Indicator May 2000

The Internet; just www.what's going on ?

Opening summary
A business revolution is in the making. By now we are all familiar with most of what's been happening here; a new way of communicating, the Internet, is facilitating all sorts of new ways of doing business. This is big, but just how big?

Well it's more than just a new way of communicating. Traditional commerce is changing to e- commerce: changing manual and previously time-consuming tasks into electronic and / or automated ones. This is bringing new, better, and (sometimes) more improved services and ways of doing things. The uptake of this new technology has been faster than any other technology ever introduced. In the past five years, about 60 million people have gone on line. The introduction of Radio took some 40 years to do this, television 13 years. In the United States one-quarter of the population use the net. Penetrating to this level of usage took seven years. By comparison, electricity took 46 years to achieve this level of market acceptance, the phone 35 years, PCs 15 years, mobile phones 13 years. (Source; International Data Corp. Internet commerce market model March 5, 1999.) The net is now big business.

Some of the more simple and immediate improvements business have taken on can be seen in company web sites and how they are being used. As just one example, visit Such sites bring together the company's entire range of products creating a library of technical information and data, plus a data base of products and associated details. For the company it is a new way of doing business.

See also for a great use of the net, and for a bit of fun visit sites like:

Companies soon found they could extend the function of their sites into direct ordering and trading, tracing and tracking products etc. To see how this technology is being integrated into business visit the Fed ex site, one of the internet's most heavily used sites. See also and in Australia www.corporate

So far, what we've been discussing came to be called business to consumer type activity. More recently attention has been focusing on business to business activity. To observe how this is affecting companies and big business activities checkout: Ariba tries to show business how to streamline their purchasing and procurement processes. See also These are aggregator sites that try to concentrate demand and bring together supplier content, creating in the process an interactive shopping mall on line for business to business activity prior to consumer level.

Business to business internet activity could be really explosive. Previously, companies had already been using electronic networks to exchange orders and invoices. This was a limited process, and you could really only deal with another business on your own network. This changed with the introduction of the net, and web browsers, making possible a whole new set of internet possibilities and facilitating the creation of market places like those mentioned above. Business to business activity, moving companies and business then into further electronic usage through; - electronic procurement of goods and services at a wholesale level, - purchasing being even further streamlined by aggregator sites (examples given), and - on line exchange trading, stock markets as an obvious example.

Slowly, this process will be applied to all old-style industries; aerospace, chemicals, coal, food, health care, paper, steel and on it goes. General Motors expects to save $12 billion each year by shifting further into this process.

Spin offs and effects.
The first effect of all this technological change is that it is forcing prodigious changes on all businesses. Not one single business activity will remain unaffected. The example of Encyclopaedia Britannica is often quoted. Earlier this decade buying the encyclopaedia of books would have set you back over $2,000. After at first ignoring competition from rivals, initially a CD-ROM from Microsoft selling for less than $100 (now free), Britannica finally was forced to completely rethink their business strategy and last year put their entire 32 volume collection onto the net, available free. (They tried a CD-ROM first, priced at $299, then access by subscription). The Britannica site, now a portal attempts profitability through sponsorship, advertising and other e-commerce activities such as strategic alliances.

In the economic sense, the effect of technology is being expressed in prices: they are coming down. This is exactly what happened during the first stages of the industrial revolution last century. If you had lived last century, prices of most items were cheaper at the end of it, than at the start. So the Internet has been deflationary (as consistently called by the EIS). Some examples:

  • IBM claiming it will sell $15 billion worth of goods over the net this year, save $600 million as it redirects business customers to its support web page, and buy $12 billion worth of goods using the net, eliminating 5 million paper invoices in the process.

  • British Telecom reported spending 10 million developing its Internet, saving 663 million last financial year in increased efficiencies.

  • GE, General Electric, the first company to realise a profit in excess of $10 billion has explicitly stated it is doing more business over the net to boost margins.

  • Cisco also has shown how to take a lot of costs out of its business having customers order over the Internet, making 40% of staff redundant.

