company’s executives decided to spend their money on a marketing campaign. For instance, Pets.com spent over a million dollars on a Super Bowl TV commercial. Although the ad spread out the company’s influence and raised its name recognition across the country, it was not enough to convince people to buy their products. Unfortunately, Pets.com was not the only one. Many competing firms did exactly the same thing by spending the money that they raised through the IPOs on ads without constructing a self-sustainable business model as if they would never run out of money. As the bubble crumbled in 2001, it became hard to borrow money. Inevitably, the lack of credit led to the eventual demise of these unhealthy internet businesses.
Today, many economists suspect that a new bubble is forming as artificial intelligence and biomedical science have once again made people over-optimistic about the future economic growth driven by technology. I believe that this is a legitimate concern, and it reminds people of the Dot-Com bubble and how those Internet companies spent a lot of their borrowed funds on plans that failed to generate profits. They overlooked that there is always diminishing return to capital. Therefore, it is dangerous to assume that there is linear relationship between the amount of capitals invested and economic growth because most of the time, this would lead to good stock performances that do not reflect the actual state of the economy.
