UPDATED 15:07 EDT / JANUARY 14 2011

What Precipitated the 1990’s Dot Com Bubble Burst [by Steve Case]

The founder of AOL Steve Case wrote today on Quora, the Q&A site, great response to the Question: What factors led to the bursting of the Internet bubble of the late 90’s?

Here is Steve’s response in its entirety. Steve’s comment has 120 comments as well as 13 other answers from technology insiders. Here is the link to the full thread of comments.

Question: What factors led to the bursting of the Internet bubble of the late 1990’s?

Answer By Steve Case

The Internet went through some fairly predictable phases.

The first was a research phase (the 70s) where some forward thinkers were working on early research projects for what was then called videotex, teletext, 2-way TV, etc These were experiments in labs as consumers did not have PCs or any practical way to get access to these services. Futurists like Alvin Toffler wrote about the notion of an “electronic cottage” (he wrote The Third Wave in 1979) but it was considered a pie-in-the-sky prediction.

Next was the pioneering phase (early 80s to early 90s) where a relatively small number of people were trying to build interactive services, but it was an uphill battle. Few people used them (and the Internet itself was still limited to government/educational institutions – indeed, it was illegal to use it for commercial purposes.) The conventional wisdom was that the market would always be limited to hackers/hobbyists. AOL was the first “Internet” company (it was actually called an “online services” or “interactive services” company at the time) to go public and I remember on the road show (in 1992) explaining why we thought this would be a large market someday. Given we had been in business 7 years and had less than 200,000 users, most were skeptical.

Suddenly interest in the Internet took off and we entered a growth phase (mid 90s). A lot of factors contributed to this: consumers started buying PCs in large numbers, PCs started shipping with pre-installed modems, network costs dropped sharply making access more affordable, software was developed to improve easy of use for mainstream users, the World Wide Web emerged, the first wave of start-ups were developed, etc. Suddenly a market that had been nascent for more than a decade was suddenly showing signs of life. As an example, AOL went from 200,000 users to 1 million in a 2 year period.

This sudden surge in interest led to the hype phase (late 90s), when people came out of the woodwork to be part of the Internet gold rush. Hundreds of companies were started, and everybody wanted to invest. Valuations shot up. Me-too companies became prevalent. Crazy ideas that had no business model and no realistic chance of success were viewed as the next big thing. As millions of people decided to go online almost overnight, companies like AOL expanded rapidly. We were literally getting America online), adding 1 million new users every month or two. Our market value soared, from $70 million at the time of the 1992 IPO to $150 billion in early 2000.

Not surprisingly, this hype phase was followed by despair (early 2000s). Some called this the Internet’s nuclear winter. Investors ran from the sector and valuations plummeted. Some companies lost 99% of their market value in a matter of months. Dozens went bankrupt. The sector went from being the hottest thing on Wall Street to being cold. New companies could not raise start-up capital. Most people thought the Internet as a passing fad.

That then led to a recovery phase (mid 2000s). Some of the companies started in the hype phase built large franchises (Yahoo, eBay, Amazon, etc), and a handful of newer companies got traction (Google, in particular). This was a slower, steadier, saner period of growth. Investors tended to be selective, betting on the winners that survived the bust that were consolidating their positions.

Now we seem to be in a boom phase again. The success of social media (Facebook in particular) and more recently social commerce (Groupon and LivingSocial) has reminded people of how quickly large, profitable, valuable franchises can be built. As a result, there is once again a rush to invest. This will inevitably lead to many disappointments, but the difference now vs a decade ago is the companies have real business models, significant revenues, etc Valuations are likely to move up – or down – quickly, but the underlying businesses are for the most part pretty stable.

This cycle – hope, hype, despair, rebound, etc – has been interesting to watch (and live through) over the past 25+ years. It is is worth pointing out though that what happened with the Internet is not unique to the Internet – the cycles just happened a little faster. Most significant inventions and industries (cars, etc) have undergone similar transitions. Success seems to need a mix of passion, perspective, and perseverance.


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