IDEA No 65
THE DOT-COM BUBBLE
In 1637 the price of a single tulip bulb was ten times the average annual income. Many investors were ruined by the drastic fall in prices that followed. ‘Tulip mania’ was the first recorded speculative bubble.
When investors buy shares because of rapidly rising prices, rather than because the shares are undervalued, a bubble occurs. Sooner or later that bubble bursts.
This is exactly what happened during the dot-com bubble of the late 90s. Low interest rates, easily available venture capital and rapidly rising share prices meant traditional measures of company performance were ignored. The accepted dot-com model was to expand a customer base as rapidly as possible, even if it produced large losses. Profit would come later. ‘Get large or get lost’ was the wisdom of the day. Such was the hysteria that, if a company added .com to the end of its name, its share price shot through the roof overnight. Over a three-year period, from 1997 to 2000, the share value of web-based businesses rose rapidly, before dramatically crashing in March 2000.
When the market fell, loss-making dot-com businesses could no longer depend on investment to keep afloat. One of the first to collapse was the fashion retailer boo.com. It had spent almost $200 million in less than a year. Lavish spending aside, the company failed because its technology was too sophisticated for the market. Too few people were online and too few of them had connection speeds fast enough to use the site as it was intended. This was typical. Dot-com companies, often run by inexperienced but computer-savvy entrepreneurs, were technology-driven rather than market-driven. Many companies failed, others limped on. Those that had financial reserves, like Amazon and eBay, held fast and recovered to become the web-retailing giants of today (see The Long Tail).
Despite the vast sums of money lost, it was not all wasted. Traditional businesses were forced to transform, huge amounts were invested in infrastructure, exciting new companies emerged, and people grew used to interacting and transacting online. The bubble accelerated the advancement of the Web and, in doing so, changed our world completely. Many of the dot-com companies that crashed had sound ideas but poor business models; they over-invested in an immature medium. Fifteen years later, the dot-com vision has become reality. Selling pet food online was never a bad idea. Investing $300 million to do so always was.■
‘Low interest rates, easily available venture capital and rapidly rising share prices meant traditional measures of company performance were ignored.’
The dot-com bubble reached its climax on 10 March 2000. Over the next 18 months $5 trillion was wiped off the value of US companies. Many dot-coms ran out of capital and were liquidated.