(January 6 ) – “Why is the Internet free? Of all the really interesting questions surrounding the Internet, this is perhaps the most intriguing. We understand that content delivered on the television or radio is free, because it is subsidized by advertising. Most of us are probably also aware that advertising on the Internet has provided disappointing returns to date, and that in any event, it’s unlikely that advertising will ever be able to support new media in the way that it supports traditional media,” writes Michael O’Neil in today’s Globe and Mail.
“So where does the money come from? For the most part, it’s supplied by Wall Street. The U.S. equity market has funnelled billions of dollars into firms such as America Online Inc. and Yahoo Inc. that provide essential services; it has also directed pots of money into companies such as Amazon.com Inc. that are exploring new Web-centric business models. Advertising does contribute something to the Internet, and user fees and government subsidies play a small role as well, but the majority of the money that pays the Internet tab comes from investors.
“The importance of investment capital has had the effect of seriously warping the evolution of electronic commerce. At the outset of the E-commerce explosion about four years ago, the market bought in to the idea that the winners are the first ones in.
“This theory held that the only real prerequisite required for E-commerce success was to ‘dot-com it’ — to be the first company in a market space to make a pure-play Internet stock available. Convinced that the enormous growth of the Internet would eventually yield huge rewards to Internet pioneers, investors pushed stock in companies like Amazon.com to levels that would be unimaginable to those trained to evaluate such old-economy barometers as profitability and customer loyalty.
“This mentality still predominates today, despite the fact that there are fewer untrammelled opportunities for Internet startups, and the fact that the quality of these opportunities continues to diminish.
“There is also an implicit recognition that success and failure, as measured by profitability, are not the primary stimuli of Internet economics. Instead, market capitalization is its own justification, and stock prices are more likely to be propelled by the perception of huge future opportunity than the reality of modest profitability. It is also less likely to be constrained by massive and continuing losses than by a perception that a firm is destined to be a niche player.
“One of the interesting developments that we at International Data Corp. (Canada) Ltd. are forecasting is the strong likelihood that this condition will change in the near future. At some point, the argument that companies able to “dot-com it” are destined to succeed will wear thin.
“Already, some analysts are casting an increasingly skeptical eye at Amazon.com because it is not getting as much benefit from repeat customers as anticipated. Many other dot-com companies have attempted to paper over fundamental flaws in their business models by using their wildly overvalued stock to buy other firms that can contribute to year-over-year revenue growth.
“However, the continuation of this practice is clearly predicated on the continuation of inexplicable valuations on dot-com stocks, which is unlikely to be a permanent condition of the stock market.
“Instead, firms active in the Internet arena eventually are going to be forced to compete. To be successful, companies will be required to combine sound fundamental business practices with the emerging practices expected by increasingly Internet-savvy customers.