Investment Strategy And The New Economy

INVESTMENT STRATEGY AND THE “NEW” ECONOMY

Dr. James R. ForcierManaging Director

Bay Analytics

15 June 2000

Copyright © 2000 by Bay Analytics. All rights reserved.

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ECONOMIC STRATEGY CONSULTING

Investment Clubs

• Women-only investor clubs earn an average return of 21%

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Investment Clubs

• Men-only clubs earn 15%

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Economics Defined

• Macroeconomics:

– Economy-wide & inter-economy concerns

• Inflation

• Unemployment

• Trade policy

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Economics Defined

• Microeconomics:

– Firm and market concerns

• Regulation/deregulation

• Pricing

• Competition

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Management Consulting• Business school tools:

• Quantitative, qualitative methods

• Marketing

• Human resources

• Business law

– Andersen, Deloitte & Touche, McKinsey

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Economic Consulting• Economic tools

• Regression analysis, modeling

• Antitrust, regulation

• Litigation-support orientation

– NERA, Charles River Associates, Law and Economics Group

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Economic Strategy Consulting• Microeconomic tools applied to business

decision-making• Market analysis (Round 1)

• Competitive strategy (Digital Island)

• Firm & product positioning (Handtrade.com)

• New offering development (Visa USA)

– Bay Analytics

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The “New Economy”• What is the “New Economy?”

– Something other than the “old” economy

• Internet commerce?

• Venture-funded start-ups?

• IPO frenzy?

• Heroic stock valuations?

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Capitalist (“mixed”) Economy

• Markets used for most transactions

• Unconstrained producers and consumers

• Unfettered industry entry and exit, capital & labor flows

• Limited government involvement

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The “New Economy” DefinedThe “old” economy

+The application of computing technology

=Significant changes in long-standing ways

of doing business

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The “New Economy” Defined

• Microeconomic characteristics (1)– Technology entrepreneurs and enablers

(software engineers, dot.coms, click and mortars, incubators)

– Wireless telecommunications and data (telephony, PDAs, SMS, 3G)

– Business data management systems (SAP, Oracle)

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• Microeconomic characteristics (2)

– Internet services: electronic mail, WWW, portals (Yahoo, Lycos)

– Internet infrastructure: intelligent networking companies (Digital Island), infrastructure providers (Cisco Systems)

– Internet content providers: NYT, Disney

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• Macroeconomic characteristics (1)

– Increased world trade

– Internationalized capital and production flows

– Domestic labor flexibility & mobility

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• Macroeconomic characteristics (2)

– Low inflation and unemployment from...

• Increased market competitiveness

• Worker productivity growth due to information and communication technology

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– Worker productivity growth due to information and communication technology

• Business investment in computer technology has grown from 7.7 % of total durable equipment investment in 1990 to 45.7 % in 1998

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– Worker productivity growth due to information and communication technology

• Increase in output growth as a result of computers may explain productivity growth from 0.33 percent 1993 to 1995 to 2.2 percent 1996 to 1998

• Increasingly accepted by economic policymakers

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– General characteristics:

• Computer-based

• Time-compressed

• Disintermediated

• Rapid evolution/changes

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“New” Vs. “Old” Economies

• How is the “New Economy” new?

– Moves at a faster speed

– Fewer intermediaries in transactions

– Production factor (capital, labor, technology) shift?

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“New” Vs. “Old” Economies

• Is the “New Economy”…– No longer capitalistic?– Constraining producers and consumers?– Relying on non-market transactions?– Restricting industry entry and exit?– Imposing greater government interference?

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“New” Vs. “Old” Economies– Rather than displacing microeconomic

theory, the New Economy magnifies and exemplifies it

• More new businesses, products, services, features• Greater disintermediation = fewer “middlemen”• More markets with more participants, greater

transparency, greater liquidity• Greater labor productivity• Increased wealth across all societal levels

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“New” Business Valuations

– Excessive for many firms without clear prospects

• Do not reflect discounted future cash flows or earnings

• Do not reflect reasonable economic assumptions about growth or prospects

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Valuation Examples• Amazon - no earnings yet despite premier

Internet positioning • Webvan - grocery home delivery with huge

capital investment in facilities• Intel - earnings from key position in computing• Cisco Systems - earnings from ‘Net

infrastructure• Vodafone AirTouch - largest wireless operator• Palm - enormous potential?

