Bubbles and Fundamentals

The recent events in the financial industry brought back memories of the Internet dot-com era of the late 1990s, only a short decade ago.

In the speculative dot-com bubble that developed during those years, a lot of people were talking about the rise of a new economy that rendered obsolete many business practices, including business models based on revenue, cash and profit.  They felt that in this new Internet economy, the emphasis should now be on increasing market share, clicks and eye-balls as fast as possible regardless of the impact on the bottom line.

There was a buzz in the air that in this new economy, "born-on-the-Net" startups had an inherent advantage over existing,” brick-and-mortar" businesses.  Because of their grounding in the physical world, it was thought that such old-fashioned companies could not possibly compete in this fast-moving digital space and were therefore headed for extinction.  Thus, many otherwise smart people rushed to invest in new Web-based companies regardless of their financial soundness, hoping to strike gold in this new economy.   

At the time, I was general manager of the IBM Internet Division.  Looking back at what we accomplished in those days, I am frankly almost as proud of what we did not do as I am of what we did.

All kinds of ideas for new Web-based companies were floating in the air.  Different groups within IBM wanted to start new projects.  Startups and VCs were asking us to invest in their new companies.  Established companies wanted to us to partner in the new Internet ventures they were starting. 

I have to admit that in many of those cases, I did not understand the business models they were presenting.  I just did not get it.  I know that when you start a new business, especially one based on a disruptive new technology or business model, it usually takes a few years for the business to start making money.  But in many of the proposals we reviewed, I did not understand how they could ever make money and turn into a real business. The proposals were generally very interesting, just not financially sound.

I am sure we missed a few good ideas we should have embraced.  But once the bubble burst, it became clear that many of those proposals were not well thought out and had no hope of ever turning into a real business. 

This was also the case with many of the dot-com companies that did get funded.  A number of these failed dot-coms were led by managers who had no idea how to build a real business, but were hoping to get very rich through a public offering or acquisition before anyone found out that the emperor had no clothes. 

By 2001, a majority of the dot-coms went under after burning through their venture capital.  The Internet and the Web were alive and well, but it was now back to the fundamentals. 

Then a few years later, we started hearing a new buzz in the air, this one coming from the financial industry.  Once more, we were asked to believe that there was a new world out there with a new set of rules quite different from those most of us had grown up with. 

We heard that borrowers can now get a mortgage regardless of their credit history, employment status, income level or ability to make a down payment, even though there is a high probability that they may not be able to keep up with their mortgage payments.  Lenders can now protect themselves from the risks that homeowners will default on their mortgages by distributing the risks using innovative securitization and financial instruments like derivatives.  And both borrowers and lenders will be fine because housing prices will keep going up with no end in sight.

As we now know, these and other flawed assumptions led to a housing bubble, with prices rising to unsustainable levels.  Once the bubble burst and home prices started to come down, borrowers, lenders and the whole economy found themselves in the middle of the huge subprime mortage crisis.  We still don't know how it all will play out.

We know we are living in times of profound change.  The Internet and Web are fundamentally transforming all aspects of business, society and our personal lives.  Many, perhaps most of the predictions made in the heady dot-come bubble days of the late 1990s are coming to pass.  We are indeed building an integrated, global, digital economy.  Billions around the world are able to access all kinds of information and applications over the Web, as well as communicate and collaborate with each other.  Whole industries, like media and entertainment, are being transformed in front of our eyes. 

But it is all based on classic, fundamental principles.  All these advances have to be grounded on solid science, technology and engineering, not wishful thinking - which is why they are taking a lot longer to come to pass than originally predicted.  More than ever, you need very competent managers with strong leadership skills, who can understand and deal with the complex systems, markets and organizations all around us.  New companies are emerging with all kinds of highly innovative, disruptive business models, but to succeed, those models must have sound financial underpinnings based on revenue, cash and profit. 

As the subprime crisis works itself out, the financial industry is poised to undergo its own massive transformation based on sound technology, management, innovative ideas and business models.  It is time to ask fundamental questions:  How will banks evolve in our emerging knowledge economy?  What does it mean to be a global, mobile 21st century bank?  How can we make it easier for people to deal with money in their everyday lives, as well as make sound financial decisions for their future and the future of their families? 

Sometimes you need a bubble, followed by a crisis, to help us all sort things out and get everyone's feet back on the ground.  As we learned with the Internet, only then can the real hard work and innovation finally start.  My hope and expectations are that something similar will now happen in the financial world.

Comments

[Jerry Heyman]

A reasonable perspective, but I don't believe that the parallels are quite so clean cut.

The dot-com fallout was built on a house of cards; get venture funding, create buzz, get first release of product out the door, get bought by someone with real resources.

The financial is also currently built on a house of cards; making loans, packaging the loans (both good and bad), sell the package. Unfortunately, the bad loans were in part mandated by US Gov't legislation...

[Chris Ward]

So what would have happened if the 'bail-out' had passed ? My understanding is that the US Government would have bought $700B-worth of something-or-other; about $3000 per head of the population.

That would surely have meant a big shift in emphasis from "Private Sector" ... the IBMs and Microsofts of the world ... to "Public Sector". New York State Department of Motor Vehicles, and so on.

(Not that either IBM or MS is likely to be taken over by any government any time soon. But other businesses would be.)

What's the Department of Motor Vehicles' take on "Growth of Internet", or "Financial Services" ? Are they strictly a "Walk in, wait in line, pay cash" organisation ? But you will be able to do it, pay cash to a real flesh-and-blood person, every year from now until the oil runs out. Stability.

IBM Lotus SmartSuite is coming to the end of its natural life, as a viable business. I don't think any retailers stock it, and even IBM itself suggests that you download IBM Lotus Symphony at no charge while you wait for your SmartSuite media kit to arrive in the mail after you pony up your $297+tax on the corporate web site. Or instead; the market for SmartSuite is very small now, not enough to justify a salesman or a developer. Just a little shelf space.

Globalisation, specialisation, huge Research and Development investment in bringing products to market (and discarding those that are best not brought to market), leaving markets when they saturate and commoditise; those are "Private Sector" characteristics, and we live or die on our own wits.

The Government does invest, massively, sometimes, to achieve a target. Who put a man on the moon, and got him back alive ?

We got silicon chips from that; it launched an industry. But Apollo itself didn't actually pay a cash dividend; it wasn't designed to.

No bail-out, at the moment. Capitalism is alive and well. It's still the United States of America, and it has to find its own solution.

Life, liberty, and the pursuit of happiness. That's the American dream. Many of us can share that dream, worldwide.

[te huur gent]

I observed this blog as quit interesting and useful. I really liked your url page.Thanks.