  • In Australia, observe how a new business called GreenNet could revolutionise the horticultural industry. Old-style; plant growers load large trucks full of plant samples and physically travelled to all nurseries in the country. New style: Growers have their entire nursery catalogue online, allowing retailers to access price lists, place orders, search for special items etc. Savings per grower estimated at $60,000 to $100,000 per year.
Priceline in the U.S. began similar projects with other industries some years back; air ticket reservation, groceries to name a few. One US marketing group ISI compared Priceline products to other non online grocery groups and found average price savings of some 60%, as below;

item		non on line store		Priceline
palmolive		$2.99			$1.37
listerine		$6.99			$2.15
Duracell		$11.98			$3.60

Even the simple business items of pens, pencils, computers, and toilet rolls, ordered over the net, is estimated to be saving business huge outlays. Apply this to shipping, customs, bills of lading, government departments, public companies etc. and you can see this process will run a long way yet.

Two of the biggest electronic commerce projects in Australia have only just started: in the Superannuation industry, the development of an industry-wide messaging system to link employers, administrators and fund managers, enabling the shifting of messages through the system electronically, reducing costs by 30%, or some $700 million worth. And in the health area, the Pharmaceutical Electronic Commerce and Communications project, a joint initiative of government and business to improve supply chain management in the pharmaceutical industry. It is estimated some $340 million could be saved here using e commerce.

Ford is about to provide each of its 370,000 employees worldwide with PCs and home Internet access to make sure its work force is Internet literate. Back home ANZ bank will soon offer staff subsidised, $5 per week, home PCs and free Internet connection, in a five-year program costing $20 million

All this has shown up in improved labour force productivity figures over the past few years, low inflation rates, (deflationary even?) and low unemployment figures. The United States is reporting e-commerce has reduced the dollar amount spent by U.S. companies on order processing from $75 to $10, on average. Stock markets and professional investors are quick to pick up on such developments. It is often said, whatever that the demand is, Wall Street finds a way to satisfy it.

The stock market
Since 1982 long-term interest rates (bonds) have been steadily declining. Since this time, equity markets have been in up trend especially in the U.S., with even the 1987 crash now just a blip on the charts. In addition, the new technology, first computers, now the internet, and all the retraining this involved has helped make companies a lot more profitable since 1991. Stock markets have an uncanny ability to anticipate such developments, often 12 months to two years in advance. (Dow theory; the market always looks twelve months ahead). Markets began progressively pricing in the trend to lower interest rates and the huge increases in productivity, through technology, years ago.

Then the business cycle picks up. Banks re-commence easier credit policies, asset prices rise further. Sometimes, especially in Western society, whenever interest rates have come off major peaks (every 50 years or so) we end up with the conditions for a sustained stock market or real estate bull run. The U.S. decade cycle expansion is now the longest-running in U.S. history at 108 months presently. So the question arises, is the stock market in a bubble ?

As always there is two sides to the story. One says we have a mania, just like the Japanese real estate and stock market of 1989, and tulips way before that. The other side argues we are in the midst of a business, indeed world economic revolution comparable to what happened in the industrial revolution. Here is my view:

The mere fact that market commentators have had to resort to so far back in history for meaningful comparison tells us something big is going on here. It is a time of unprecedented innovation. This will last a long time, decades, and has a long way to run yet. It is all a question of timing, both in the short and long term. Right now though the present is looking very similar to past patterns in history.

In the end, the bubble will deflate (not necessarily burst - probably has already) for a very simple reason; each company will at some stage have to justify its earnings, or lack thereof. Yes we all study charts and trade the technicals, but in the long run it is the company's fundamentals that sets the charting parameters.

For sometime now, practically all investors have been chasing returns, any returns, higher than what you can get in a bank, which have been declining with lower interest rates. So of course the higher the market goes the more we are attracted to buy. Yes the Internet is revolutionising the way we do business, but it is still very much a charity model currently. To attract business (eyeballs) much of what is on the Net is either being given away or sold at a discount and / or a loss. One site in particular, with an advertising spiel "the lowest prices on earth" is selling products below cost, attempting to create its own image synonymous with its spiel, the discounting to be covered via web banner advertising. Now the market may believe this for a while but ultimately it is a negative gross margin. Like selling $10 notes for $9. This is not a sustainable long-term business model. At sometime in the future Internet investment will be forced to produce a return on capital, or bust.

