Net consolidation is a natural, accelerated business cycle
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 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.
"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.
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 Commerce and professor of information systems, economics and computer science at the University of Texas, says the recent legal battles over digital music show that few people fully understand how quickly the Internet forces business models to change.
"We're still in the midst of the revolution, and there's no business model to deal with the revolution--so people just sue companies while they're trying to get their act together," he said. "We're still seeing the shooting going on."
In the long run, Whinston and other experts say an examination of the Internet's short history shows that its economy is still fundamentally sound and poised for long-term growth. They cleave the Internet economy into three periods:
The first phase started in the late '60s with the creation of the Arpanet, the forerunner to the Internet developed by the government and academic institutions. It ended with the introduction of the World Wide Web in the early '90s--before many commerce and business models became clear.
The second phase began when new applications sparked competition--beginning with the first Mosaic browser in 1993 and ending with the U.S. government's antitrust suit against Microsoft in 1998--a period when entrepreneurs wrested the Internet from academics, and business models, however shaky, emerged.
The third and current phase is when the Internet tapped the mainstream--the founding of Amazon.com and the growth of e-commerce starting around 1998. By 2002, e-tailing is expected to generate more than $41 billion in the United States alone, more than triple the estimated online sales of $11.9 billion for this year, according to research firm Jupiter Communications.
With or without corporate consolidation, the Internet is already making more of a financial impact in roughly four decades than the automobile industry did in a century. The Net economy exceeded $500 billion in revenues in 1999, compared with roughly $350 billion for the automakers, according to a study by the University of Texas for Cisco Systems. Researchers expect revenues this year to top $850 billion.
The study shows the Internet to be an even hotter and faster-revving economic engine than had been thought. The Net economy grew 174.5 percent from 1995 to 1998 and 68 percent from 1998 to 1999.
As this growth continues, the power bases behind the Internet economy could change with global expansion--along the lines of the shift from American-made automobiles and consumer electronics to Japanese products in the 1960s and '70s. Many believe that the medium, long dominated by U.S. consumers and e-commerce with English as the Web's unofficial lingua franca, will change dramatically as its international usage rises.
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."
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