The Free Market 19, no. 4 (April 2001)
"That which hurts, teaches."
--Max Gunther
Among the follies of our own age seemingly has been the dot.com boom. Indeed, it is apparent now that much of the resources invested in the Internet were wasted.
Or were they? There is something to be said for the value of folly and the usefulness of error. There is much to be learned from the wreckage of some of the Internet bombs. Investors are much better off for the experience. As La Rouchefoucald noted over 300 years ago "He who lives without folly is not so wise as he thinks."
Bill Bonner, who writes the Daily Reckoning, picked up on this theme in his December 6 column, "Cleansing the Investment Pool." He wrote, "That is the thing about technology and the future -- it is always very promising. And, thank goodness, there are some investors selfless and brave enough to try to develop it." Bonner quoted Harvard Professor Josh Lerner, who noted that even in failure there is great benefit because these failures lead to a greater understanding of what works and what doesn't.
Bonner notes some of the grim statistics of the Internet's fallen angels: eToys lost an average of $4.04 on every order; Webvan (which was going to deliver your groceries to your door) lost $12.90 per order; and one-time Wall Street darling Drugstore.com lost a staggering $16.42 on every order! Such carnage could not long continue. The run that these companies enjoyed is long over. To use John Train's felicitous phrase, they are "bobbing around in the pool at the base of the waterfall," wondering what to do next.
Among the most well-known of the dot.coms is struggling Amazon.com. Individual Investor voiced skepticism in its December 2000 issue in a piece with the foreboding title, "Will This Be Amazon's Last Christmas?" Amazon shares, which traded as high as $113 in December 1999, fell to $11 in February 2001. The question that investors have been asking is "Will Amazon ever make money?" Amazon is losing an average of about $2.91 on every order. Moreover, Amazon is saddled with over $2 billion in debt. Apparently selling a commodity like books at a deep discount is not enough. Future investors will take note.
The entire Internet dot.com scene is not about failure. There are a handful of profitable firms, Yahoo and Internet.com, for example. The greatest success has been America Online, a company that has richly rewarded its shareholders over the years. The lesson here: Content is king. Better still, content with millions of paying customers. With over 26 million subscribers, AOL was profitable. Now it has joined with Time Warner in a $111 billion merger.
It is easy to dance on the graves of the crippled Internet companies now. It is harder to know beforehand without trying. To some observers investments were made that were surely so patently stupid that they have no defense. As Bonner noted, "There is smart money in markets. And there is dumb money. And there is money so imbecilic that it practically cries out for euthanasia." Perhaps.
Yet many of the successful giants of today had their own peanut galleries in earlier days. Even Coca-Cola had its skeptics. "Just sugar water," old-time doubters would say. Or what about the first automobiles, cranky unreliable contraptions that they were? It would have been easy to laugh at them and stick to your horses. The point is that the future is unknown and part of the entrepreneurial gift is the desire to try something new.
Everything can't go right. We need our losers as much as our winners. As Gilbert and Sullivan noted in The Gondoliers, "when everybody's somebody, then no one's anybody." And thus, if all our investments and entrepreneurial ventures succeeded . . . well, there would be no successes. Early twentieth-century speculator Arthur Cutten used to say that there would be no thrill in winning if you never lost.
The idea of a salutary downturn is a familiar part of the distinctive Austrian theory of the trade cycle (a "fun-starved idea," James Grant has observed). Although we are not talking about an economy-wide bust (yet), many of the same lessons apply. Not a reason for government intervention, with its disclosure laws and complex web of securities laws, the shakeout in technology shares is part of the healing.
Schumpeter's gales of creative destruction never cease blowing. Everywhere there is abandonment of the old and adoption of the new. The market has its own built-in mechanisms for correcting failure quickly. Rather than impede this process with increased regulatory scrutiny or government action, we should recognize the necessity of this creative process.
Christopher Mayer is a commercial lender for Provident Bank in the suburbs of Washington, DC. He may be contacted via email at cwmayer@provbank.com