Now without being alarmist, it is usual that bubbles of the past have come to an end once interest rates have about finished being lifted by Reserve banks. And central bankers have a marvellous way of repeating history. They (read Greenspan) will push up interest rates to, as they will call it, "protect economic prosperity", and will continue to do so until it is too late. As occurred every other cycle since World War II. In reality I believe that this behaviour is all part of a much bigger economic cycle: the move up (ultimately unsustainable because it is driven by asset prices from bank credit expansion), causes eventually the move down. And the cycle turns once again. (The cycle occurs this way because society does not collect the economic rent of public resources, allowing it instead to accumulate into the hands of private interests, but that is another story. E-mail me if you would like further understanding here. The EIS business cycles class studies this phenomenon in depth). History might also reveal that the flood of money pre millennium and the Y2K scare has had a lot to do with the bubble.

Watch this year for much discussion on whether Reserve Banks can engineer a "soft" landing for the economy. It's all repetitive of course. Higher interest rates will slow the economy. Rates are an extremely difficult instrument, notoriously fickle in timing and higher rates are most likely to move the economy into recession. Our policy makers won't say so of course, preferring instead to use the language of 'restraining a booming economy". Be prepared.

At the very peak of the decade business cycle, greed kicks in. Usually it is substantial too, and very hard not to get caught up in. Our publications last year highlighted a list of ten to watch for, all of which were flashing at least amber in colour, if not red. Here is what we alerted you to in our May 99 "Indicator":

"Signs of a movement into top gear. A study of history reveals all the classic signals of an economy in full swing;

  • rampant gambling, average per person loss in Australia $634 yearly

  • Warren buffet tells shareholders he sees nothing on the horizon to attract his $15 billion cash reserve

  • highest ever debt levels, average per person debt level in Australia stands at $3,600

  • mailed invitations to wealth seminars practically every morning

  • shades of 1989 in the local auction rooms, though more discreet at the present

  • luxury car registrations at their highest point since 1989, so too thoroughbred horse sales."
And we said at the time this was likely to go on for many months yet. Earlier this year the intensity of greed got worse;

  • day traders, in fact most traders for that matter, treating stocks as commodities rather than actual businesses with an underlying value.

  • Amazon giving its two newest executives $2 billion in stock options (March 16th) plus cash bonuses of $7 million each for signing up. That's stockholders' money I might add. (Each day one third of the entire available shares of Amazon changes hands.)

  • financial scandals and public company executive ripoffs of which 1999 was a classic year. Trumble's $11 million to walk, Macquarie Bank's $50 million for advising Boral on its division into two companies, and from the sublime to the ridiculous Yahoo, with sales of a mere $200 million and a market cap of $41 billion at one stage (shares outstanding 100 million multiplied by share price last year just above $400) bigger than established giants with multibillion-dollar sales like Boeing, Monsanto, and Colgate-Palmolive.

  • E-bay earns 8% of its revenue through the trading of beanie babies !

  • In Hong Kong Richard Li's Cyberworks is oversubscribed some 500 times, in Singapore, Singapore technologies IPO is oversubscribed 165 times. Now there's a mania.
That's the business cycle for you. We are living through another peak right now. (And when one man is permitted to gamble $94 million - yes $94 million - through just one Australian casino in under 6 months, greed rules.)

All bubbles deflate. I might add that no one ever rings a bell to signal the top of the market; meaning that at the top, or least somewhere near it, it never looks like it. All the good news is coming out, things look rosy and as I said before it is very hard not to be caught up in it. Bubbles usually end up ugly. But that said, markets always recover and go on to bigger and better things.

If the market does not recover immediately from here, it would indeed be ironic in light of the following article, published in the Financial Review February 17th, entitled "much ado about nothing".

