The Internet At 50: How the Dot-Com Bubble Burst

This is the second article in a series reflecting on the Internet at 50. For the first article, click here. 

As the new millennium began, greed, ignorance, and misplaced hopes within the tech world nearly destroyed the financial potential for the internet.  But as described by Harlan Lebo, author of 100 Days: How Four Events in 1969 Shaped America (Amazon,Barnes & Noble), the real message that emerged after the dot-com bubble burst had even more important implications for the role of the internet as an enduring global force.

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“When will the Internet Bubble burst?” For scores of 'Net upstarts, that unpleasant popping sound is likely to be heard before the end of this year.”

                                                – Jack Willoughby, Barron’s, March 2000

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It was too good to last.

By the late 1990s, the internet had evolved beyond anything that the pioneers of digital technology could have imagined 30 years earlier.  From the first crude connections that had linked computers for academics and government agencies, the internet had blossomed into a dynamic and wildly-popular technology for a rapidly-growing public audience. 

And with that popularity, the internet became a river of investment opportunity and potential profits for dot-com developers and entrepreneurs. 

The formation of online companies – quickly dubbed “dot-coms” – became the business trend of the decade. With almost-daily unveiling of new dot-com enterprises, multi-million-dollar investment deals, and even bigger stock offerings, the prospects for a new era of internet-based business never looked brighter. 

From the mid-1990s until 2000, investing in budding dot-coms was the wildest of rides, expanding within an aura of wealth, power, and optimism that had become the hallmarks of the go-go internet world.

Lavish spending on marketing reached a high-profile peak on January 30, 2000, when 14 dot-com companies each paid more than $2 million to advertise during Super Bowl XXXIV – inspiring the game to be called the “Dot.com Super Bowl.”

But behind the extravagant spending and flashy deals festered a problem – a simple, disaster-provoking problem: for the most part, neither the new dot-com companies nor the investors who bought into them had the slightest idea what they were doing. 

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Much of the “growth” of new internet companies was a façade, an industry fed by novelty and perceived investment potential – but in most cases without planning or financial evidence to back up the talk. Hard-boiled financiers threw common sense out the window, investing in companies that, with even a moment of consideration, would have been viewed as the most absurd folly.

In retrospect, investment mistakes are always crystal-clear, but even so, the depth of the miscalculations in the late 1990s now seems unfathomable.

“Investors desperately, desperately wanted the dot-coms to succeed,” said Jeffrey Cole, director of the Center for the Digital Future at USC Annenberg. “Company management offered promises about the potential for their startups, and backers had expectations that had nothing to do with reality.

“The dot-com bubble,” Cole said, “was business plans written on the backs of napkins.”

The problem for many of the start-up companies was demonstrated in a single question from editor Rich Karlgaard to a young vice-president of “business development” at a start-up. When Karlgaard asked if the dot-com was profitable, the executive said, “We’re a pre-revenue company.”

In 2000, the bubble burst.

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What pin had pricked the surface? Some warnings had been coming from calmer voices, but the reckless types viewed the alerts as unwelcome noise. With legions of companies operating with no rational business plans for short-term survival – let alone long-term success – and most roaring ahead with a “grow big, grow fast” mentality, the collapse was inevitable. 

On March 10, the prices of dot-com stocks peaked – the slide began.

An indisputable alarm came on March 20, 2000, when Barron’s, the weekly financial magazine, splashed its cover with drawings of mounds of cash on fire behind the headline “Burning Fast.” The issue featured a study of more than 200 internet firms, with the publication’s analysis of “which ones could go up in flames, and when.” 

“When will the Internet Bubble burst?” asked columnist Jack Willoughby in his column titled “Burning Up” that preceded the study. “For scores of 'Net upstarts, that unpleasant popping sound is likely to be heard before the end of this year.” 

Barron’s followed up the original story three months later, this time with “burn rates” for internet companies that were blazing through their cash at the end of 1999; by the time the list appeared in Barron’s, the problems were much worse. At the top of the list of companies draining their reserves were such now-forgotten names as Netzee, CDnow, Boo, Beenz, eToys, Flooz, Kozmo, and Netivation; none would survive. For many other dot-coms as well, the cash from investors was beginning to run out. 

By April 6, dot-com stocks had lost nearly $1 trillion in stock value.

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The consequences of the bubble’s burst dragged on for several years – the worst of them in 2000 and 2001 – as a growing list of dot-com companies floundered under the weight of too-high expectations and too-low revenue. 

The fate of two companies in particular tells much of the story of the business misjudgments and the misplaced investor enthusiasm that created the dot-com collapse. Perhaps the most high-visibility example of the peak and downfall was Pets.com, which called itself “a new breed of pet store.” 

Pets.com debuted in February 1999 – with financing from some of the premiere venture capital companies – selling a full line of supplies for America’s pet owners. Marketing for Pets.com was backed by plenty of traditional print advertising, but it was the company’s mascot, a sock puppet of a ragged-eared dog that appeared in dozens of television commercials and became the company’s high-profile face to the public.  

The puppet (voiced by comedian Michael Ian Black) became instantly popular with a celebrity presence that extended far beyond corporate marketing: the puppet was “interviewed” on talk shows, and had his own giant helium balloon in the 1999 Macy’s Thanksgiving Day parade. 

But within months, the puppet would become the poster child for the entire meltdown.

Even with such a high-visibility position in retailing, Pets.com was never a sustainable enterprise. The company lost money almost every time a purchase was made, as it sold millions of dollars’ worth of products for as little as one-third of their cost in the hopes that customers could be converted to high-margin buying. 

