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Published: February 28, 2007

 
 

Lessons of the Last Bubble

Smaller bets can make the next technological boom more productive and enduring.

Illustration by Lars Leetaru
Quiz time: What percentage of dot-com startups have failed?

If you are like most people we have informally surveyed, you probably estimated around 90 percent. A few people posit a slightly lower failure rate; some say the rate was 98 percent or more. Virtually no one assumes that the numbers of dot-com failures and successes have been roughly equal, but that’s what our research found. Of nearly 2,000 business-to-business (B2B) e-Marketplaces launched during the dot-com days, 55 percent remained active for at least two years after September 2002, when the Nasdaq hit its lowest point. (See “Through the Service Operations Looking Glass: An Empirical Model of B2B eMarketplace Failures,” by T. Laseter, E. Rosenzweig, and A. Roth, Darden School working paper.) We conducted a separate study of a random sample of companies seeking venture-capital funding in 1999 and found that the five-year survival rate was 48 percent. (See “Small Ideas, Big Ideas, Bad Ideas, Good Ideas: ‘Get Big Fast’ and Dot Com Venture Creation,” by David Kirsch and Brent D. Goldfarb, Robert H. Smith School of Business research paper no. RHS-06-049, Nov. 2006.)

The misperceptions are understandable. Fresh are the memories of such mega-failures as Webvan and eToys, along with the Nasdaq’s staggering $4.4 trillion drop in market capitalization over the course of the 30 months between its peak in March 2000 and that September 2002 nadir. We now know that the collective business psyche overreacted to the market potential of the Internet, and that led to an inevitable correction. Some pundits are starting to proclaim a new “Web 2.0” era, arguing that we overreacted on the downside as well.

Karl Marx once said that “history repeats itself, first as tragedy, second as farce.” But understanding the lessons of the early dot-com era may help us avoid both tragedy and farce in the face of the next emerging opportunity — whether it be nanotechnology, green energy, globalization, or Internet Boom 2.0. Many of the lessons are counterintuitive, which may explain why history has indeed repeated itself all too often.

Too Few Failures
The 50 percent failure rate of the dot-com era still seems high, until we put it into perspective. Compare the dot-coms to other business realms: From 1996 to 1998, for example, the survival rate for independent restaurants open for three years ran 39 percent. That is, a form of business with a very measurable market, using cooking technology that has existed for decades or more, failed 61 percent of the time. By omparison, the failure rate of Internet-based businesses tapping unknowable market opportunities with an unproven technology platform seems far more tame.

Perhaps this data simply suggests that the dot-com era was an overall success. Despite the trillions of dollars of market capitalization lost when the Internet bubble burst, maybe one should celebrate that the losses were not greater. But we disagree with this perspective. In fact, we bemoan the low failure rate.

To be clear, we do not wish that more startups had failed. Rather, to us, the low failure rate indicates that too few entrepreneurs were funded and too few new ventures launched. Had twice as many been launched, the short-term failure rate for individual businesses might have been higher, but a larger number of successful business models would probably have emerged, and these would have led to more enduring businesses in the long run.

As Kenichi Ohmae suggested in The Invisible Continent: Four Strategic Imperatives of the New Economy (HarperBusiness, 2000), the dot-com era was like the exploration boom that launched the United States’ westward movement in the 18th and 19th centuries. The Internet opened up an entirely new continent for colonization. Many venture pioneers sought to settle this new land. Upon reflection, the fact that so many companies survived suggests that the first wave of the dot-com revolution suffered from too little entry, not too much. The hype-happy phase of the bubble created a land-grab mentality, with early entrants seeking to control the high ground rather than continue exploring. And, when the bubble burst, new explorers could not get the funding to start a new expedition of the remaining uncharted territory. Had the fall not been so dramatic, more firms could have sought to productively exploit the new terrain.

 
 
 
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