Beyond the Bubble

The torrent of venture-funded Internet start-ups and wildly successful initial public stock offerings...

The torrent of venture-funded Internet start-ups and wildly successful initial public stock offerings by such companies from 1998 through early 2000 rippled into Harvard Business School's entrepreneurship classes. Professor Myra Hart and her colleagues had to fight to remind students that attractive business plans don't predict practice--that a huge gap separates idea from implementation. "The kids tend to think they're in control," she said.

Reality corrected that misperception. Comparing last spring to the fall term, when the prices of some of the most popular Internet stocks declined more than 90 percent and layoffs began to replace frantic hiring, Hart said, "It's amazing how chastened they are by what they read in the newspaper." (Gallows humor: As start-ups and stock options suddenly seemed less attractive last fall, the Internet-speak "B-2-B" and "B-2-C"--for "business-to-business" and "business to consumer" electronic-commerce enterprises--transmogrified into students' new-old career preferences, "back to banking" and "back to consulting.") Hence the usefulness of a case on an Internet entity where, as Hart summarized it, the "kids" who had the initial business vision "had to go out and get some grown-ups" to survive.

Seen in historical terms, the Internet crash was entirely predictable. In a world of untamed change--in technology, competition, economic conditions, and public policies--where risk cannot reliably be reduced, finance professor William Sahlman said, "It's stupid to pursue opportunities where the reward is low." Accordingly, investors have repeatedly poured waves of funds into companies pursuing seemingly lucrative new technologies; their enthusiasm has inevitably been followed by clusters of failures or forced mergers. Sahlman and Howard Stevenson, the founder of modern entrepreneurship studies at the business school (see "Conceiving a Curriculum," page 38), memorably documented one such cycle in "Capital Market Myopia," a 1987 article on the more than 100 companies, nearly half backed by venture capitalists, which competed in the new market for computer disk drives. A similar situation arose in the early computer-workstation market, where dozens of companies each staked their claim to 10 percent of the business.

Sahlman and Stevenson took an almost resigned view of the Internet bubble, even before its deflation became audible. As 12 percent of the M.B.A. class of 2000 headed for work as "owner, partner, or entrepreneur" (more than double the proportion a year earlier, and four times the 1998 level) and 16 percent prepared to pursue venture-capital careers, Sahlman forecast a downturn. A "sure-fire predictor," he told the school's New Business magazine in the fall of 1999, "is that business-school enrollments in entrepreneurship courses are now at record highs." He subsequently criticized the venture community's lax standards: "'Is it an Internet company?' That's due diligence." Comparing this stampede to the earlier fads for computer hardware, Stevenson said, "At least they had revenue models." He said the founders and backers of many firms were seduced by visions of quick riches: launch a company while planning to sell it in a few months to naive investors or to another, bigger player.

The factors that contribute to establishing a viable business were progressively obscured in the gold rush, as "the Internet put the opportunity set on steroids," Sahlman said. "Students are doing things much earlier in their careers than was ever the case before. It used to take 10 to 15 years to earn your stripes. Now," with ventures funded before students graduated, "it's minus 10 to 15 weeks."

Until the stock market brought Internet companies back to earth last spring and venture capitalists tightened their standards, Stevenson said, "Anyone thought having experience made you a dope." As the past 12 months have made painfully clear, he said, "Knowing something helps."

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