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The World That Never Was

by Glen Emerson Morris

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The loss of some 4.6 trillion dollars by investors in the stock market due to the technology crash raises some valid questions about the future of e-commerce, but contrary to what some of the market analysts are saying, the current market crash doesn't question the basic validity of e-commerce. What crashed was a market based on speculation, and an assortment of very dubious assumptions, nothing more.

Many startups were based on business plans that assumed it was going to be possible to have a monopoly on some kind of market segment, from pet supplies to groceries, and that the payoff from that monopoly would be astronomical. All they had to do to win was be the first, and be the biggest, so the theory went. It didn't bother analysts that in some cases companies were paying $200 in acquisition costs for every customer they made a sale to, or that they lost money on every sale they made, even after leaving out acquisition costs. In the end, the market share would make it all worthwhile, so the theory went. In reality, things went differently, very differently.

In one case, a startup founder raised hundreds of millions of dollars by selling the idea that his company would eliminate the middlemen between producers and consumers, and make a fortune in the process. The business was able to get lots of orders when it finally went online, hundreds of millions of dollars later, but a problem turned up when the orders were turned over to the product's manufacturers. The manufacturers weren't setup to ship directly to customers, that's what they depended on the middlemen for. By the time this problem became apparent to stockholders, the founder had cashed out over 50 million in stock and retired to a mansion in the South.

Repeatedly, in the world of e-commerce startup investing, a number of basic assumptions were made that were, at best, profoundly optimistic, and more often than not, completely groundless. In effect, many e-commerce businesses were designed for a world that never was.

Assumption one: a monopoly is possible on the Internet. This overlooks the fact that the Internet architecture is based on decentralization, and was deliberately designed to resist centralization. It also overlooks the fact that Internet transactions don't scale well, especially when it comes to the hardware, software, and engineering it takes to support them. It's very easy to support a Website the sell several thousand items a day, but it's very difficult to support a site that sells several million items a day.

Assumption two: the business that gets there first, wins. This overlooks so many historical examples to the contrary, like Apple's Newton or the IBM and Apple personal computers, that you have to wonder if the rumor was started by stockbrokers just to encourage sales. Whatever the origin, in practice, this assumption led to a rush job on the software programming that made these sites possible, which frequently caused major malfunctions once the business started using it. In one case, an e-commerce pet supply's website was accidentally programmed to send the wrong brand of dog food to customers, and the company's customer service representatives, without orders to the contrary, just told customers to keep the crates of the wrong brand, and sent them crates of the brand they actually ordered. Between lost inventory and extra shipping charges, the hit on income was enormous. It was also unnecessary, since it could have been avoided by taking adequate time to program and test the Website's ordering system in the first place.

Assumption three: market share matters more than lack of profits. In reality, lack of profits always matters. Market share might offset relatively lower profits, but it can't offset losses.

Assumption four: it's both necessary and possible to work programmers and other high tech employees sixty to eighty hours a week on a permanent basis. In reality, tired people don't think very well, and the long-term consequences of over-working employees tend to be expensive. The FAA won't let pilots fly if they haven't had enough rest; programmers shouldn't program if they haven't had enough rest either, at least not if money is at stake.

Assumption five: conventional laws don't apply to e-commerce companies. In their rush to be first, many startup founders completely ignored a variety of federal and state laws on everything from labor issues to taxes. In reality, it didn't take long for this practice to catch up with them. Some former e-commerce founders are now being sued by ex-employees for things like unpaid accrued vacation time, and both founders and ex-employees alike are being charged by the government for AMT (alternative minimum tax) taxes for previous gains on stock that's now worthless.

In retrospect, the recent losses on Wall Street due to Webmania take a psychologist to explain, not a business analyst. In many ways, the current situation can only be compared to the Tulipmania crash in the Netherlands in 1637.

Within a century of their introduction to the Netherlands, tulips had become so popular with the rich that small fortunes were spent on rare, mutated, tulips, especially those with unusual coloring. By the early 1630s, trading in rare tulips was so heavy some brokers were making over $40,000 a month, indexed to today's dollars. However, in 1637 the market crashed completely, wiping out many middle class Dutch families.

After the crash, the Dutch didn't give up investing in agriculture, or give up studying how plants could be bred to have different and improved qualities. They just gave up investing in the idea that rare tulips would always be worth a fortune.

The same attitude should be applied to e-commerce. The idea of selling things over the Internet is still a solid idea. It's just that profits are going to have come from good business practices, not theoretical monopolies.

The New Economy is real, and the computer revolution will continue to offer advertisers new ways to connect with consumers with enormous potential. However, some basic rules of the Old Economy are still in effect, and are likely to stay that way. Like the law of gravity, the law of the bottom line is impossible to ignore.

Copyright 1994 - 2010 by Glen Emerson Morris All Rights Reserved

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