As reported; " Corp is listed on the New York Stock Exchange and is capitalised at almost $33 million. It is currently trading at about $4.60 per share with a fairly active turnover of 63,400 shares in a week. But this company doesn't do anything and apparently has no plans to do anything other than nothing. It's Bloomberg Business description reads currently Corp has no business operations. The company is seeking to acquire or merge with a business or company. Further, a recent Securities and Exchange Commission filing by the company confessed that the company is not currently engaged in any substantial business activity and has no plans to engage in any such activity in the foreseeable future. And as the paper went on to say, six months ago, the company, which has little more to do than manage its equity profile, enacted a 5 for 1 stock split, which has seen its shares soar from 32 cents in July to the current $4.60 at Friday's close, for more than a seven fold increase for a company that does nothing, plans to continue doing nothing and which is worth $33 million."

A keen student of history would know that at the height of the South Sea bubble in England of 1720, a company was floated with its articles of association reading "A company for carrying on an undertaking of great advantage, but nobody to know what it is". I have been told, though am yet to confirm, that one of the last IPO's floated in 1929 just prior to that crash was Mausoleum Inc, a Funeral and Graveyard site owner / operator.

Important to note though, this technological revolution is based on solid and very real productivity advances. It will lead to some amazing developments, great ideas, and plenty of jobs for those that want them. Here are some examples of the huge potential growth still latent within this revolution. (Remember, the internet is not the bubble, the stock market is; expectations being priced in way too far ahead of reality.)

  • Ross Perot, the US billionaire and founder of Perot Systems (revenue last year $781 million) says business to business sales via the net has been the key to his companies growth, citing recent research suggesting this sector of the market will triple in size over the next two years. Note; Perot is building an internet business with cash flow.

  • Bloomberg reported last year, Quantum, a global recycling company from California "is building its first US plant inside a local prison after failing to find workers who would work for minimum wages in converting old tyres into rubber mats and tiles. The company isn't the only one taking alternate routes to hiring. Whether looking for factory workers or white collar technical experts, companies are paying referral bonuses to churches and synagogues, offering free massages and manicures to recruits and even bringing in people from abroad. Thirty eight states in the US now have similar programs of hiring workers through prison systems.

  • Cisco systems and Cogent Communications are building fibre optic cables to link 12 major US cities on a new data network. This is not going to stop just because the stock market deflates a little. (Involves a lot of fibre optic cable and routers)

  • wireless access to the net via mobiles, rather than pc's (Amazon and Sprint have teamed up to offer Internet shopping on wireless phones)

  • Home automation; products to link together pc's, printers, faxes and general home appliances and white goods. Voice recognition, to make the net even more accessible.

  • Dow Chemical Company has budgeted for $162 million (Aust) spending on internet activity next financial year.

  • Intel is struggling to meet demand for its processors, the larger Nasdaq tech stocks are still beating analysts estimates of earnings this quarter; markets do not collapse whilst this is occurring.
From US research, 63% of US adolescents prefer being on line to watching TV, 55% prefer online communicating, rather than over the phone.

The Canadian Government (like it or not) is about to introduce biometric identification technology at Canadian airports. Unisys will be commissioning its iris identification system whereby travellers pass through a series of gates that compare you (and your eyes) to recorded information stored on your id card. A match allows you to proceed.

So what's next.
Don't be a lemming with the new technology. The net revolution is not over, not by any stretch of the imagination. But developments will go in cycles - just like in the past when railways replaced canals as the new means of transport. At that time, the 1840's, many canal owners went into protection mode. Consortiums were founded, and with the help of the maritime navy, even managed at times to prevent bridges being built over "their" canals, thereby effectively postponing the spread at rail - for a time. Progress continued of course. The people demanded better, faster, more efficient services.

I noted with interest the following; the AFR 30.3.00 attributed a great quote to Westfield's, David Lowey, who is considering laying broadband cable through all Westfield shopping centres. "He can see opportunities", the article pointed out, going on to say "But he is a rarity in the conservative property industry. In the main, the industry has responded to the new technology as if it were a threat, not an opportunity - and in so doing has handed the upside to providers like Davnet." (Well not quite of course - the laying of broadband cable anywhere immediately increases land value.)

Keep an eye on where the productivity gains are flowing. Never forget, society's economic gains accumulate in the private enclosure of public space. So it is the rent seeking behaviour of entrepreneurs that must be watched. (If you don't follow this, do the EIS cycles class) The internet may be new technology, but it will develop along historical patterns. The development of the worlds railroads illustrate what to look for.

