2006 December 07 Thursday
Dot Com Bubble Excesses Seen As Exaggerated

The Wall Street Journal reports on some researchers who have found the dot com failure rate was not out of line with other industries in their formative years.

A recent paper suggests that rather than having too many entrants, the period of the Web bubble may have had too few; at least, too few of the right kind. And while most people recall the colossal flops of the period (Webvan, pets.com, etoys and the rest) the survival rates of the era's companies turns out to be on a par, if not slightly higher, than those in several other major industries in their formative years.

The paper is being published in a coming issue of the Journal of Financial Economics. As noteworthy as the findings are, even more interesting is the process that led to them. The work is an outgrowth of the Business Plan Archive at the University of Maryland. Its goal is to become a kind of Smithsonian Institution of the Internet bubble, saving for posterity every business plan, PowerPoint presentation and venture-capital term sheet -- the more frothy and half-baked, the better -- that it can get its hands on.

Perhaps then the venture capitalists have not increased the availability of capital to the extent that we are led to believe. If they really had increased the availability of capital then as a result I'd expect a higher rate of new business failures. Though another interpretation is that the VCs increased the availability of management talent so that the amount of capital invested could increase without higher rates of business failures.

Quite a few of the start-ups still exist but are smaller firms.

The study suggests, though, that the dimensions of that crash might be misunderstood. Nearly half of the companies they studied were still in business in 2004. Prof. Kirsch says that most people believe just a few percent made it through.

The study found that the attrition rate for dot-com companies was roughly 20% a year, which is no different from what occurred during many other industries, such as automobiles, during their early boom periods.

So the dot com boom was just a typical period of irrational exuberance. Nothing out of the ordinary.

Share |      By Randall Parker at 2006 December 07 05:58 PM  Economics Industry

Wolf-Dog said at December 7, 2006 8:14 PM:

Although it might be true that the percentage of internet companies that failed (during the 2000-2003 purge) was not extraordinary, the decline in the market capitalization of the internet stocks from the peak in March 2000, was probably much more than $1 trillion. (Nasdaq was worth $6 trillion in March 2000, and NYSE was worth $10 trillion in March 2000.) The NASDAQ-100 index (which is more than half the market capitalization of NASDAQ) declined nearly 80 % between 2000 and 2003, while the NASDAQ composite itself declined slightly less. But the Internet Index (INX) declined almost 95 %. This represents one of the greatest transfers of wealth in history. The market does not "hold money", it merely transfers the money from one person's bank account to another. There was no loss of money, but while the value of the stocks was fluctuating downwards, the ones who were the best informed, simply pocketed the money of the naive people by selling their Internet stocks. Since Standard & Poor index declined 50 % during 2000-2002, many trillions of dollars simply changed owners...

Bob Badour said at December 8, 2006 10:11 AM:
half of the companies they studied were still in business in 2004

I took a course on entrepreneurism once, and the speakers involved with venture capital said the VC's follow a 1 2 3 rule. For every six companies they fund, three will fail, two will become walking wounded that survive without any real return on the investment, and one will make enough money to pay for all the others plus a healthy return.

The figure that half are still in operation just confirms the VC's have a clue about what they are doing.

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