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Internet Business Opportunities

• Retail value of e-commerce estimated to be $20 billion by 2004

• Internet industry, 1999:– Revenues grew 62 percent to $524 billion– Created 650,000 jobs– Now employs 2.5 million people– Revenues could hit $850 billion this year

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Internet Potential - Consumer

– CyberShopper ‘99 Survey of 1,000 American Internet users:

• 53 percent of users surveyed purchased an item online (2x 26 percent in 1997)

• Spending an average of $206 per online purchase, up 38 percent in past 12 months

• 36 percent of Internet shoppers still apprehensive about Internet security

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Internet Potential - Consumer– CyberShopper ‘99 Survey of 1,000 American

Internet users:

• Purchasing fewer products from retail stores (35 percent) and catalogs (38 percent)

• 70 percent believe information they find while "shopping" on the Internet strongly influences their overall purchasing decisions

• Concern about online credit card fraud has dropped by about half (to 21 percent) since 1997

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– New York Times research on U.S. Internet Users (reported 5/24/99):

• Products leading online sales – books and publications (52 percent)– computer software (42 percent)– travel-related items (37 percent)

• Clothing/apparel shows largest growth in online purchases – 149 percent increase since 1998

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– New York Times research on U.S. Internet Users reported 5/24/99:

• 99 percent of respondents said they are at least “somewhat satisfied” with Internet purchases

• 79 percent report being “very satisfied”

• 83 percent of users in the market for a new vehicle plan to use the Internet in their purchase process

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Internet Potential - Business• Online retailing may not be more cost

effective than traditional retail stores• Example: REI

– Internet site requires smaller staff, but higher salaries for technological knowledge

– 300-person Seattle store and 60-person Internet site payrolls about equal

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effective than traditional retail stores• Example: REI

– Incessant requirement for upgrades has forced spending of $15 million on technology since 1996

– Many buyers expect products will arrive more quickly than catalogue orders

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effective than traditional retail stores – Cost-reduction from disintermediation, time

and labor savings• For many intermediaries eliminated, new ones

are created • Example: Amazon.com:

– Ingram Book as an intermediate supplier– UPS and DHL for delivery– AOL for customer acquisition

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effective than traditional retail stores – Real questions are cost and customer

acceptance

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Internet Potential - Business

• Greatest potential for Internet growth probably lies in business cost reduction and customer-specific marketing & sales– Reduction in production times– Reduced inventory and labor costs– Mass customization

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Internet Potential - Business

• Buyer consortia for production purchasing

– Auto manufacturing: Ford, GM, Daimler

– Electronics

– Aerospace

– Replaces Electronic Data Interchange

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Stock Market Economics• “Buy and hold”

– Power of compounding versus risk of market timing

• Minimize transaction costs– Investment advisor versus solo– Load versus no-load funds

• Performance equivalence• Front-end/back-end loads, management fees,

expense ratios, long-term cost amortization

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Stock Market Economics • Start-ups and IPOs

– Small business failure rate is very high (80-90%)

– Poor investor returns for most IPOs (in 2/3 of cases share price falls first year)

– Aside from initial share allocation, long-run average returns from IPOs lag S&P 500

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Stock Market Economics

• Start-ups and IPOs

– Over the past 15 years, 68% (average) of the firms going public were profitable

– In 1999, only 25% of firms were profitable

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• Start-ups and IPOs

– IPOs with positive earnings per share in twelve months prior to IPO:

1990 - 85% (97) 1995 - 72% (363)1991 - 75% (267) 1996 - 63% (431)1992 - 68% (375) 1997 - 68% (304)1993 - 70% (468) 1998 - 59% (222)1994 - 78% (316) 1999 - 22% (441)

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• Stock Market “Bubble” – Price-to-earnings ratios (cost of stock vis-à-

vis profits) are about twice their historic average

– Over long run, stocks will regress towards earnings potential of operating companies

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• The stock market is overvalued because…– Investment capital is readily available– Investors haven’t done sufficient research– Investors have unreasonable expectations:

• Earnings will produce profits to sustain share prices and projected price-earnings ratios

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• The good news:

– Investor exuberance reduces the cost of capital and generates investment funds – much of which fuels business development and economic growth

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Stock Market Economics• Internet risks

• Insufficient net space– Petstore.com

• “Land grab”- having customers is not enough– Amazon.com

• Positioning challenge– (see newspaper advertising example)

• Illusive efficiency - many claims as yet unsupported

– Webvan (can you say “Peapod”)

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• Internet risks– Lack of business experience/capability– Example: Riffage.com

• Palo Alto Internet music site• Recently purchased Great American Music Hall• “We don’t have anybody on our staff who knows

about running the Music Hall. That was part of the attraction for us.”

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• Mounting losses/help needed:eToys Egghead.comPlanetRx.com Fogdog.comAutoweb.com Garden.comBuy.com HomeGrocer.comCDNow Streamline.comDrugstore.com Cybershop

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• 95% of e-tailers won’t survive to see 2001– iVillage (women’s interest site) - lost $1.30

per dollar in revenue 1Q2000– InsWeb (online insurance) - shares fell 89%

this year; reducing workforce by 40%

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