When the dot-com bubble burst in 2000, she sent a significant number of companies to the wall. Investment banks had been encouraging huge investment in dot-com companies by launching Initial Public Offers (IPOs), allowing investors and entrepreneurs to profit from large fortunes by selling shares of their companies.
Most dot-coms that listed the stock exchanges had taken little more money from investors and had little prospect of making a profit. Traditional performance metrics were neglected and large spending was seen as a sign of rapid progress.
LinkedIn is still losing money after its $ 26 billion purchase by Microsoft.
Cash burn was to build brands and create network effects – where something gets more value the more people use. These are the main drivers of the platform business. With Amazon, for example, the more vendors, the greater the benefit for potential customers and vice versa. Together, this would create the basis for future profits, assuming that the underlying business case was sound. Most were not – and almost every idea attracted large amounts of funding.
Fast forward 19 years and, after a similar "app" boom, investment banks are anticipating IPOs as they predict volatile market conditions that arrive later in the year. Uber and Lyft applications, valued by investment banks at $ 120 billion and $ 15 billion, will be placed in early 2019 to overcome the collapse. Both are deficient – with Uber's losses approaching $ 4 billion in 2018, after a loss of $ 4.5 billion in 2017. Traditional metrics have been ignored and user growth taken as a proxy for profitability future. But this requires a huge leap of faith.
Uber, like many others, has managed to raise funds readily available and has raised more than $ 22 billion of investors so far. The problem of being able to raise funds so readily is that it discourages focus and efficiency. Uber is not only developing the ride model, but also the sharing of bicycles, delivery of food for travel and standalone vehicles. The latter is also being developed by most major automakers, as well as by Google.
Monetizing users is difficult in terms of attracting advertising or signatures
Snap Inc., owner of Snapchat's social media application, is also struggling as it is running out of funds fast – despite the $ 24 billion price tag in 2017. Shareholders can not intervene, as only founding stock is entitled to vote. LinkedIn is still losing money after its $ 26 billion purchase by Microsoft. Twitter has just made a small profit for the first time after being adopted as the chief channel of US President Donald Trump for US policy announcements.
The investment bank's belief is that network effects will create economies of scale and create "win-win-win" markets that emulate Facebook, Google, and Amazon. But reality is far from the truth, for most differ in several important respects.
Two types of application
Most applications fall into two categories. There are those who use content to lure users in the expectation that these users can be monetized – usually through the sale of advertising or the collection of signatures. These include the likes of LinkedIn, Twitter, Snapchat, Facebook. Then there are those who provide a service or goods such as Uber, Lyft, Deliveroo, Amazon.
Applications that use content have found that content can be extremely expensive to stay new and it is difficult to monetize users in terms of attracting advertising or signatures. Investor funds are used to develop content in the hope of creating enough users to pay for it and eventually show a profit. The reality is that users tend to move to the next fad before they can be monetized.
As far as goods and services are concerned, investor funds are used to give prominence to the market through advertising and subsidize prices for suppliers and customers. In fact, they are trying to create network effects, which should persist when low-price incentives are withdrawn.
But that means paying more to suppliers than at the market rate and then selling to customers at a lower rate than the market. In markets with low switching costs, such as greeting and food delivery applications, users will simply return to the most competitive offer when incentives are withdrawn.
In Uber's case, despite an imminent IPO, it failed to withdraw expensive incentives due to the collapse of user growth. The economies of scale are also quite limited, as Uber is discovering when trying to remove incentives for drivers, which has resulted in strikes. Indeed, the model works only with incentives, which investors are required to fund.
The big difference with Facebook, Amazon and Google is that they are among the first to create network effects. Uber has faced constant competition and firm resistance around the world, resulting in huge battles of investor-financed attrition. Snapchat has discovered that Instagram and WhatsApp (both belonging to Facebook) are waiting for them, making it very difficult to compete with users.
It's only a matter of time before the application bubble explodes. Big tech companies, such as Apple and Facebook, have tumbled nearly 40 percent in recent weeks – indicating that markets lose confidence even in established technology companies to reach their predictions. This does not bode well for applications that have not yet been listed. When it comes to investment markets, history repeats itself over and over again and again.
John ColleyProfessor of Practice, Associate Dean, Warwick Business School, University of Warwick
This article has been republished in The Conversation under a Creative Commons license. Read the original article.