The Dotcom Bubble - Reading Project

MVE220 - Financial Risk

Discussants Group 7

Emilia Nicander: 20010215

Cynthia Aynedjian: 20020508

William Samin: 19990827

Gunnar Löfquist: 19990310

Innehåll
Background................................................................................................................................. 3
The technology ......................................................................................................................... 3
Speculative bubbles ................................................................................................................... 3
Build up to the bubble................................................................................................................ 4
Analysis ....................................................................................................................................... 5
Macro perspective ................................................................................................................... 5
How it affected the overall economy........................................................................................... 5
Small investors’ impact on the dotcom bubble ............................................................................. 6
Micro perspective .................................................................................................................... 7
How the investments affected the dotcom companies ................................................................... 7
Different outcomes for different companies................................................................................. 7
Conclusion .................................................................................................................................. 9
Reading list: ...............................................................................................................................10
Sources .......................................................................................................................................11
Introduction
As the internet began its journey in the 1990s many entrepreneurs and investors quickly got
fascinated over the endless possibilities this new technology could bring. Today, many of
these visions have become reality and the internet is something we take for granted and use in
everyday life. In the late 1990s however, the technology was not yet mature enough to be
commercialized to the extent investors and the rest of society thought. The overconfidence in
the dotcom companies fueled the equity markets, creating one of the biggest speculative
bubbles in economic history. This report will analyze how this speculative bubble could arise
and how the dotcom bubble affected the overall economy from both a micro and macro
perspective. How is it possible for a whole society to forget about financial risk and fiscal
responsibility and base their investments solely on speculative forecasting of a not yet
profitable technology?

Background
The technology
In the 1980s the internet grew commercially as the semiconductor- and optical networking
industry heavily improved. This gave new economic opportunities to deliver the services to
the public. At the time the customer base was around half a million people. After further
improvements with the technology the number of users grew exponentially. In 1990 the
WorldWideWeb was introduced which gave new commercial opportunities. This gave
Stanford Federal Credit Union the chance to offer fully online internet banking services,
which also made them the first financial institution to do so. As technology became better it
allowed the commercial volume to grow reciprocally. Moore's law affirmed this as it
predicted that the performance of a computer should double every 18 months. It is said that in
the late 90s the internet usage grew by 100 percent a year, which also means that the annual
growth of users was between 20 percent and 50 percent. Netscape developed SSL, which is a
method to transfer secure data launched in 1994. This opened for an online shopping market
as the customers now could transfer money safely. The following years many companies
launched their online shopping sites. Until 1995 it was free to register an internet domain, but
it was added a fee as the interest grew. At the time there were around 12000 registered
domains, but the number increased to two million in the following three years which
demonstrates the public interest. (1stwebdesigner.com, 2022)

Speculative bubbles
Speculative bubbles are a recurring phenomenon in economic history. One of the most
famous examples of this, despite the dotcom bubble, is the dutch tulip mania in 1636.
Although the speculative bubbles occur in different forms, it is still possible to find several
similarities. Speculative bubbles consists of 4 stages:
1. Displacement - Expectations are created, which increases investments. However, the
majority of people are still observant and unconvinced.
2. The Boom Stage - When average people realize the opportunity of earning money by
stocks, the value of the assets start to rise drastically. Furthermore, people that have
 not been interested in stocks before start to be involved in it. This means an increase of
participants in the market.
3. Euphoria - In this phase several average investors start to avoid economic models and
their decisions turn into mania. The values of the asset reach a high unrealistic level.
4. Profit-taking - Investors that are experienced notice the fad, realize that the asset is
overvalued and sell. Nevertheless, it is very difficult, even for an experienced investor,
to notice the warning signs.
5. The Burst - The value of the asset decreases as fast as it rose. Everyone that has
invested wants to liquidate.

