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End of the beginning for digital economy

The Net economy is not doomed. It simply is experiencing the kind of natural consolidation that recast many other industrial landscapes, from automobiles to banking.

 

Net consolidation is a natural, accelerated business cycle

News.com Special Report 
By Rachel Konrad
Staff Writer, CNET News.com
June 23, 2000, 4:00 a.m. PT

It's been a miserable spring for the new economy.

The tech-heavy Nasdaq Stock Market has lost almost 20 percent of its value since April. E-commerce pioneers have collapsed. Cash-strapped dot-coms have laid off legions of workers.

Is the digital economy doomed?

Hardly. Although disruptive to employees and stock markets, the business of the Internet is simply experiencing the kind of natural consolidation that recast many other industrial landscapes, from automobiles to banking. But along the way, the so-called new economy is beginning to endure some difficult growing pains, felt more acutely than in previous cycles because of the Net's hyper-accelerated pace.

Unlike today, where an explosion of technology companies compete for venture capital, experts predict the Internet economy of 2005 will be a network of established businesses whose influence comes from and stretches around the world. And it will be full of old-world names that many investors Chart: Capital gains have been ignoring--behemoths such as Procter & Gamble, Chevron, Coca-Cola and Boise Cascade.

"The Internet considerably shrinks the size of our universe," said Kenin Spivak, chief executive of Los Angeles-based Telemac, a private wireless technology company. "However, once past the euphoria, the business model for success is no different than any other industry."

Indeed, Darwinian principles have applied without fail throughout the nation's economic history:

• Between 1904 and 1908, more than 240 companies competed in the automotive business. Now there are about 40 worldwide. Robert Eaton, recently retired chairman of DaimlerChrysler, formed from the 1998 merger of Chrysler and Daimler-Benz, has predicted that only about five automakers will exist a decade from now.

• The savings and loan industry soared in the 1980s and pushed the economy along with it as billions of dollars were invested in everything from office towers to windmill farms. But by the early '90s, the industry was a shell of its former glory as scores of S&Ls collapsed under the weight of bad loans and outright fraud.

• Around the same period, consolidation swept the banking industry, which had been largely unchanged since the Depression. By 1996, Securities Data reported that 70 banking mergers valued at more than $1 billion had taken place. In 1997 and 1998, the total number of mergers approached 300.

Although the Internet economy is only a few years old, its unprecedented speed is driving it into this consolidation phase much faster than has happened in other industries. According to Securities Data, 639 Internet-related mergers and acquisitions took place in 1999, totaling $36.7 billion. The rate is expected to rise even more in the next several years.

These are still the growth engines... "Merger and acquisition activity will clearly pick up this year as valuations are corrected, and a lot of these companies come into play," said Todd Bakar, director of research for San Francisco-based investment bank Chase H&Q. "These are still the growth engines of the global economy...but they're going to get a dose of reality."

So what can be expected of these buyouts and mergers, based on lessons learned from previous economic booms and busts? The answer depends largely on what becomes the catalyst for further consolidation.

The current phase of the Net shakeout is almost entirely the result of the severe stock market decline, similar to the collapse of the banking industry after the crash of 1929. Unlike that securities business of old, however, today's market is subject to wild swings--and if the Nasdaq sees another bull run, companies may optimistically decide against merging to rescue their bottom lines.

Yet even with a stock resurgence, Net companies remain vulnerable to factors that have stifled other industries, such as unforeseen competition or legislation. For example, e-commerce companies could suffer further if Congress decides not to extend a current ban on Internet-specific taxes that is set to expire in October of next year. And the antitrust climate in Washington, reflected in the Justice Department's case to break up Microsoft, could complicate business in all sectors of the new economy.

Whatever the reason, most experts agree that the number of players will

shrink during the next five years until several large companies dominate each segment of the Internet: three or four giant portals, three or four giant e-tailers, three or four giant Internet service providers.

Placing bets on the possible victors is risky, however. Today's big and well-known Net firms, such as Amazon.com and Yahoo, could be tomorrow's subsidiaries of Sears and AT&T--or any number of large foreign companies that have recently shown an interest in U.S. Net companies.

"All of these little companies making a splash with IPOs are driving the economy and setting its direction, so we have to listen to them," said Don Heath, CEO of the Internet Society, a nonprofit standards-setting organization for rules governing the Internet. "But the overwhelming majority will be gobbled up by someone more formidable. Most of the companies that created the future won't be around to see it--at least in the form in which they exist today."

Much as engineering improvements fundamentally changed the transportation industry--from ships and trains to automobiles and airplanes--new technologies are expected to dictate the Internet economy's winners and losers.

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Dot-closures
Changes in technology have threatened to wipe out some of the past year's hottest Internet niches altogether. Business-to-business companies, which connect product makers and their suppliers in super-efficient virtual trading posts, may fade after big companies develop software and expertise to build their own marketplaces.

Likewise, portals may languish as powerful search technology enables people to mine data not only from the Web but also from individual PCs scattered around the world. Napster, which allows people to swap MP3 music files with other users, links roughly 10 million desktop PCs--more computational force than all the servers at Yahoo. File-sharing technology from Freenet and Gnutella present an even greater threat by promoting distribution of intellectual property from movies to spreadsheets.

Andrew Whinston, director for the Center for Research in Electronic

U.S. corporations collect 85 percent of international revenues earned through Net transactions and represent 95 percent of the global value of Internet companies. But according to International Data Corp., a research firm in Framingham, Mass., more people will be online in Europe than in the United States next year.

Global e-commerce is already heating up: Terra Networks bought American portal Lycos in May in an all-stock deal valued at $12.5 billion--the first time a U.S. portal has been acquired by a foreign company. France's Vivendi and Canada's Seagram on Tuesday announced a $34 billion all-stock merger that creates a new global media power to rival AOL Time Warner.

But just as the car and TV markets became global industries, the Internet economy is well positioned to do the same--and in much less time. Yahoo, for instance, has 1,500 advertisers on its European Web sites. In the first quarter of this year, Yahoo Europe reported $22 million in revenues, about 10 percent of the U.S.-based company's total.

As the Internet goes wireless and people get email and other information via cell phones and pagers, Europe seems poised to lead the newest phase of Internet growth. In Western Europe, 41 percent of residents use cell phones, compared with 31 percent in the United States. Wireless use is also growing fast in Asia, which already dominates key areas of electronics manufacturing.

Steve Jones, head of the Department of Communications at the University of Illinois in Chicago, said the very idea of the Internet economy is becoming passé as it evolves into the mainstay of the global economy. By 2005, he said, there will be no such thing as the digital economy.

"It's impossible to sort out even what it is," Jones said. "We can talk about the old economy vs. new economy, but the Internet has been so completely absorbed into our economy that that's an artificial distinction that will eventually dissolve."  

 
   Net casualties
Dozens of e-commerce companies have felt the pinch in recent months, as their venture funding and stock market valuations have dried up.
The following have gone out of business:
Toysmart
Red Rocket
Toytime.com
Babytime.com
Foofoo.com
Digital Entertainment Network (chapter 11 reorganization)
Violet.com
Craftshop.com
Surfbuzz
Epidemic Marketing

The following have been bought by another company:
eParties
Petstore.com
Lycos
Boo.com
Reel.com

The following have laid off workers:
Furniture.com
EMusic.com
Salon.com
CBS Internet unit
Oxygen Media
APBnews.com
KBkids
AltaVista
Skymall
Quepasa.com
Amazon.com
Petstore.com
Beyond.com
PlanetRx
MedicaLogic/Medscape
Learn2.com
Living.com
Drkoop.com
Kozmo.com

Source: CNET News.com

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