In spring 2000, Pets.com spent $17 million on sales and marketing, at the same time bringing in half that much in revenue. By autumn, the company was spending $158 for each customer it acquired.

(Perhaps the Pets.com leadership should have heeded the words of their own mascot; among the puppet’s many antics in commercials, it could often be heard singing the first line from the song, “Spinning Wheel,” by Blood, Sweat, and Tears: “what goes up, must come down….”)

Later, many would ask: what could explain the reasons that investors sank money (literally) into the company?

“Perhaps venture capitalists should have been leery of Pets,” wrote tech columnist Mike Tarsala, “since even off-line retailers barely make any margin on pet food – the company's staple seller. The money came rolling in anyway.”

The company’s strategy could not last; less than a year after the puppet balloon floated through Manhattan, on November 9, 2000, Pets.com stopped taking orders, and the company laid off most of its 320 employees. In June 2008, CNET named Pets.com as one of history’s greatest dot-com disasters.

The demise of Pets.com may have been a high-profile debacle, but other meltdowns were even more costly, including several that showed just how unaware dot-com investors could be – even when alerted to problems. 

Possibly the worst of all was Webvan.com, the grocery delivery service, which opened in 1996 operated by a team of executives – not one of whom had management experience in the supermarket industry. 

When Webvan stock went on sale in November 1999 – and in spite of public notices that the company had already lost more than $65 million for the year and warned of losses for “the foreseeable future” – the stock sold for 65 percent over its initial offering price.

With huge expenses – at one point committing $1 billion for construction of distribution centers and delivery trucks – Webvan expanded too quickly, its costs far outstripping its revenue by millions, then hundreds of millions. The prospects for attracting customers were unrealistic and the returns were low; on July 8, 2001, the company website carried the notice, "We're sorry. Our store is temporarily unavailable while it is being updated. It will be available again soon." 

The next morning, 2,000 Webvan employees were laid off, and company closed – eight months after the initial stock offering. Overall, the company lost $830 million – reportedly the largest of the dot-com disasters. 

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But many of the more responsible dot-coms survived the bubble relatively unscathed, including eBay, Priceline, Craigslist, Monster, WebMD, and others that still thrive today. All were companies that had not over-promised and had not over-expanded, and each had something that almost all of the failed dot-coms had lacked: a thoughtful business model based on solid financial planning and realistic projections.

After the bubble, there were some well-earned opportunities for “I-told-you-sos.” In 1999, superstar investor Warren Buffett had warned early investors – those whose stock had risen based on unreasonable expectations – to get out before the end came. 

"After a heady experience of that kind," Buffett said of the gains in previous years, "normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities...will eventually bring on pumpkins and mice." 

Buffett – whose purchases of companies in 2000 did not include a single technology firm – was pummeled by critics for his seeming lack of vision. But in 2001, with his investments intact, he looked back on the fallout, saying, “The fact is that a bubble market has allowed the creation of bubble companies – entities designed more with an eye to making money off investors rather than forthem.” 

When the dot-com dust had cleared, the results were gruesome: by 2004, more than half of new dot-coms – hundreds of companies – had failed. About $5 trillion in stock value was lost. Hundreds of cocky start-up executives who through initial stock offerings had been made instant millionaires – on paper at least – found themselves penniless. 

And thousands of employees – some estimates as high as 85,000 – confident that they had joined exciting and viable ventures, were abruptly on the street. The ripple effects also damaged the value of other successful dot-coms, and of computer and software companies as well.

Perhaps worse – but understandable given the financial debacle – investors temporarily lost faith in new dot-com investments, whether they were sustainable or not: in 1999, 107 start-ups doubled their stock value on the first day; in 2000, the number dropped to 67; by 2001, the number was zero.

Of the 14 dot-coms that advertised on the 2000 Super Bowl, in less than a year, five were gone. For the next Super Bowl, E-Trade, a company that survived the bubble, produced a commercial that showed a chimp riding a horse through a ghost town of defunct dot-coms. The ad ended with the single line: “Invest Wisely.” 

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As a cautionary tale and a business school lesson about irrational investor expectations, no modern example proved better than the dot-com bubble. But even more telling about the role of the online technology in the American experience was the viewpoint that emerged after the disaster which revealed the perception – a hope to some – that the internet was going to wither, if not completely disappear.

“After the bubble burst,” said Cole, “it was amazing to see how many people in industry assumed that the collapse meant the end of the internet itself.”

“We had been studying the internet since the early 90s,” Cole remembered, “and at meetings I would be asked, ‘now that this internet thing is over, what are you going to do now?’ They assumed that when the bubble burst, the usefulness of the internet had ended – and as a result they wouldn’t have to relearn how the business world works. 

“And I wasn’t just hearing this view from leadership in retail – it was journalists, advertising executives, and people in other fields as well. 

“But we knew,” Cole said, “that in spite of the bubble burst, a failure of the internet could not be farther from the truth.”

Those who watched the online world could see that not only was ‘the internet thing’ still relevant, but it was more popular than ever. 

Even while the dot-com debacle festered as daily news between 1999 and 2002, Internet use did not decline at all – in fact going online continued to increase.  By 2001, at the peak of the crash, more than 70 percent of Americans were internet users, and were spending an increasing amount of time online at home every day, and at work as well. 

Even after the collapse of many dot-com retailers, the number of Americans who bought online grew as well; by 2001, half of internet users had also become internet buyers – and continued to buy online. 

In spite of the burst of the dot-com bubble, the message was clear: America had no intention of giving up on the internet.