(Investopedia, 2022)

Build up to the bubble

The dotcom bubble is said to begin at Netscape's initial public offering in 1995. In the late
1990s there was a massive rise in the equity market caused by large investments in internet -
based companies. In 1999, 39% of all venture capital investments were going to dotcom.
Between 1995 and 2000 the tech-dominated Nasdaq index rose from below 1 000 to 5 000. At
the end of 2001 most dotcom stocks went bust, even the shares of blue-chip technology stocks
like intel and oracle lost more than 80% of their value. (Investopedia, 2019)
Analysis
Macro perspective
How it affected the overall economy
The following years after the bubble had burst the economy in different parts of the world was
affected differently. It took Nasdaq about 15 years to regain its value it had in March 2000
and many companies had declared bankruptcy in the aftermath. Overall, the public opinion
about IT companies was damaged. Even companies which were not directly involved in the
dotcom bubble from the beginning were seriously harmed. For instance, Intel, which is a
company noted on the stock market in the 80s fell around 60% and it took them a long time to
recover. The general public lost their trust for the potential of the internet and therefore the
whole industry was slowed down for a couple of years. (studysmarter.de, 26-04-22)

Sweden was one of the countries that was heavily affected by the dotcom boom due to their
early involvement in the bubble. In the middle of the 90s Carl Bildt was the first Prime
minister to send an email to another government. There were also several tv shows about the
stock market and the public interest grew fast. A reason why this occurred may be the
aftermath from the finance crisis in Sweden in the first half of the 90s. In just a few years
Swedish unemployment rose from 2 percent to 12 percent. When the population started to
recover from the crisis and therefore could save more money the interest to invest grew. (IT-
bubblan som aldrig sprack, 2021)

Another reason for the dotcom bubble to grow faster was the development of the new
American economic system. The term emerged in the 90s after a 20-year period of a
slowdown in the economy, when it suddenly changed. Around 1995 the economic growth
accelerated. In America the employment rose and the inflation which earlier were at high
levels decreased. This made the business leaders reconsider their old business models and that
the old laws of economics were irrelevant. Many thought that an improvement in the
computer software would have a bigger effect on the economy than it had. An occasion to this
was that with the internet you could lower the unit cost to almost nothing and the expectations
were unreasonably high. The new economy emerged to describe how new internet companies
could be worth billions of dollars even if they had large losses and small revenues. To
motivate these absurd values, economists came up with the idea to value companies after the
number of employees instead. (ungaaktiesparare.se, 28-04-22)

At the time there were four ideas that dotcom companies followed. Firstly, a business idea
should reach the market as soon as possible to be the first brand the customer would think
about. Secondly, since the internet connection would increase in the following years, every
company should invest more than they needed at the time in the software. Their platform
needed to support several currencies and languages to be able to expand to new markets. The
companies’ homepages had to support images and sound to stand out from the others. Thirdly,
all start-ups should launch their websites in a bigger region than they could manage for the
time. Many companies had offices in other countries even before their service had launched in
the main country. This was not seen as a problem since the company just planned for growth
and therefore were foresighted. Lastly it was important to have a large database about the
customers to understand what their needs were. The meaning of this was to send
advertisements to them and therefore there was a big focus on marketing overall, even if the
company did not have any sales yet. Consequently, did the market overestimate the intrinsic
value of the companies and what they were worth. (internetmuseum.se, 28-04-22)

Small investors’ impact on the dotcom bubble

Market bubbles, like the dotcom bubble, are investing fads, meaning that there is an overall
exaggerated enthusiasm for a specific investment, which eventually is unendurable in the long
term. Accordingly, the main reason that the stock price arises is the expectations on it rather
than the intrinsic value of the companies. (Investopedia, 30-01-2021)

It is important to determine the difference between investing in a fad or a trend, as an investor.

From an experienced investor’s point of view, it is easier to comprehend the difference and
therefore also highly profitable to invest in fads. However, this is not the case for the small
and average investor, who has not any further experience in investing. These types of
investors have more of a herd instinct, which means that they are more likely to invest in
similar investments as others with the belief that others have made their research.
Furthermore, this behaviour is mostly driven by the fear of missing out on a profitable
investment. The herd instinct is proven by several psychological theories, claiming that
people focus more on wealth relative to others’ wealth, rather than on their individual
economic growth. Thus, the relative-wealth is a big concern for humans and is a big leading
factor in the creation of bubbles. (US. News, 2018)

