Welcome to the End of Company Profits Link (one day only) 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. )2000 Bloomberg L.P. All rights reserved.

-- Possible Impact (posim@hotmail.com), March 10, 2000

Answers

With the simplicity of Internet company business models, soon it will be possible to use a search engine to pick the lowest price for a commodity, such as a book, from dozens of online suppliers, much as consumers now drive by one gas station to seek a slightly cheaper one down the road. The ease of this capability via the net, however, guarantees that the "New Economy" will be based on convenience and not profit.

And consider all the free email (hotmail.com), long distance (dialpad.com), and internet access (excite.com) "companies" now popping up devoid of any net earnings.

When the idiots now falling over themselves to buy inflated NASDAQ stocks finally realize this, we will see the greatest stock crash in history, bar none.

-- Tommy Tulip (@ .), March 10, 2000.

On the positive side, a competitive marketplace is a boon for consumers. One critical element of a competitive market is free and full information. The Internet allows consumers access to information making oligopolistic behavior much more difficult. Contrary to Lewis, this does not eliminate profits... it simply lowers them. The price of a good (or service) in a competitive market must include "normal" profit... in the long term.

The Amazon.com phenomena is based on an EXPECTATION of future profits. Upon this expectation, investors are speculating wildly. Amazon.com is worth the current valuation only if it meets these expectations.

The NASDAQ is like a horse race where thousands of dot.coms are running. Only a few of the companies will emerge to "win" the marketplace. And what happens to the investors who bet on the rest? The stock will be little different than the losing tickets at the local racetrack.

The speculative bubble of the Internet is based on a theory... that the 'net is more than an online version of the Home Shopping Network or catalog browsing. The Internet bubble depends on the notion that firms will be able to profile customers in such great detail, they will be able to target market with amazing success. This type of profiling (and the buying and selling of personal data) is opposed by privacy advocates. If the privacy group win some successes, you'll see some dot.coms headed down.

-- Ken Decker (kcdecker@worldnet.att.net), March 10, 2000.

I see a major crash coming.

I called it wrong in 1999 because I was not aware of the major influx of liquidity which the FED spread across the board to banks and investors.

Several months have passed, and the monies have been channeled mostly into tech stocks, which have boomed out of control. Greenspan knows he cannot stop this mania except by drastically increasing interest rates. But if he does so, then *BOOM*. And if he lets it blow off, then *BOOM*.

This game will end badly with few winners and many losers. There's no way this stock market can be sustained until the elections. The factor of FEAR is near...

-- dinosaur (dinosaur@williams-net.com), March 10, 2000.