Don't Call It a Bubble

It may be tempting to draw parallels between Web 2.0 hype and the dot-com frenzy. But hard numbers show this isn't 1999

I spent last week in Memphis, Tenn., as far away as I could get from Silicon Valley. I have been immersed in the Web 2.0 scene for the better part of a year—attending no fewer than a dozen events in the prior month alone—and I was tired of it. Tired of the small talk; tired of being "on"; tired of mugging for photos that would be posted on someone's blog the next day. I needed a break.

Then I read Michael Arrington's "Silicon Valley Could Use A Downturn Right About Now." The TechCrunch blogger hearkened back to 2005, when there was a lot more "goodwill and community surrounding innovation." When new ideas were discussed over burgers and beers—not hyped at lavish parties. Companies were launched in living rooms. Now they're drawing millions in venture funding—not all of it deserved.

Weak Parallels

I see his point. I, too, recall that in the not-too-distant past—before Google (GOOG) shelled out $1.65 billion for YouTube in 2006—people were starting companies because they thought they had cool ideas—not just to flip a startup to Yahoo! (YHOO) or Google. There was less talk of "exit strategy" and more emphasis on fun projects put together with friends on a shoestring budget.

That air of excitement has given way to a climate of giddiness. At no time was that more evident than on Apr. 16, the opening night of the Web 2.0 Expo, when at least five parties were in full swing in a several-block radius of San Francisco's South of Market district. The hottest ticket was for the NetVibes "Universe Launch Party" at hotspot 111 Minna. The whole affair felt downright breathless.

My hunch is most of the people at the party—and the hundreds lined up outside—didn't even know what NetVibes does. For the record, it's a site that lets you grab mini applications from other sites to create your own mashed-up home page.

I'll admit it. It felt a lot like 1999. But as tempting as it may be to draw stronger parallels between today and the period before the dot-com bubble burst, once you move beyond gut feelings, the comparison simply doesn't stand up.

What's Different

Consider some areas of glaring contrast between today's Net startups and the dot-com implosion of a half-decade ago.

• IPOs. Not only are we not seeing the IPO frenzy of years gone by, we're not seeing Web 2.0 IPOs, period. Yes, Internet companies like NetSuite are planning to sell shares and a few others like are considering an IPO. But among the companies specializing in the user-generated content, social media, and social networking that make up the Web 2.0 scene, there's not a one.

Even Facebook, which has already turned down $1 billion from Yahoo, likely won't sell shares to the public until 2009. Say there was a big Web 2.0 bust tomorrow; without IPOs, you're pretty much limiting any potential financial carnage to the companies and their investors, not the countless individual and larger investors singed a half-decade ago. In 1999, a record 270 venture-backed companies went public for a combined $21 billion. They weren't all dot-coms of course, but many were pumped up by the dot-com hype. Last year, 57 companies went public, for a total of $5.1 billion.

• Technological and market changes. In the U.S., almost 70% of adults are online, and almost half use high-speed connections. In 2000, about 40% were online. Plus, it costs dramatically less to do business, thanks to open source software and low-priced Dell (DELL) servers.

Web 2.0 sites are still mostly marketing themselves through the Web, not costly TV ad campaigns. And there's less need to change consumer behavior: More than half of U.S. teens are using social networking sites, and 48 million Americans have posted content online. Even if you add in parties and T-shirts, you're still not close to the corporate-cash burn rates of the late 1990s.

• VC spending. Venture capitalists invested $850 million in Web 2.0 businesses in 2006. The tally has been doubling annually since 2002, but the median size of those deals was just $5 million and the median valuation was $6 million. Across all venture capital categories the median valuation was $18.5 million.

Now, compare that with the $34 billion in VC money invested industrywide. So-called clean-tech companies alone drew $1.28 billion, up from $664 million the year before. The median value for these companies was $7 million. The market for clean tech is huge, but in many cases the business models are hardly proven. And while it's true that plenty of experimentation is happening online, and many social networking and social media businesses will not succeed, no one would question that billions of advertising dollars are headed online. Much of that revenue will fuel Web 2.0 growth plans.

• Acquisitions: Yes, there are a lot of Web 2.0 acquisitions, but other than YouTube, none has topped $1 billion—and the vast majority has been under $100 million. That's not a bubble; that's efficient outsourced innovation for companies like Google and Yahoo—not unlike the way Cisco (CSCO) gobbled up networking, routing, and software technology for years.

In 2006, 336 venture-backed companies were purchased, netting $16 billion. In 2000, fewer such companies were acquired, but the 318 targets fetched $68 billion.

Necessary Froth

What's happening now in the nouveau dot-com world is frothy, no doubt. And there will be a correction as companies that can't cobble together a business plan go belly-up. But that's no different from Silicon Valley business as usual.

Froth only becomes frightful when the fallout spreads. If all of these Web 2.0 companies go out of business, the toll in San Francisco would indeed be high. Legions of young, talented people would be out of work. Venture capitalists would lose money, but not their entire funds. And we surely wouldn't see anything like the two-year slide that knocked the Nasdaq from 5,132.52 to less than 1,200, drained retirement savings accounts, and left thousands out of work.

So why the hand-wringing? It's because the bust was so bad before. Even a whiff of that is scary, and reminders abound: the parties; fuzzy business models; talk of eyeballs, not revenue; young, cocksure CEOs with little business experience. No one wants to believe again only to be mocked and out of a job in the next year.

But cycles like this are what make Silicon Valley great. People don't flock here from all over the world or park billions of dollars on Sand Hill Road because smart people sit around eating burgers and drinking beer and talking about products. They do it because every decade or so Silicon Valley births a handful of the world's largest, most exciting, and most transformative public companies. And as painful as it may be, that doesn't happen without some hype, herd mentality, and even carnage along the way.

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