In the case of the dotcom bubble, small investors were misguided by the internet focused
companies and their potential disruptive innovations, which might have replaced big, settled
companies in diverse markets. Therefore, the belief in the growth of these companies
increased drastically, which is observed by the overvalued assets during the late 1990s.
Although the new technology might play a big role in the future, it still has to pass a certain
development in order to presently make it in the market. Several companies focused more on
advertising, which meant that less money was spent on the development of the technology and
the operation. Despite that companies had a vision on how the internet should be used in their
service other factors around it were not sufficiently conceived. This means that the offers
were not as practical as they should be to attract customers. For instance, when evolving e-
commerce, parts as to how the purchased product should be paid and delivered was yet not
discovered.Additionally, many companies were also before their time because the technology
was yet not fully developed. A lot of people did not understand the use of the internet and
neither had the need for the services that were offered. Consequently, many people thought
that the companies would succeed simultaneously as none of them were supporting the
companies’ services through demanding their offers. (Ideas.Ted, 2018)

These behavioural patterns can be seen today as well, and history might repeat itself. This is
clearly illustrated in meme-stocks, which means that high expectations on companies’ growth
spreads faster through social media. (Investopedia, 2022) Accordingly, more average and
small investors that necessarily are not interested in investing in stocks, will indirectly be
involved because of their herd instinct and FOMO (“fear of missing out”). In similarity with
the dotcom bubble, small investors might get misguided, especially when they do not have
any previous experience on stocks and investments.

The results of investing and being unaware of the risks is what happened to several small
investors during the dotcom bubble. As a result of Japan entering a recession, a large sell -out
started, and the technological focused stock prices got affected. Considering that several small
investors only invested by herd instinct, they were not prepared for the big fall out and did not
have the opportunity to sell in time. The losses have been calculated to 5 trillion dollars and
many people were left with enormous debts instead. (CFI, 2015)

Micro perspective
How the investments affected the dotcom companies
Traditionally, is a listed company valued based on its profit and in addition to that the
expectation of what the company's future can generate. During the dotcom-bubble however,
speculative forecasting became the single most important factor in stock valuation. This
resulted in, as previously stated, capital markets throwing money at the dotcom sector during
this internet boom. This led to a race between the startups to quickly get big to be able to
attract investors. The dotcom companies therefore focused a lot on marketing inorder to gain
publicity. At the time, many startups strived to make use of the first-mover advantage, which
can be defined as a firm’s ability to be better off than its competitors as a result of being first
to market. (CFI, 2015) Therefore, some companies spent almost their whole budget on
marketing. However, this aggressive marketing strategy took resources from the main
business. It had become more important to make it on the stock market and be appealing to
investors than making a profitable business since it was possible to get money from investors
even without revenue and profit. The companies lacked the logistic structure to be able to
operate the type of business that their vision would require. (Investopedia, 25-06-19)
Venture capitalists invest money in a contractor for usually about one to two years, then they
exit and expect to sell it for more than they had invested. The feverish stock market meant
that there was a kind of automaticity in this; venture capitalists could make money even on
bad and shaky business ideas since almost every dotcom stock skyrocketed at IPO. Thus, the
venture capitalists often pushed for the market introduction since they could make a lot of
money from it. (Moaffak Ahmed, 2020)

However, after a while, more and more started to realize that the value of many dotcom stocks
was unrealistic. For example, the Swedish company Icon Medialab was worth 4.9 billion SEK
but made a yearly negative result of 250 million SEK. The stock value was merely based on
speculation and lacked value-creating processes. The internet had not yet reached its full
capacity and the customers did not know how to use the platform. The technology was not
mature enough to be commercialized to the extent that the investors thought. (Ibid)

Since the internet-based companies were showered with money, many of them got used to the
abundance and started spending money on unnecessary things. The irrational economic
climate made many lose their sense of fiscal responsibility. (Investopedia, 25-06-19)

Different outcomes for different companies

The dotcom bubble affected a lot of companies world wide which had many consequences,
even bankruptcies. However, even though the burst of the bubble hit most firms, its outcome
varied heavily depending on their fundamentals and ability to adapt to the situation. In order
to conclude factors which helped corporations survive the dotcom bubble, we compare two
different companies and their situation previous to the bubble, during the bubble and the
aftermath.

