The Internet Delivers on Its Promise

At a time when Wall Street firms are being punished for misleading investors about dot-com stocks during the bubble, it's all too easy to confuse financial hype with technological reality. Many people are quick to dismiss any talk of an "Internet revolution" as so much '90s blather. Wrong. There's a world of difference between crazy valuations and serious technology, between Internet stocks and the Net itself. While investors have been bemoaning their fate, chief executives have been busy embracing the Net. It's time to get over the bubble talk and get real about technology's promise.

Or risk falling behind. The strong upturn in profits last quarter during a period of weak economic growth is testimony to the productivity-enhancing power of the Net. Through boom, bust, and recovery, annual productivity growth has powered along at around 2 1/2%. Without it, companies would have been forced to slash payrolls even further during the worst days of the recession. With it, companies are generating higher profits without big gains in revenues. As the economy picks up steam, productivity will likely boost profits even further.

Despite conventional wisdom, electronic business has exceeded even the starry-eyed projections of 1999. Business-to-business commerce transacted online will reach $2.6 trillion in 2003. And many surviving dot-com companies are doing surprisingly well. Some 40% of publicly held Net companies, including Inc. (AMZN ), were profitable in the fourth quarter of 2002, and half are expected to be profitable by the end of this year. True, there has been vicious triage in the field. Venture capitalists poured $100 billion into more than 6,000 Net startups over the past decade, and 2,000 disappeared. Many ideas, some harebrained, some not, failed. But eBay (EBAY ),, Yahoo! (YHOO ), Google, Expedia (EXPE ), and others are making money, thanks to a resurgence in online advertising, and they are changing the face of business.

Just as former IBM (IBM ) Chief Executive Louis V. Gerstner and others predicted, mainstream Corporate America is turning out to be the chief beneficiary of the Internet. Using it, companies are streamlining production, inventory, and sales; cutting costs; and tracking their customers. It apparently takes four to six years after first installing new systems before productivity gains are maximized. Most companies are in their third or fourth year, which may explain why productivity growth has been rising consistently during the downturn, instead of dipping as it usually does in a slump. It may also mean that productivity and profits may be stronger than expected in the second half of 2003 and in 2004.

The U.S. economy has had bad luck for three years. The bubble, terrorism, corporate fraud, war, and now SARS. Yet it has weathered these mostly unexpected shocks rather well. Smart monetary and fiscal policy has helped. But the real key has been Internet technology, which provided the flexibility and productivity to adjust quickly without drastic cuts. Think what the Net will do for the economy when we get back to normal.

    Before it's here, it's on the Bloomberg Terminal.