The Rise and Fall of the Internet Bubble

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The Rise and Fall of the Internet Bubble

Introduction

What was the Internet bubble? “A bubble occurs when investors put so much demand on a stock that they drive the price beyond any accurate or rational reflection of its actual worth, which should be determined by the performance of the underlying company” (Beattie, 2014). The Internet bubble was the boom in the share prices of stocks of the dot-com companies (Folger, 2011). The dot-com companies offered goods and services for free at first because they expected to build enough brand awareness to gain revenue off their services in the future. The Internet companies reflected the business-to-consumer, consumer-to-business, and consumer-to-consumer aspects of e-commerce. “Business-to-consumer is an e-commerce model in which businesses sell to individual shoppers” (Turban, King, & Lang, 2011a, p. 8). “Consumer-to-business is an e-commerce model in which individuals use the Internet to sell products or services to organizations or individuals who seek sellers to bid on products or services they need” (Turban et al., 2011a, p. 9). “Consumer-to-consumer is an e-commerce model in which consumers sell directly to other consumers” (Turban et al., 2011a, p. 9).

In the 1990s, the impact of technological devices driven from the e-commerce occurring on the dot-com companies’ websites was opening the eyes of many investors. The investors were seeing the return from their investments because of the desire for e-commerce websites bringing the world closer than ever at the time with social media sites, online travel agencies, and online department stores. However, investors were pricing shares beyond the performance level of these new Internet companies, and companies invested in technology will go as far as they can to stay on top and sometimes that can be too far. Investors would see a sudden crash by 1999 that would ruin several Internet companies for good. This would be known as the rise and fall of the Internet bubble.

I will first give a briefing on the rise of the Internet bubble because it is important to be informed on that aspect before a person can understand the significance of the fall of the Internet bubble. I will then inform you on what happened during the fall of the Internet bubble. It is also important to be informed on why this fall of the Internet bubble occurred. I will refer to some preventative actions that could have been taken to stop the unsafe surge of valuation of the Internet companies. I will report on the companies that survived after the fall of the Internet bubble, and the companies that have diminished because of the fall of the Internet bubble. My goal is for you to understand how important the fall of the Internet bubble was because of how it affected the future of many Internet companies that we are familiar with today.

The Rise of the Internet Bubble

In the 1990s, the world was able to use technology that would allow people to shop, communicate, and receive news without having to leave the comfort of their own home (Smith, 2011). This technology was the Internet, and it withheld all of the dot-com companies. Like companies that are not connected with the Internet, these companies were getting investors interested. There were online companies that had great ideas that were sure to bring in revenue. Investors started buying shares of stock because they were optimistic that “companies that operated online would be worth millions of dollars” (Smith, 2011).

The new dot-com companies along with their investors saw “record-setting growth as the companies experienced sudden rises in their stock prices” (Chichoni, 2013). They took this as a sign to “move faster in their expansion and with less caution than usual” (Chichoni, 2013). The companies were so excited to see that their ideas were being valued so high, which was making even more investors interested. However, the companies and investors forgot that there must be enough revenue to support the debt, dividend payouts, and other financial factors of a business (Smith, 2011). There was not enough revenue coming in for these high-valued dot-com companies, so they were about to see a crash of the bubble that would cause the demise of several of the companies.

The Fall of the Internet Bubble

Unfortunately, due to many factors during the time of the Internet bubble in the 1990s, the dot-com companies saw a fall of the Internet bubble, also known as a crash. “A crash is a significant drop in the total value of the market, almost undoubtedly attributable to the popping of a bubble, creating a situation wherein the majority of investors are trying to flee the market at the same time and consequently incurring massive losses” (Beattie, 2014). Investors were trying to sell the shares that they had invested in with the companies that they overvalued because they did not want to completely lose the funds that they had invested. “The collapse of the Internet stocks caused the 2001 stock market crash even more than the September 11, 2001, terrorist attacks. The market crash cost investors five trillion dollars” (Smith, 2011).

There were companies that were able to survive from the crash but not before they saw major loss in the value of their ideas. Many had to revise their business models so that investors would be interested once again. Investors took on huge losses, but many of them were not afraid to invest in the companies that were able to build even better business models than before the crash. Several companies were not able to pick themselves back up after the crash, but there are companies that have become the most powerful in the world that experienced loss from the crash. Investors seem to get the biggest blame for the burst of the Internet bubble, but it certainly involved the dot-com companies that had not become secure enough in their brand as well.

