The dot-com bubble: Valuation Before Profit
During the dot-com bubble, a company could carry a huge market valuation while still losing money. Amazon offers a striking example: by 1998, its valuation exceeded $14 billion, yet it was not making a profit. Its revenue had increased sharply around its public offering, but that growth had not delivered profitability. Many other internet companies attracted eager venture capital investors despite also being unprofitable. The possibility of future earnings helped draw money into businesses whose present results looked very different from the prices investors were willing to pay for their shares.
The market boom developed alongside wider use of the Internet and the World Wide Web. Computer ownership expanded in the United States. Internet use expanded, although access remained unequal; NTIA reported the divide between income groups was widening in many cases. New startups emerged as information technology became a greater part of the economy. These changes gave the enthusiasm a technological setting: the Internet was spreading, and investors wanted exposure to businesses associated with it. That expansion provided a backdrop for rapidly growing startup valuations and readily available venture capital.
Other conditions made financing easier to obtain. Falling interest rates increased the availability of capital, while the Taxpayer Relief Act of 1997 lowered the top marginal capital gains tax in the United States. That tax change increased willingness to make speculative investments. The Telecommunications Act of 1996 was expected to produce new technologies, and many people wanted to profit from those developments. Against this background, investors became eager to finance dot-com companies at almost any valuation. An Internet-related prefix or a .com suffix in a company's name could become part of its appeal during the dot-com bubble.
Investment banks had their own incentive to encourage the rush. They profited substantially from initial public offerings, most of which took place on Nasdaq, and promoted investment in technology. Rising share prices and confidence in future profits encouraged investors to set aside traditional measures such as price-to-earnings ratios. At the height of the dot-com bubble, a promising business could go public and raise substantial money without having made a profit. Some had not generated material revenue or even completed a product. Employees with stock options could become paper millionaires, although lock-up periods often prevented them from selling their shares immediately.
Inside many companies, the spending strategy favored rapid expansion. Businesses incurred net operating losses while committing heavily to advertising and promotion, aiming to establish market share or mind share quickly. Products and services were offered free or at a discount, with the expectation that enough brand recognition would eventually allow profitable pricing. The slogans included "get big fast" and "get large or get lost." Some companies also spent lavishly on elaborate offices, luxury vacations for employees, and expensive launch parties. Money raised from investors could support aggressive growth efforts before the company had developed a profitable business.
The same period brought a costly expansion in telecommunications capacity. In the years after the Telecommunications Act of 1996, telecommunications companies invested more than $500 billion in fiber optic cables, switches, and wireless networks, largely using debt. Capacity grew much faster than demand. Governments in places such as Virginia's Dulles Technology Corridor funded infrastructure and encouraged expansion through favorable business and tax conditions. When financing became harder to obtain as the dot-com bubble burst, high debt ratios helped drive some companies into bankruptcy. Bond investors recovered just over 20% of their investments, while several telecommunications executives had sold substantial stock before the crash.
The reversal arrived through a series of market shocks and business failures. On March 20, 2000, MicroStrategy announced a revenue restatement, and its shares lost 62% of their value that day. In April, the Nasdaq Composite suffered a steep weekly decline. By June, dot-com companies were reassessing their advertising spending. Pets.com went out of business in November, only months after completing its public offering. Other online shopping companies, including Webvan and Boo.com, also failed during the crash. Amazon and Cisco lost large portions of their market capitalization, showing that surviving the period did not mean avoiding severe market losses.
After the dot-com bubble, the loss of venture capital changed how executives and investors approached operations. A company's remaining lifespan was measured by its burn rate, the pace at which it spent existing capital. Many businesses exhausted that capital and went into liquidation. Advertising and shipping businesses scaled back as demand for their services fell. Yet 48% of dot-com companies survived through 2004, at lower valuations. Layoffs of programmers created a glut in the job market, and enrollment in computer-related university degrees dropped noticeably. Office furniture also became part of the liquidation process, with Aeron chairs sold off in large quantities.