Internet and Profit Do NOT Seem to Go Together

I do not know if apocalyptic sounding comments are appropriate or inappropriate just before the new Jewish year. According to Jewish tradition, the new year is clearly a time of introspection on our part and judgment on G-d’s part. I think therefore, that reviewing our actions, including those in our work and business, is appropriate at this time.

The following article effectively paints the picture of a high tech bubble. The principle behind such a bubble is that companies and products are valued far beyond their true worth. The obvious question is, how do you measure “worth”. The simplest answer is that “worth” can be measured by how much people are willing to pay for the item or service. This leads to a circular definition that does not really help.

Without trying to explain economic models and how markets work [which is definitely beyond my scope], a bubble happens when investors are willing  to treat a company or service  as having far greater “worth” than it should. Imagine that there is a company that sells “X”, and makes a profit every year of “Y”. An investor, for whatever reason, decides to buy the company and pay 20 times the amount “Y”. If this company makes one million dollars a year in profit, this external investor  pays $20 million for the company. If the idea of an investment is to make back not only the money invested, but much more, this would seem to be a very irrational purchase.

The classic case in which this make sense, is when an investor believes that this company making $1 million a year, has the potential to make $100 million a year, in the relatively near future. This is by no means hard to imagine considering the series of start up companies that regularly appear in the news, which have started literally in someone’s basement or a small office, and in a few short years have become billion-dollar enterprises.

The risk in this approach is that the company may not make $100 million in the near future. In fact, like any company, it might go broke. I recently read about one company that had introduced a new technology that seemed very promising, until the first formal studies were done, which basically proved that there was no benefit to using this technology. This company does not have long to live.

No matter how promising a technology may appear, it is always a significant, and perhaps even a tremendous, gamble on the part of the investors, when they put money into further developing the technology. If a large number of investors invest a great deal of money in a whole series of companies that all eventually fail to make a profit, you can have a sudden dramatic loss of funds across the board. All investors big and small can be hit by such a universal devaluation of the companies they have invested in. This can have far-reaching effects and can cause financial damage far beyond the tech world. Such bubbles have happened before and it took years to fully recover from them.

Opening and closing companies, successful and failed investments – these are all part of the cycle of business. But when too many companies have been overvalued based on their assumed potential, a lot of people can lose huge sums of money. For some people, and perhaps even many people,  these losses can be catastrophic. So the owner of a tech company with a valuation of hundreds of millions of dollars, can find him or herself in terrible debt, within a short period of time. High-tech and big-time investments is not a game for the weak hearted. I personally am very conservative with my money. And that is why I will also likely never hit it big with an investment or a startup of my own. I am just not willing to take the risk.

The title of the article I linked to, is How The Internet Killed Profit. The author of this article describes a new reality where the consumer is constantly presented with a range of services, often at a minimal price to even being free. The business plan for many of the companies providing these services, is literally to be bought out by one of the major companies that do actually make money and have huge cash reserves. Companies like Apple and Microsoft are constantly on the lookout for new ideas and talent that can be incorporated into their existing products, thus increasing the business value of these products to the purchaser. For example, Microsoft in the recent past, purchased Skype. There were those that were surprised by this purchase, given that Microsoft already has a product that provides very similar functionality.

It could be that Microsoft purchased Skype in order to get access to the millions of people who use Skype on a regular basis [and can thus be a target audience for other Microsoft products that do cost money]. Another option is that Skype  had a unique technology that Microsoft wanted to incorporate into other Microsoft products. A further option is that the team of people working at Skype were top of the game in their expertise, knowledge base and productivity. Therefore it could be that Microsoft wanted to have such people as their employees. I will note one more possibility which is that Microsoft wanted to own Skype’s patents on various technologies. Such patents can be highly valuable when competing with other companies that are selling similar products. Enforcing such patents can make it easier for a company like Microsoft to keep competitors at bay.

In any case, there are multiple reasons why Skype or any other startup, might have specific value to one of the major companies. When a big company purchases the startup, the owners and developers of and investors in the start up, often all independently make a very nice amount of money. But at a certain point, a problem may arise when the big companies decrease their purchasing of smaller companies and startups (and this could happen for any number of reasons).

It could also be that in one particular field, there are so many startups competing for the same target group of people, that each startup ends up providing more and more for less and less income. Ultimately, all of these startups end up having very little value when one of the big companies is looking to purchase one of them.

In the area of personal transportation, 100’s of companies are competing. There are UberLyftHailoSidecarBlaBlaCar, and Djump to name a few. There will likely be a shakeup where only one or two of these companies will survive. And even then, it may be that these two companies still can only survive if a much bigger company purchases them. And if no one purchases them, they may also utterly fail.

I would like to paraphrase the article’s last paragraph that sums up this issue very succinctly:

We’re spoiled people. We are becoming the most demanding customers ever. But we are not actually customers. We are users  who don’t pay. We have no contract, no loyalty and we flock to the latest shiniest thing. In companies’ desperation to count users, they forgot to make money. Perhaps the Internet killed the profit margin and also common sense.

Ultimately, there is no magic and the general financial market will find a way to provide the services we need and want for a price that is sustainable. The path to this end point will be riddled with the virtual bodies of countless startups. Still, if we jump back 10 years and then look forward, there is no question that the tech industry is incredibly successful and that the average user has gained tremendously. Let us hope that the same can be said in 10 years from now.

I want to wish you all a Shana Tova full of the only things that really have value: love, friends and family. But above all else …

Thanks for listening.

About the Author
Dr. Nahum Kovalski received his bachelor's of science in computer science and his medical degree in Canada. He came to Israel in 1991 and married his wife of 22 years in 1992. He has 3 amazing children and has lived in Jerusalem since making Aliyah. Dr. Kovalski was with TEREM Emergency Medical Services for 21 years until June of 2014, and is now a private consultant on medicine and technology.
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