A company founded in 1994 by the entrepreneur Jeff Bezos, focusing on e-commerce, is one
of the firms in the spotlight from the dotcom bubble (Britannica, 26-04-22). Even though they
work within e-commerce, Bezos stated that Amazon instead was a technology company
working to simplify transactions online. After one year in business with the website, Amazon
had 15.8 million dollars in revenues which then rose to 610 million in 1998 (ibid).
Furthermore, in the beginning of 2000, Amazon sold bonds worth more than 500 million
dollars just one month before the market started to plummet (NY Times, 27-04-22).

Because the company had growing revenues and a large amount of capital when the bubble
burst, they used funds to cut costs where possible. In an interview, Bezos said “The stock is
not the company and the company is not the stock. [...] Every single thing about the business
was getting better and fast.” (Bloomberg, 27-04-22) which describes the fundamental aspect
of the corporation at the time. Moreover, in the interview he discusses what happened when
the bubble burst and explains that raising money in the market crash would be hard, but since
they already had capital to progress it was not an issue for them (ibid). To conclude why
Amazon survived the dotcom bubble burst, there are two major reasons which made a large
impact on the company. Firstly they had a solid business plan with growing revenues and
amount of customers, something that allowed them to see past the plummeting stock and
focus on the fundamentals of the company. Secondly the firm had raised capital just before
the bubble burst, which allowed them to continue to invest funds through the period when it
was difficult to raise capital.
The company Pets.com is another case in the spotlight from the dotcom bubble. Their
business plan was an internet based pet shop where customers could buy supplies for their
pets. Pets focused heavily on promoting their website and completed an initial public offering
in february 2000. Even though their business plan had several questionable parts in it, such as
how they were going to transport dog food and similar things which were heavy, investors
were intrigued and therefore the IPO was successful. However, unlike Amazon, Pets did not
have a solid business to stand on when the market started diving. This meant that investors got
impatient when the firm did not show any profits. Therefore, already in October the stock of
the company had gone from 11 dollars to a mere 0.22 dollars and they had to declare
bankruptcy. A noticeable difference between the two companies, even though both had newly
received funds, is that Amazon’s business plan was more thought through and did not have
any questionable parts within it. Thus, one might reason that is the foremost reason why Pets
did not survive the dotcom bubble. (Investopedia, 27-04-22)
Conclusion
During the build-up of the dotcom bubble the equity market was fueled by overconfidence in
the new technology and what it could bring which led to speculative and fad-based
investments. The large hype regarding the dotcom sector created a “fear of missing out”
making both investors and everyday citizens invest heavily in dotcom stocks. The abundance
of venture capital funding for startups made the market skyrocket. The dotcom companies
began to focus too much on marketing in order to attract investors instead of creating a
profitable business. Later on, investors started to realize that the many dotcom stocks were
overvalued and were not able to turn profit. As the capital began to dry out more and more
companies went bankrupt since their main income came from investors. Japan entered a
recession that caused uncertainty in the market making even more investors leave the market.
The market now started to drop as rapidly as it rose, meaning the dotcom bubble had burst.

Looking back at the dotcom bubble it might seem obvious that it would burst eventually. The
bubble could perhaps have been prevented if the investors had focused more on the
substantial value instead of speculative forecasting when making investments. The dotcom
market and the technology were not yet mature enough to be commercialized to the extent
investors and society thought. The world was so caught up by the vision of the internet that
they forgot to look behind the bright ideas and question the new technology’s ability to be
profitable. The companies should also have focused on developing the operations and making
a profit instead of just marketing in order to create a business that would make it in the long
run and therefore not be as dependent on investors. If the banks would have informed their
customers about the big financial risk of investing in internet-based companies then many
citizens might not have had to lose as much of their savings, thus the socioeconomic
consequences could have been reduced.

