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Best Business Books: Internet

Of Bits and Books and the New Economy

(originally published by Booz & Company)

The financial Internet “bubble” was inflated on August 5, 1995, when a company called the Netscape Communications Corporation held its initial public offering. On that day, Netscape’s stock rose 107 percent. Netscape ended the trading day with a market capitalization of $1.03 billion on quarterly pre-IPO revenues of $11.9 million and losses of $1.6 million. At the time, that made Netscape’s IPO the most successful in history. Over the next five years, hundreds of Internet-related companies went public, raising billions from the public markets.

Netscape is an apt symbol for how quickly the Internet raged into public consciousness. After all, it was only two years earlier, in the summer of 1993, that Netscape’s cofounder, Marc Andreessen, an undergraduate computer science major at the University of Illinois, had released Mosaic, the free beta version of the first Internet browser. A simple piece of software, it instantaneously mutated the Internet’s look and feel, from arcane Unix commands to the point-and-click world of WYSIWYG (What You See Is What You Get). Two years later, as the bell closed on Netscape’s first Nasdaq trading day, Andreessen’s stock was worth $58 million.

Just as it was easy to justify the wild valuations and IPOs of the period from August 1995 to the Nasdaq crash in April 2000, today it is equally easy — and naive — to claim that the whole Internet phenomenon was merely some sort of bubble economy, fueled entirely by greed and the willful naiveté of investors looking for one sure bet after another. Anyone involved in the New Economy, be it journalists like myself (at the time, and still, a contributing editor to Wired), new Internet startups, or divisions of “old economy” companies hoping to profit from moving into the dot-com side of business, had an interest in claiming that an economic revolution was at hand. Implicit in this notion of a historic transition to a new economic era was the premise that the Internet was not merely a technology, but rather the next step in human, and social, evolution.

Analysis by Analogy
Today, many of the same cast of characters have an interest in seeming sagacious and prudent: After the orgy, probity rules.

Nonetheless, something happened from 1995 to 2000; it wasn’t just a case of one confidence game after another. Forget the social impact of the Internet for a moment, which is real and ongoing, regardless of what the Nasdaq might have us believe. What, if any, new business lessons were learned from this period? What, if anything, was new in the New Economy? With this in mind, it is time to revisit some of the New Economy books that came out toward the end of the 1990s, when enough publishers, trailing the investment bankers, had figured out that there was something to cash in on.

Where to begin? On Barnes & Noble’s Web site I found 49 titles that matched the criterion of “economic aspects of information technology of information society,” which is a search engine’s way of saying “books about the New Economy.” Even more can be found if you search by “digital” and “business” — 200 titles match that combination. The titles were peppered with the requisite “big change” buzzwords: Practical Strategies for Competitiveness in the New Economy, Succeeding in the Digital Culture of Tomorrow, Unchained Value: The New Logic of Digital Business, and so on.

It all seems a bit suspect by today’s standards; most of these books are embarrassing to carry around. I was seen on the beach reading Evolve! Succeeding in the Digital Culture of Tomorrow (2001), and my companion, whose dot-com went bankrupt, laughed at me, rolled over, and continued reading Vanity Fair.

If there’s a fundamental critique to many of these New Economy books, it’s the precept that there ever really was such a thing as a “new” economy between 1994 and 2000. More realistically, there was a complex financial Ponzi scheme, the U.S. version of the schemes that brought Albania and Russia to their knees in the early 1990s. Whereas tricksters in those countries willfully defrauded the public by promising astronomical rates of returns on deposits while embezzling the deposited funds, Internet IPOs were more rational. After all, these IPOs had been filtered through the hands of seasoned investors, starting with venture-capital funds, ending with blue-chip investment banks. If these people put their money into, why shouldn’t you?

Implicit in the New Economy was the idea that no one over the age of 30 could understand the Internet, and that the economic precepts that had guided finance  were no longer valid. There were new rules, and just because an investor didn’t understand them didn’t mean he shouldn’t invest in Internet-related companies.

As the house of cards collapsed in 2000, leaving persistent rumblings that the U.S. Attorney’s office in the Southern District of Manhattan was preparing to let loose a hard rain of indictments on some of the best-known investment banks on Wall Street for collusion and price fixing between analysts and underwriters, publishers disgorged one last flow of New Economy books to bookstores across America. It’s no wonder they haven’t sold.

