In his 1942 book "Capitalism, Socialism, and Democracy", an Austrian-born political economist, Joseph Schumpeter, argued that capitalism is always evolving. Schumpeter coined the famous term on business cycles, “creative destruction”. Creative destruction is the continuous dismantling of long-standing practises and markets in favour of new innovative ones for any capitalist society to survive. With this, incumbent businesses must either adapt quickly or fail. The theory can be used to explain many monumental innovations in history—from water power through the industrial revolution, internal combustion engines and electricity. And the internet revolution in the 1990s was no different.
The internet caught the world by surprise. It was growing faster than any previous technology, hardly giving the world time to process. But the internet had also created a level playing field that promised inclusivity in participation and gains. College students were experimenting on anything, while many conventional businesses laughed at how absurd people thought the internet could change how businesses worked, let alone way of life. Within a short period, however, the net exploded. The number of websites increased from about 4 in 1991 to 10,000 in 1994 when Netscape browser launched, and over 10 million by 1999.
The rapid growth of the internet led to unprecedented boom in startups. New business models emerged and investors were scrambling for any trend that promised to ‘internetise’ anything. This ultimately resulted in the infamous dot com bubble and the market crush.
For most people the period 1995-2000 is synonymous with buzzy phrases, such as "irrational exuberance", "unreasonable economic optimism", “speculative investing", or "lofty valuations". Some argue, however, that the stock market had already been in a frenzy recovering from the 23% single day drop of 1987 Black Monday. Regardless, we cannot tell precisely what caused the bubble because assets bubbles are notoriously hard to recognise in the moment and easy to misjudge in hindsight. But one thing for sure is that the 90s and the dot com bubble are filled with invaluable lessons that we can use to understand the present and potentially prepare for the future.
Retail goes online
There are many areas of life and businesses that were disrupted by the internet, but I find retail and advertisement/marketing the most interesting—and perhaps the best representation of the dot com bubble. Here we will highlight few of these and how they cumulatively contributed to the bubble.
Amazon: The everything store and the birth of e-commerce
It was unavoidable for people to develop ways to transact online once the internet took off. This was made possible in particular when Netscape introduced Secure Sockets Layer (SSL) technology. The encryption security protocol ensured secure communication and sharing of sensitive data on the internet. One of the first people to take advantage of the internet commerce was a thirty-year-old senior vice president of a multinational hedge fund. While researching the internet space for his job, Jeff Bezos realised that the internet held great promise for e-commerce. Bezos believed from the start that soon people would be able to buy and sell anything online. He also wanted to be a part of the internet revolution, so he quit his job in 1994 to pursue his dream.
However, Bezos knew that everything was too ambitious to begin with. He settled for books because of high demand, low cost, wide range of titles, and fewer distributors on the market. Almost a year since the official launch of Amazon website, Wall Street Journal featured a front-page story about it in May of 1996. This story proved to be the one thing Amazon needed: free publicity and credibility. Soon after, the company was in the spotlight, symbolising the birth of a new industry and attracting more investors than they needed.
Barners & Nobel, one of the biggest book distributers, launched their own website in 1997 when Bezos rejected their partnership request. It became a big story as people feared that this would spell the end of Amazon. Soon after Amazon went public and raised $54 million. At that point the 'Earth's largest bookstore' had already built a strong and efficient platform of its time. The business was growing at about 900% in revenue and turning over inventory 150 times a year compared to 4 times for traditional bookstores. In 1998 Amazon expanded its product line to include CDs. The following year they added electronics, toys and tools. Today Amazon is estimated to have a catalogue of over 350 million physical and digital products (including marketplace sellers) selling to over 100 countries.
eBay: Giving power to the individual
About three months after Amazon's launch, the Paris-born entrepreneur, Pierre Omidyar, launched AuctionWeb with a vision “to give the individual the power to be a producer as well as a consumer.” What began as a personal hobby of bringing buyers and sellers in an “honest and open marketplace” soon took off and became the first online auction site. Between December 1997 and December 1998, the number of registered AuctionWeb users exploded from 340,000 to over 2.1 million, and the platform hosted over 13.6 million auctions during the fourth quarter of 1998. In 1997 the company changed its name to eBay and a year later IPO’ed at a $2 billion valuation. Unlike Amazon in the early days, eBay was not involved in transaction or delivery logistics. It was merely facilitating connections between buyers and sellers, and getting a percentage of sales.
