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The Real Meaning of the Internet Economy

"Arguing in My Spare Time," No. 4.03

by Arnold Kling

January 23, 2001

The February 2001 issue of FastCompany contains an interview with Marc Andreessen. The magazine asked the former Netscape founder what he believes to be true about the Internet economy, given that the deflation of the bubble has exposed a number of fallacies.

Andreessen's responses indicate that his current opinions stick pretty closely to what he believed before the bubble. I share that point of view. In particular, my beliefs about the real meaning of the Internet economy also are consistent with those that I held before the bubble.

Probably what struck me most about the Internet when I became aware of it late in 1993 is the potential to reduce the capital intensity of businesses. Now you can have a software company without having to manufacture shrink-wrapped boxes. You can have a newsletter without paying postage and printing. Using a web site, you can engage in marketing without buying mass-market advertising. You can process sales worldwide without having to build a chain of stores.

Because of the Internet, it has become easier for people to organize into smaller business units. You no longer need to plan and manage large capital expenditures, so you do not need a large bureaucracy. What I expect the Internet to generate is an increase in the number of small businesses, and a reduction in the proportion of the population employed in large enterprises.

For the past 150 years, the trend has been toward large enterprises--the organizations of the Dilbert sector. During that span, we have moved from family farms to cube farms. Now, I am suggesting that the migration will start to reverse. Not back to agriculture, but back to smaller enterprises where individuals have more autonomy.

Not everyone will join this reverse migration. I would not want to fly in an airplane that was assembled by trial-and-error rather than careful planning. I do not want my bank to be a guinea pig for the latest software. There are plenty of organizations that ought to be bureaucratic.

Not everyone agrees with the vision that the Internet facilitates small businesses. Many pundits saw the Internet as simply another industrial revolution. They expected consolidation to take place in the Internet economy. It often is pointed out that the number of automobile manufacturers shrank dramatically from 1900 to 1950.

However, Internet businesses do not need the same level of capital as automobile manufacturers. Internet-based services do not need a large-volume assembly line that produces "any color as long as it's black," in Henry Ford's famous phrase. The Internet carves the mass markets of yesterday into narrow niches. Narrow niches can be served by small businesses.

The optimum-sized business in the Internet era may not have enough revenues and profits to be traded on the stock market. This is only fitting, since the Internet business also does not require the massive amounts of capital that the stock market is designed to raise.

The Internet bubble was an anachronism. Egged on by venture capitalists and the media, investors made huge bets that the Internet would follow the path of an industrial economy. The hypothesis was that well-capitalized companies would capture large, winner-take-all markets. The demise of the dotcom stocks reflects the falsification of that hypothesis.

The collapse of the dotcom stocks may look like consolidation, but there is an important difference. Consolidation would mean that as losers are winnowed out, clear winners emerge. In fact, after considerable winnowing, it is difficult to discern any triumpant firm in the market for online pet supplies, online drugstores, online flower sales, or many of the other dotcom competitions. If the winner takes little or nothing, then it cannot be called consolidation.

The venture capitalists did not really promote the type of migration that I am expecting. True, there were many instances of middle-aged executives leaving old-economy companies to join Internet IPO's. But they were not leaving the cube farm behind.

The venture capital industry attempts to build new large firms as quickly as possible. Venture capitalists used to think in terms of several years, but the bubble fostered the illusion that the process could take just months. Register a web address, raise some VC money, and--presto! Instant cube farm.

However, the economic meaning of the Internet is not that it provides a mechanism for creating instant cube farms. I believe that the economic meaning of the Internet is that it allows some of us to leave cube farms for smaller companies.