The future of Internet stocks
To anyone watching worldwide stock prices, prices of Internet-related stocks are a puzzle. I recently saw a table of valuations of 15 major Internet stocks, showing multiples from 8 to 230. This sounds all right, if future growth prospects are tremendously exciting, until you hear that these are multiples of sales and not profits! Thirteen of these 15 stocks had losses in the latest 12 months.
The outfit that I respect the most among these - At Home, a producer of high-speed links into the home - is a striking example. In 1998, it did sales of Rs.142 crore and made a loss of Rs.1290 crore. It has a market capitalisation of Rs.31,820 crore.
The david-and-goliath story of Amazon versus Barnes & Noble now verges on folklore. It parallels the story of how NSE overtook the 120-year old BSE in 1995 by being immune to traditional assumptions. The established bookstore Barnes & Noble owns 1,025 stores and holds inventory of millions of titles. Amazon obsoleted this edge by selling books through the web and holding no inventory. But does it make sense when Amazon is five times more valuable than Barnes & Noble, while it is still making massive losses? There has never been a company which has generated such a great furore by losing so much money.
What future possibilities could sustain these valuations? Are these stocks going to be cited alongside tulips in the history books of the future?
"Owning the net" The first intuitive concept is that since the net is a major development, any firm which can "own" some slice of it is very valuable. An analogy that we sometimes hear is that of settlers going off into an unexplored continent, fencing off pieces of territory.
This concept is hard to make concrete. The net is not finite, like real estate. Nothing prevents a new player from establishing a new operation on the web. The entry barriers thrown up by existing outfits are fairly small. A good new product should be able to obtain market share.
Could entry barriers come from convenience and habit? Would consumers continue to go back to Yahoo, even if better alternatives exist, since they're used to it? The web browser market has given striking evidence on this. If consumers were willing to settle for the product which conveniently came their way, and did not care about product quality, then Microsoft's web browser would command as much market share as Microsoft Windows, which it is bundled with. Microsoft's browser is on 85% of computers when the machine reaches the customer. Yet, on 51 of 85, the customer takes quite some trouble to switch to Netscape. With Yahoo, the cost of switching is even lower: you just have to click here to switch.
At the level of technology, is there a way for a vendor which "owns" vital technology to collect a tax and earn trillions of rupees by charging one paisa per access? Luckily, all technology in the net grew out of university research, with US government funding, and hence went back into the public domain. It uses the "open source" traditions of the Unix community, where the "source code" for all innovations is available to all for use, criticism and improvement. Hence, ownership of the net by any vendor is infeasible. Two non-profit groups of vendor-neutral engineers, called the Internet Engineering Task Force (IETF), and the W3 Consortium, steer the technology.
Vendors have obviously tried hard to inject proprietary technology into the net. Users should exercise care in order to avoid vendor lock-in. If you hear words like "ActiveX", "COM", etc. being bandied about in your office in connection with the net, then you have a problem: these are ways to get vendor lock-in. However, safe alternatives exist in each of these areas and can easily be adopted; you only need to be watchful. For example, the W3 consortium runs a validator where you can supply the URL of any web page that you want to test for HTML standards compliance.
Hence, I believe that even though the technology that went into the net is quite remarkable, there is little opportunity for any vendor to obtain profit from rents on it. Hence, few technology companies figure in the club of "Internet stocks" which have stratospheric valuations. Open source software is a public good for all human kind.
Advertising Can these valuations be supported by the prospects of net advertising? The web now accounts for roughly 1-2% of ad-spend; TV is at 25%. There is little doubt that this will rise dramatically in the future, as consumers shift their viewing time away from TV to the web. Does this imply that Yahoo is worth as much as CBS (the TV giant, which has 37 times the sales of Yahoo)?
- Web ads command less consumer attention than TV ads. They are smaller and have less visual appeal. The TV viewer is relatively listless and undirected, he is more vulnerable to unsolicited advertising. The web viewer thinks about where each click can take him, and is harder to distract using ads. Hence, web advertising in the US, today, runs at rates like $10-$15 per thousand viewers, as compared with $25-$35 for TV, even though web users are richer. The web will shrink the quantity and quality of TV viewer-ship, and hence TV ad-spend, but this reduction won't be fully transferred into web ad-spend.
- It is not clear that the existing Internet companies will be the ones to capture these future advertising revenues.
Retailing Can these valuations be supported by the potential of net retailing? Selling over the web is undoubtedly a way to cut across layers of distribution, and directly reach customers. However:
- For each rupee saved through net-retailing, the consumer will benefit by a lower price to some extent.
- Comparison shopping is easy on the net, and finding the cheapest source is increasingly getting easier. This could shrink margins.
- Manufacturers can directly do retailing, thus obsoleting existing retail channels. But this does not necessarily involve today's "Internet stocks".
Firms in the age of the Internet Ultimately, what the net does is to provide a completely new way to think about advertising, distribution, customer support; i.e. everything that links up firms to consumers and to each other. A
http://www.maruti.co.incould satisfy the advertising, product information, sales and customer support functions of Maruti; this would transform the way in which Maruti sees these business processes. When the net is exploited in this fashion, it will work wonders for Maruti.
In this, we are probably witnessing the embryonic stages of a remarkable re-fashioning of modern capitalism. The scale and scope of this transformation is likely to outstrip all our preconceptions today. But such a future for the Internet does not necessarily translate into profits for the current clutch of "Internet stocks", which need not have a major role in such a re-crafting of Maruti and of every firm in the world. In the cloud of possible futures that flutters around us, only a few paths involve Yahoo being much more than a yellow pages vendor, and Amazon being more than a bookstore.
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