Cause of the Fall of the Internet Bubble

There is not one distinct cause that can be connected to the burst of the Internet bubble. Investors were so excited about the funds that could come from the concept of dot-com companies that they forgot to focus on the aspects of generating revenue or cash flow (Smith, 2011). “In addition to not focusing on the necessary aspects, analysts used very high multipliers in their models and formulas for valuing Internet companies, which resulted in unrealistic and overly optimistic valuations of the Internet companies” (Smith, 2011). Before the crash occurred, the “newer Internet companies were being overvalued by 40 percent” (Smith, 2011). This was not entirely the analysts fault because the companies should have also given their input on the long-term results of their business models. These companies were new at implementing their ideas and were “staffed with individuals that did not have the necessary experience or goals to work in the industry” (Gokli, 2007), so they were not yet comfortable with valuing their own work. Instead, these companies were hoping that investors were captivated enough by their ideas so that they did not need to have solid long-term business plans at the time (Gokli, 2007).

“In the mid to late 1990s, society’s expectations of what the Internet could offer were unrealistic” (Smith, 2011). “Internet entrepreneurs were captivated with dreams of becoming dot-com millionaires and billionaires” (Smith, 2011), and they were going use any funds they could to make those dreams come true. This included letting investors overvalue their companies so that they could gain more dollars per share (Gokli, 2007). “Most dot-com companies would spend the investors’ money without having to be monitored” (Gokli, 2007). “Many investors ignored the fundamental rules of investing in the stock market, such as analyzing P/E ratios, studying market trends, and reviewing business plans. Instead, investors and entrepreneurs became preoccupied with new ideas that were not yet proven to have market potential” (Smith, 2011).

Prevention for the Fall of the Internet Bubble

During the time of the Internet bubble, companies saw an unsafe surge in valuation. There were methods of prevention that could have been followed then and should be followed now to make sure that another Internet bubble is avoided. Companies need to realize that “popularity does not equal profit” (Smith, 2011). There are specific social media sites, such as Facebook, that receive a major amount of attention, but this does not mean that they are worth investing in (Smith, 2011). “It is better for investors to research companies that have solid business fundamentals” (Smith, 2011). Popular Internet sites cannot always produce reliable long-term investments (Smith, 2011). Investors need to make sure a company is going to have a “strong revenue source” (Smith, 2011) for a long period of time.

“Companies were valued by measuring their future profitability” (Smith, 2011). However, this method can lead to overly optimistic valuations (Smith, 2011). It is never a good idea for investors to “invest in a company that is based solely on the hope for large profits rather than the real numbers that are appearing” (Smith, 2011). Investors should make sure that companies are making reasonable speculations when it comes to valuation. “A business model is a method of doing business by which a company can generate revenue to sustain itself” (Turban et al., 2011a, p. 29). A reliable business model is essential when investors are researching potential companies to invest in (Smith, 2011). “Many investors were not realistic concerning revenue growth during the Internet bubble. An investor should never invest in a company that has not figured out how to generate revenue” (Smith, 2011).

“Investors should understand the basic business fundamentals when determining whether to invest in a specific company” (Smith, 2011). “A company should have reasonably predicted financial variables, such as overall debt, profit margin, dividend payouts, and sales forecasts” (Smith, 2011), for investors to include in their decision-making process. It is not wise for investors to rely on just a good idea if the good idea is not going to be able to produce the funds to keep the business alive. Investors need to recognize the relationship a company has established with the stock market (Smith, 2011). In order to perceive this relationship, “investors need to know the company’s beta value, which states the degree to which the stock of the company changes with the economy” (Smith, 2011).

Surviving Companies after the Fall of the Internet Bubble

Several companies saw a major loss during the occurrence of the crash of the Internet bubble. Even though some of those companies were the ones to see the biggest amount of loss, they are thriving in today’s business world. “Amazon.com, which is an example of a business-to-consumer e-commerce model (Turban et al., 2011a, p. 8), was one of the worst losers in the dot-com bubble crash” (Naylor, 2013). The company was selling a share for over 100 dollars during the Internet bubble, but they were only selling shares for 10 dollars after the burst of the Internet bubble (Naylor, 2013). “Amazon has gone through two major financial bubbles, but it has now grown to be the largest online retailer in the world. It is pricing its stocks per share at approximately 360 dollars today” (Naylor, 2013).

“EBay, which is an example of a consumer-to-consumer e-commerce model (Turban et al., 2011a, p. 9), was spared the worst of the carnage of the Internet bubble bursting” (Naylor, 2013). “The company was possibly saved because its product, online auctions, grew in popularity” (Naylor, 2013). During the company’s first day of trading, they started at an offered price of 18 dollars, but the amount nearly tripled to 53 dollars the same day (Naylor, 2013). “Priceline, which is an example of a consumer-to-business e-commerce model (Turban et al., 2011a, p. 9), was founded in 1998, just before the dot-com bubble burst” (Naylor, 2013). After the company saw its initial stock jump to over 86 dollars, “the company saw its stock price crash to under 10 dollars post bubble” (Naylor, 2013). “Priceline was able to survive due to the fact that the company’s business model was retooled in the early 2000s to focus more on hotels than airfare. One share of Priceline stock costs over 1,000 dollars today” (Naylor, 2013).