In general, the majority suffer from a single flaw — analysis by analogy. Because there’s so little quantitative information on the New Economy, so little evidence of successful companies, writers are often left to string together case studies: first-person descriptions of working at and how the under-30 management relates to their over-30 colleagues.

Better Takeaways
So, which, if any, New Economy books are worth buying? We could dissect the bad, but it’s more relevant to examine the good, and at least two books stand out as taking a more rigorous approach than many.

Unchained Value: The New Logic of Digital Business (2000), by Mary J. Cronin, is one. Cronin, a professor of management at Boston College, breaks out the “new value system” of the “digital economy” into a set of discernible processes that are still valid today. According to her model, the New Economy is really a new value chain grounded in information management and relationships with vendors and customers. Cronin’s central thesis is that monolithic, centralized enterprise resource planning (ERP) systems are giving way to disaggregated, modular information systems, with aspects of the information flow controlled by various players (both competitors and partners) that all have to share information to maximize the value of the network.

Where her thesis gets wobbly, in hindsight, is the conclusion that this will level the playing field between large and small corporations. Where once large corporations enjoyed an economy of scale from their IT infrastructure, Cronin writes, this “is well on the way to being commoditized as high-powered vertical marketplaces provide end-to-end online trading, distribution, and supply chain management services that are open to all.” The prime example she cites of this phenomenon is a company called OpenSite Technologies, which was acquired by Siebel Systems Inc. in May 2000 for $542 million in Siebel stock. Siebel’s primary line of business is selling ERP software, albeit software that now runs on Web servers as opposed to mainframes.

The open, dynamic trading networks forecast in Unchained Value are looking more and more like the old model of ERP systems, with companies making tremendous capital expenditures expecting to get proprietary information, thereby increasing their competitiveness and raising barriers to entry against new players. With this in mind, it’s hardly worthwhile to study Cronin’s rules for launching a “digital value system,” when the rules for networked systems are the same ones that shaped ERP in the 1980s. Just because enterprise data is in XML (the flexible computer language used to create common information formats and enable sharing of both the format and the data using Internet technology), as opposed to an arcane COBOL format, doesn’t mean it’s open to the world. It just means it’s easier to import and export information. Whether one chooses to make a system open, regardless of the standard it’s coded in, is a business issue, and it seems that, by and large, closed COBOL systems have merely been replaced by closed XML systems.

Given the healthy cynicism that the reader, circa fall 2001, now feels toward New Economy books, it’s refreshing to pick up a volume from 1999 that opens with a hearty dose of curmudgeonry. The authors of Information Rules: A Strategic Guide to the Network Economy, Carl Shapiro and Hal R. Varian, are both professors at Berkeley, and together they’ve written a surprisingly age-free book that holds up admirably in today’s bruised times: “The thesis of this book is that durable economic principles can guide you in today’s frenetic business environment. Technology changes. Economic laws do not.”

What distinguishes Information Rules is a rigorous attempt at quantifying change through economic models, as opposed to models-by-analogy. Since no one, certainly not New Economy business managers, has time to read books anymore, it’s best to cut to the chase, and get to the “takeaway,” as PowerPoint jockeys put it.

The takeaway in Information Rules is that what makes the New Economy new is the confluence of two powerful forces — supply-side economics and demand-side economics. The first, and older, force, supply-side economics, is the traditional effect of economies of scale. It simply states that larger companies tend to have lower unit costs. General Motors is a classic example of traditional economies of scale at work. What complicates things, however, is that companies have a natural “ceiling,” a point at which the complexity of running and maintaining the organization starts to undercut whatever economies of scale exist (again, General Motors is an example). Or, as the authors of Information Rules put it:

Positive feedback based on supply-side economies of scale ran into natural limits, at which point negative feedback took over. These limits often arose out of the difficulties of managing enormous organizations. Owing to the managerial genius of Alfred Sloan, General Motors was able to push back those limits, but even Sloan could not eliminate negative feedback completely.

Enter a new force: “network economics.” This force, a creature of the Information Age, is driven by demand-side economics, as opposed to the supply-side economics inherent in the economies-of-scale theory. In the economy of networks, demand creates efficiency. The authors cite Microsoft as a classic example:

Microsoft’s dominance is based on demand-side economies of scale. Microsoft’s customers value its operating systems because they are widely used, the de facto industry standard. Rival operating systems just don’t have the critical mass to pose much of a threat. Unlike the supply-side economies of scale, demand-side economies of scale don’t dissipate when the market gets large enough: if everybody else uses Microsoft Word, that’s even more reason for you to use it too.