As seen many times in economic history, speculative bubbles are notoriously hard to
recognize while happening but seem obvious after they burst. Most likely, we will see bubbles
like the dotcom occur again in the future. However, by studying the build-up of previous
bubbles we might get better at recognizing the financial risk and spotting the signs earlier on.
Reading list:
For those who want to learn more about the dotcom bubble and its impacts, we have put
together a reading list below:

• A one hour long documentary produced by SVT about the dotcom bubble, mainly
focused on the Swedish perspective. https://www.svtplay.se/video/30165160/it-
bubblan-som-aldrig-sprack

• Over all facts about the dotcom bubble. An article by the Corporate Finance Institute.

https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/dotcom-
bubble/e
• An article from Luleå Tekniska Högskola about the dotcom bubble. https://www.diva-
portal.org/smash/get/diva2:1026991/FULLTEXT01.pdf

• A radio documentary produced by P3, Sveriges Radio

https://sverigesradio.se/avsnitt/93814

• An article about five companies in the dotcom sector that survived even after the
bubble burst.
5-successful-companies-that-survived-the-dotcom-bubble.aspx
Sources
Bloomberg (2018, 20 September) Jeff Bezos Says Amazon Stock is ‘Not The Company’.
Bloomberg TV. https://www.bloomberg.com/news/videos/2018-09-20/jeff-bezos-says-
amazon-stock-is-not-the-company-video

Bloomberg News (2000, February). Amazon Sells Convertible 10-Year Notes. The New York
Times. https://www.nytimes.com/2000/02/12/business/amazon-sells-convertible-10-year-
notes.html

Britannica. (2022, 2 April). Amazon.com Retrieved 26-04-22 from

https://www.britannica.com/topic/Amazoncom

Britannica. (2022, 7 April). Internet Retrieved 26-04-22 from

https://www.britannica.com/technology/Internet/Foundation-of-the-Internet

Corporate Finance Institute. (2015). Dotcom Bubble Retrieved 27-04-22 from

https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/dotcom-bubble/

Internetstiftelsen. (n.d). Så var it-boomens affärslogik Retrieved 26-04-22 from

https://www.internetmuseum.se/tidslinjen/sa-var-it-boomens-affarslogik/

Investopedia. (2019, 25 June). Dotcom Bubble Retrieved 26-04-22 from

https://www.investopedia.com/terms/d/dotcom-bubble.asp

Investopedia. (2019, 31 October). Why Did Pets.Ccom Crash So Drastically?

Retrieved 26-04-22 from
https://www.investopedia.com/ask/answers/08/dotcom-pets-dot-com.asp

Investopedia. (2021, 30 January). Investing fads Retrieved 26-04-22 from

https://www.investopedia.com/terms/i/investing-fads.asp

Investopedia. (2021, 15 August). 5 Successful Companies That Survived The Dot-com Bubble
Retrieved 26-04-22 from
https://www.investopedia.com/financial-edge/0711/5-successful-companies-that-survived-the
-dotcom-bubble.aspx

Investopedia. (2022, 22 February). Meme Stock. Retrieved 27-04-22 from

https://www.investopedia.com/meme-stock-5206762

Anatomy of a Crash: The dot-com bubble (2020, 1 April), Cooler future, Moaffak Ahmed.
Retrieved 27-04-22 from
https://www.coolerfuture.com/blog/anatomy-of-a-crash-dot-com-bubble

IT-bubblan som aldrig sprack. 2021. Sveriges television, SVT1, 21 february

https://www.svtplay.se/video/30165160/it-bubblan-som-aldrig-sprack

StudySmarter (n.d). Dot-com Bubble

https://www.studysmarter.de/en/explanations/economics/macroeconomics/dot-com-bubble/
How Technology and FOMO Create Stock Market Bubbles, (2018, 15 February), US. News,
Money. Retrieved 27-04-22 from
https://money.usnews.com/investing/investing-101/articles/2018-02-15/how-technology-and
-fomo-create-stock-market-bubbles

Örnéus, K (2020, 24 June) 20 år sedan IT-kraschen Unga Aktiesparare

https://www.ungaaktiesparare.se/artiklar/20-ar-sedan-it-kraschen-0

1stwebdesigner. (n.d). The history of online shopping – from the 1960´s to the 1990´s,
retrieved 29-04-2022 from
https://1stwebdesigner.com/history-of-online-shopping/