“Shutterfly is an internet-based personal publishing service that allows users to create prints, calendars, photo books, cards, stationery and photo-sharing websites” (Folger, 2011). The company was able to “survive the dot-com burst and go public in 2006 with an IPO share price of $15.55” (Folger, 2011). “Today, Shutterfly trades above 60 dollars per share” (Folger, 2011). “Coupons.com was founded in 1998 after realizing that the coupon business had yet to adapt to the new internet economy. In 2011, the company attracted 200 million dollars from institutional investors, and it was valued at one billion dollars” (Folger, 2011).

Companies that Diminished after the Fall of the Internet Bubble

There were companies that survived the fall of the Internet bubble and are thriving in today’s business world. However, there were companies that would never be heard of again after the crash of the bubble.

Pets.com was a pet food and supplies company that is perhaps the most recognized flop from the dot-com burst. The business model for this company was not sustainable. Pets.com lost 147 million dollars in the first nine months of 2000, and the company was unable to secure more cash from investors. Pets.com when public in February 2000 and its stock started at 11 dollars per share, rising to a high of 14 dollars per share. The rally was short-lived and Pets.com’s stock quickly fell below one dollar and stayed there until its demise. (Goldman, 2010)

Even though “Pets.com is recognized as the most famous flop, Webvan was the biggest flop” (Goldman, 2010). “The grocery delivery service grew too fast, expanding its services to eight cities in just a year and a half” (Goldman, 2010). After reaching its peak at only 30 dollars per share, the company announced it was closing in July 2001 (Goldman, 2010). By this time, “its stock had already fallen to six cents per share” (Goldman, 2010). EToys.com was selling shares for $84.35 in October 1999, but “16 months later the company warned its investors that these shares were worthless” (Goldman, 2010). The online toy retailer was popular for holiday shopping (Goldman, 2010). However, “after reporting a 74.5 million dollars loss in the last quarter of 2000, the company filed for bankruptcy with a 247 million dollars debt in February 2001” (Goldman, 2010).

TheGlobe.com is not remembered for becoming one of the first social media sites in 1995 that allowed users to create and post their own Web pages as much as it is remembered for its record-setting initial public offering. In November 1998, the company set the offer price at nine dollars per share, but the stock opened at 87 dollars. Shares of theGlobe.com had risen to a high of 97 dollars during its first day of trading before closing at $63.50. However, in August 2001, the company’s stock was delisted by the NASDAQ stock exchange for failing to stay above one dollar per share. (Goldman, 2010)

In 1998, Disney created Go.com to “compete with the likes of Yahoo and AOL” (Goldman, 2010). “In November 1999, Disney even created a tracking stock for Go.com, a separate class of stock that reflected the performance of the new Web property” (Goldman, 2010). After not being able to grow its user base by more than 21 million visitors per month, “Disney announced it would shut down the site in January 2001” (Goldman, 2010). “The company took a write-off of 790 million dollars” (Goldman, 2010). Go.com and the other companies that diminished after the fall of the Internet bubble were not necessarily failures because their share prices were valued to high at the beginning of their existence, but these companies were not able to build enough brand awareness during the time that other Internet companies were being overvalued. Therefore, the companies were not able to stay alive when the most popular companies were struggling to stay alive during the crash of the Internet bubble.

Conclusion

It has been seen throughout history that when a bubble occurs, a crash is not too far from occurring as well. This was certainly the case with the Internet bubble in the 1990s. The dot-com companies involved wanted their services and products to be enough while they figured out a solid long-term business plan that investors could rely on. Investors did not care enough about the solid long-term business plans because they saw a huge amount of potential in the dot-com companies. This led to the investors overvaluing the companies that wanted to expand too fast to keep up with the valuation. The dot-com companies and the investors became part of a crash that would the demise of several companies. However, there were a few dot-com companies that were able to survive the burst of the bubble, and they have become some of the biggest businesses in today’s world.

“The amount and percentage of goods and services sold on the Internet is increasing rapidly, despite the failure of many dot-com companies” (Turban et al., 2011b, p. 88), so electronic retailing is still a needed segment in this world. “According to the Internet Retailer, approximately 60 percent of adult U.S. Internet users shop online and/or research offline sales online” (Turban et al., 2011b, p. 88). Investors and companies need to prevent another bubble from occurring because the dot-com companies are part of a thriving industry. A great business model is the best place to start for these companies, and investors need to make this factor a priority when researching potential investments. Indeed, the dot-com companies that exist today have given a performance worth a high valuation, but investors should allow newer companies to prove their capabilities as well before overvaluing them. The burst of the Internet bubble in the late 1990s and early 2000s did affect the future of some dot-com companies in a good way, but some were affected in a bad way. These companies have significance in our present and future lives, so everything must now be done with caution to prevent the world from experiencing another burst of an Internet bubble.

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