"By building a simple system, with just a few guiding principles, eBay was open to organic growth"
- Pierre Omidyar, Founder of eBay -
Webvan: If we build it, they will come
Suddenly online retail companies were emerging from every corner. One of the most popular was Webvan, a 1996 grocery business that promised home delivery within a 30-minute window of the customer’s choice. Bowing to investor pressure to 'Grow Big Fast', Webvan embarked on aggressive expansions in different cities simultaneously without proving its business model or having proper infrastructure. Building infrastructure from scratch also proved difficult and extremely expensive. However, Webvan still managed to raise over $395 million venture capital money from big names like Benchmark, Sequoia, Softbank and Goldman Sachs. In November 1999 they raised a further $375 million in an IPO that valued the company at more than $4.8 billion. At its peak in 2000, Webvan would make about $178.5 million in revenue, but that meant nothing compared to the $525.4 million expenses. Therefore, when the market dried in 2001, Webvan’s bankruptcy was almost inevitable.
Pets.com: Reach as many people as possible (at all cost)
A similar story was observed with pets.com, an Amazon backed online seller of pet supplies founded in November 1998. Pets.com employed aggressive and costly marketing strategies for a quick publicity. During its first fiscal year, it made $619,000 in revenue but spent around $11.8 million on advertisements. The young company was also too comfortable selling at colossal loss to entice buyers. In November 2000, nine months after IPO, pets.com would announce liquidation—with the share price trading at $0.19 compared to the $11 at IPO.
Kozmo.com: From the internet to your office in under an hour (at our loss)
Kozmo.com was another ambitious retail dot-com. It launched as a quick and efficient online retailer for small products like videos, games, books and food. They also offered free delivery. Founded in in 1998, kozmo.com raised around $250 million from Amazon and other investors. However, kozmo.com's free delivery model proved unprofitable from start. By 1999 net loses were as high as $26.3 million on $3.5 million revenue. And when the company decided to introduce a delivery fee, it was too late. Attempts to raise further funding also proved impossible in 2000. Eventually, kozmo.com shut down in April of 2001.
Boo.com: Maybe too early, too big, too grandiose
In Europe, two serial entrepreneurs who had sold their other internet online bookseller website, bonus.com, wanted to put the continent on the dot-com map. In 1998 they started an online business selling branded fashion apparel called boo.com. The company was too ambitious and probably far ahead of its time. They wanted to go global quickly and to provide in-person shopping experience online when the internet was still in its infancy. Even pre launch, boo.com had become very popular, thanks to management's extravagant advertising spending of about $135 million venture capital money. However, boo.com neglected the importance of getting simple things right, such as user experience. About 40% of visitors could not access the site, and those who did found it difficult to use. Conversion rates were also much lower than expected, while products returns much higher. Within eighteen months, boo.com made headlines again, now as Europe’s first big internet bankruptcy.
The burst
Many dot com companies shared similar characteristics: 'Get Big Fast' strategy, extravagant spending on marketing, and selling at loss. People became too comfortable with loss-making businesses as long as market valuations were going up. Thousands of startups were born during the dot com, each wanting to be the Amazon of X or the next Yahoo! or Netscape. There was no shortage of venture capital money either. In 1998 about 139 new venture capital funds were created, representing $17.3 billion fresh capital. IPO market was also hot in the late 90s. Many famous internet companies more than doubled their first day gains. Some like Yahoo! would increase their market cap to over $120 billion at its peak, while trading at almost two thousands times its earnings (2000x P/E). Others like Priceline.com, an online travel agency for finding cheaper vacant airline seats that would exemplify the dot-com era, managed to achieve overnight success. Launched in April 1998, Priceline raised $100 million, spent $20 million on advertisement in the first six months and went public exactly a year after. On IPO day, Priceline shares went up from $16 to $88 before settling at $69. This achieved the highest first day valuation for an internet companies.
It is very difficult to pinpoint a causes of an asset bubble or a catalyst that bursts. Some point to the 1998-99 Fed’s hikes of interest rates and the 2000 recession in Japan. Suddenly stock prices were falling and bankruptcies reported on a regular basis. Now everybody started to care about business models and profitability. All the insane amount of money that had been floated would be whipped out even faster than it had been invested. By 2002 investor losses were estimated at around $5 trillion. Thousands of businesses and jobs would vanish. And the internet dream would seem illusional or dead. But that was just the end of the beginning. The experiment performed and the lessons learnt would be the foundation of the 21st century. Why does this matter? How is it relevant today? Can we use it to (dare to) predict the future? Check out part 4 where we will try to answer those and connect the dots.
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