INVESTMENT STRATEGY AND THE “NEW” ECONOMY Dr. James R. Forcier Managing Director Bay Analytics 15 June 2000 Copyright © 2000 by Bay Analytics. All rights.

INVESTMENT STRATEGY AND THE “NEW” ECONOMY

Dr. James R. ForcierManaging Director

Bay Analytics

15 June 2000

Copyright © 2000 by Bay Analytics. All rights reserved.

Bay Analytics

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” Defined

The “old” economy

+

The application of computing technology

=

Significant changes in long-standing ways of doing business

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• 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.com

PlanetRx.com Fogdog.com

Autoweb.com Garden.com

Buy.com HomeGrocer.com

CDNow Streamline.com

Drugstore.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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Bay Analytics ECONOMIC

STRATEGY CONSULTING

Thank You!

INVESTMENT STRATEGY AND THE “NEW” ECONOMY Dr. James R. Forcier Managing Director Bay Analytics 15 June 2000 Copyright © 2000 by Bay Analytics. All rights.

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