Railroad development opened up fantastic new opportunities for trade as I'm sure you can imagine. One's first glimpse of the new iron horses in the 1840's must have been really something to behold in those days. Innovation and investment went ballistic, and there were three manias (bubbles) associated with it; 1847, 1857, 1866. In the US alone, freight rates halved, then halved again between 1870 and 1950. A deflationary economic spiral developed.

Who gained ? Consumers certainly did for a while, with cheaper prices, better goods and more choice. Eventually - much later - so did labour with the eight hour working day. But a far larger part of the gain went to those entrepreneurs - the rent seekers - who controlled key exchange locations - more particularly in those days the land value underneath.

So watch our own entrepreneurs and more to the point these days the value of the spectrum. Gains will also show up in share prices, as deals are done, buyouts initiated, strategic link ups confirmed. Some will go bad, too, which will wipe millions from stock prices very quickly. A great time to be trading, but you will have to be alert. And quick. And better informed. Information spreads quickly with this new technology. As is always the case, stock prices will pre-empt this knowledge, prior to public announcements. Your charts will alert you to these trends, as EIS has shown you.

The possibilities to come
The internet, and the next few years will be incredibly exciting. Without trying to forecast specifics, here's a few things to think about/ watch for.

  • The internet is likely, in time to carry much of the world's phone traffic. Internet servers may even replace telephones exchanges. If voice data does migrate to the net though, internet servers will never be permitted to replace telephone exchanges until engineers find a way to make it feasible for government agencies to tap our voice conversations as they do now by phone. [Digital phones were delayed for this reason]

  • Watch the development of on-line service sites ie as we do more and more business on line, we will look for more and more answers on-line eg insurance quotes, downloadable form letters, bill paying, employment sites, downloadable books. The possibilities are endless, and will reduce business costs continually.

  • More media wars. The value of exclusive broadcasting rights for sport continues to rise. Notice John Elliot keeping Carlton football club and Carlton football ground. The AFL got most other clubs out of their own grounds before each club realised the value of their own turf, advertising space and now internet access via webcasts.

  • Stock exchange systems to allow traders to trade directly via mobile/phones with Wireless Application Protocol - WAP abilities. [New Zealand has started already]

  • The making and distribution of films entirely without film, ie made with digital technology. Starwars II and III are to be shot digitally. Think about this: cinemas receiving copies of their films via satellite or over fibre optic cables. Multiple copies, no loss of quality. What does this do for Kodak film? Piracy? Theft? PC "crash" (Does windows crash much ?) during the film. And what about encryption requirements when sending the film to cinemas, smart cards, decoders etc etc. Film projection will be museum pieces next decade.
Music format using MP3. Limitless copying and transfer. You have read enough already on the possibilities of this technology without more comments from me.

India and China getting on line. Hardly started yet

The top 20 net stocks in the US are those providing the internet "plumbing", - Cisco, Microsoft, Dell, Sun, IBM, Oracle. Akin to the shopkeepers of the gold mining days of the 1850's who sold shovels to the miners. Far more profitable in the long run. Therefore: at all times remember the time frame of the stock you are trading, & how it generates its revenue. Stop losses on specs are critical. This keeps your capital alive to continue to play the game.

The death of white goods shopping. Washing machine broken down? Have the manufacturer deliver you another, free. Connected to the internet you're charged only for use ie per wash. Now trialling in Sweden. Observe: this puts such companies into the business of selling services, not just manufacturing.

I remain of the belief that inflation will continue to surprise our experts on the lower side of expectations. Older style companies just have to keep introducing technology at lower costs, remain competitive etc etc. I believe this process has a long way to run yet. The internet and associated technology (& its introduction) has enormous implications and exciting investment potential.

- eg wireless telephone and internet services in cars
- household appliances connected to the net
- book publishing over the net
- constant outsourcing by companies to better "specialists"

Some things however do not change
Internet companies still do what all successful businesses do, brand building, attractive displays, customer service and satisfying consumer demand. Nothing new about that. [though being on-line, you may find customers adapting your business to their needs]

On the stock market, for such companies that own the technology, their share prices will spike from time to time, and trend at other times. Stay alert for the spikes, but trade the trend; it is, and remains, your best investment friend.

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