Welcome to the End of Company Profits By Michael Lewis

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From: Dan Kohn (dan@teledesic.com)
Date: Fri Mar 10 2000 - 17:33:56 PST


Welcome to the End of Company Profits
By Michael Lewis

(Michael Lewis, the author of ``Liar's Poker'' and ``The New New Thing,'' is
a columnist for Bloomberg News. His opinions don't necessarily represent
those of Bloomberg News.)

New York, March 10 (Bloomberg) -- Since the Dow Jones Industrial Average
reached its record high on Jan. 14, the ``blue chip'' benchmark has
plummeted 15 percent, while the Nasdaq stock index has soared 24 percent.
This new trend in the U.S. stock market is even more unsettling than the
indiscriminate bull market of the past nine-plus years.

The sort of big established companies with lots of profits that make up the
Dow find themselves lunging toward a bear market, while the newer, smaller
companies that make up the Nasdaq are still seeing their stock prices rally,
no matter how much money they lose. This is exactly the opposite of the way
a stock market is meant to function. So why is it functioning this way?

Oneexplanation, widely offered, is that the markets have finally wised up to
the fact that the Old Economy and New Economy are no longer uneasy partners,
but enemies, in the miraculous U.S. economic expansion.

Moreover, investors are now treating the struggle between Old Economy and
New Economy companies more and more as a zero sum game. By their handling of
capital they seem to be saying, more or less, that a dollar increase in the
expected future profitability of a New Economy enterprise implies a dollar
decrease in the future profitability of an Old Economy business. Good news
for Amazon.com Inc. and eBay Inc. is bad news for Wal-Mart Stores Inc. and
Sotheby's Holdings Inc.

Goodbye, Profits

That is, the markets have finally bought the argument that Silicon Valley
futurologists have been making for the past six years: Bricks-and-mortar
businesses will not be forced to co-exist with their Internet cousins but
will be devoured by them.

This new way of thinking about the Internet revolution may not be entirely
insane. Old bricks-and-mortar businesses obviously find their profit margins
reduced by Internet competitors, and therefore should be less able to
attract capital.

But the new way of thinking isn't entirely sane either. The reduction in Old
Economy profits does not imply anything about New Economy profits. It is not
merely the profits of Old Economy firms that are threatened by the Internet.
It is corporate profits, period.

This is especially true of the New Economy firms with the best-known brand
names, those involved in e-commerce. Take Amazon.com. The company behaves
more like a charity than a business, selling books at, or below, cost.
(There has never been a better time to be a best-selling author.)

Amazon.com's astonishing stock market success -- its shares are up about
3,800 percent since going public in May 1997 -- is premised on the belief
that after some indefinite period, the dust will settle on the Internet
boom, and Amazon.com will be among the few companies left standing. Then,
presumably, it will cease to sell New York Times bestsellers at cost.

Goodbye, Loyalty

But the success of Amazon.com is itself evidence against its core beliefs
about the way its business will one day work. After all, customers
previously believed loyal to independent bookstores and to Barnes & Noble
Inc. were happy to drop their old fashioned merchants once Amazon.com
offered them an easier, cheaper way to buy books. And you'd expect an
e-customer to be even less loyal than a bricks and mortar customer, as it is
so easy for the Internet buyer to shop around.

And why should the newly acclimated mass of e-customers have anything like
the inertia of bricks and mortar customers? Amazon.com has taught them to be
disloyal shoppers.

Given this, and the absence of any of the old-fashioned barriers to entry
for would-be competitors, it will be impossible for Amazon.com to price much
profit into its products. The same argument can be made for virtually every
e-merchant. And if the merchants cannot find profits, the businesses that
serve the merchants won't either.

Better Mousetraps

Today the stock markets are saying that the New Economy will spawn new
businesses that are not less but more profitable than the Old Economy ones
they replace. It's hard to say why New Economy investors believe this.
Perhaps they are -- as University of Michigan psychiatrist Randolph M. Nesse
has proposed -- heavier than average users of anti-depressant drugs. Or
perhaps they assume that any company that builds a better mousetrap, as
Internet companies often do, must be paid well for it.

But there is a paradox at the heart of the Internet: It builds better
mousetraps that don't pay very well. It increases efficiency at the same
time it eliminates the possibility of profit. It has created a social and
economic revolution on the scale of the Industrial Revolution, with no real
economic justification.

Then again, perhaps investors don't believe anything at all about the New
Economy. They just think other people do.

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