It’s just not much more difficult to sell 10 million copies of MS Word than 1 million, especially when it comes bundled and preinstalled on other companies’ computers, such as those sold by Dell and Compaq.

The kicker here is not demand-side economies of scale in action. They’ve been around for a while, as evidenced by earlier standards wars, such as Betamax versus VHS (where the “better” technology lost out to the more “open” technology; consumer demand preferred the openness of VHS to the picture quality of Betamax).

What really makes the New Economy new is the convergence of supply-side and demand-side economics into one powerful force. The trick is finding an industry that is naturally subject to this convergence of effects. Most are not, and probably never will be. Either they move too many atoms (General Motors, for instance), so the complexity of supply-side management will always stalk them and constrain growth, or they’re just too “virtual” and can’t function by being “closed.” This is the plague of so many dot-coms — in the attempt to get eyeballs, they never charged for anything, and thus, while enjoying certain demand-side effects, couldn’t monetize everyone’s attention. Examples of a company that enjoyed the “double whammy,” as Shapiro and Varian put it, are rare. They cite Nintendo (more than 100 million Game Boys sold to date). Others I would add: eBay, ICQ (now AOL Instant Messenger), AOL itself, Microsoft, and possibly Palm.

To Have and to Hold
It’s revealing that all of these examples, with the exception of eBay, are tied into physical, real-world products. Windows ships on a physical PC. AOL either ships on a PC or, rarely now, comes on CD-ROM or diskette. The Palm OS comes on a PDA, built by Palm, Handspring, or companies like Kyocera, which makes hybrid PDA/cell phones. ICQ, if it hadn’t been for its acquisition by AOL, was probably doomed to a death spiral, as it had no sources of revenues other than rapidly falling banner ad CPMs.

What’s new in the New Economy is the ability to combine a proprietary standard that serves as a barrier to entry (be it the Nintendo operating system or the AOL application) with easy economies of scale and a proven revenue source from a physical object (Game Boy units and cartridges; Dell laptops with Windows on them; Visors with the Palm OS). People like to pay for atoms. They’ll pay for bits, but those bits are best tied to a physical object, as the audio CD versus MP3 battle demonstrates: A kid will pay $16.99 for Madonna’s new CD, but won’t pay anything close to that for its MP3 equivalent. Why? Because with an MP3, there’s nothing to hold.

Ultimately, eBay is the most interesting phenomenon of all. If there is one true New Economy company that only the Internet could have created, it is eBay. It embodies all the elements that every business student has ever aspired to: minimal production costs that stay effectively flat in proportion to escalating demand; no inventory or distribution costs; inherent word-of-mouth marketing; pricing decisions managed entirely by its customers. What is there to do at eBay? I’m sure managers there would tell me that they have lots to do. But compared with Microsoft or General Motors, or just about any other profitable company on the planet, it seems that aliens could swoop down and kidnap all of eBay’s work force, and the place could just run itself on auto-pilot for a long while, until someone noticed the return of guns and human organs for sale. Other than that, we’d never be the wiser.

How do we make more successful companies like that? For some reason it’s very hard. Information Rules doesn’t have the secret formula for success, but it comes closest to giving us a primer on how to think about these issues. Especially today, as emphasis has shifted from the completely virtual company to hybrid atoms-and-bits companies that sell something tangible, Information Rules’s emphasis on linking traditional business models to the opportunities and challenges of a networked economy remain insightful. If there is one New Economy business book that has the shelf life to make it through these economic times, that’s the one. Of course, if you’re looking for the magic potion that will solve all your Internet problems, there isn’t a book out there with the recipe. If there were, one thing is certain: The author wouldn’t be in the book business.

David S. Bennahum,
David S. Bennahum is a partner at New Things LLC, a New York–based venture-capital group that finances mobile telecommunications infrastructure and software. He is the author of Extra Life: Coming of Age in Cyberspace (Basic Books, 1998) and a contributing editor to Wired. His article “The Biggest Myth of the New Economy” appeared in the First Quarter 2000 issue of s+b.
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