"A company for carrying on an undertaking of great advantage, but nobody to know what it is."--from an eighteenth century prospectus, in the time of the South-Sea Bubble
We are at the collapsing end of an Internet bubble. For two years, new companies opened up daily, offering free faxing worldwide, customizable cursors, and products you could buy for much less than it cost the company to acquire you as a customer. So-called "application service providers" offered you the ability to store your data on their web server (but failed to explain why that was better than storing it on your own capacious hard drive) or to run buggy, slow applications inferior to the slightly less buggy and slow Microsoft applications which came with your computer. Why this happened and why it ended is an interesting moral inquiry.
First, a word about my own relationship to the subject matter. I helped launch, and served for three years on the board of directors, of a technology consulting firm which went public in 1997. The stock broke within six months after the offering, then later made a brief resurgence as an Internet stock, then broke again. In 1995, I started another consulting firm, this one specializing in Internet technology, and served as its CEO until earlier this year. Consulting firms, even ones concentrating on the Internet, are not "dot-coms"--they are based on an old-fashioned and rather unexciting business formula, that of selling the time of expert individuals at a mark-up, like accountants or lawyers. However, some of our clients were dot-coms, and more generally as someone making a living in that industry, I have been a front row spectator to the rise and disintegration of Internet companies. I also invested a small amount of my own money, about five thousand dollars total, in several companies of which I had some first hand (but not insider) knowledge. At one point this small portfolio was up around 80% in a few months time, and like many other idiots, I felt like a genius. It was a time when "every fool aspired to be a knave." Now that portfolio, which I am still haplessly holding, is down about the same percentage.
One of the lessons to be derived from the collapse of the Internet bubble is "plus ca change, plus c'est la meme chose". In law school, around 1977, I took a securities law course, and on the first day the professor told us of a company which went public during the 1968 bull market, whose business model was to string a line of balloons between the earth and the moon. The offering was eagerly oversubscribed on opening day.
No discussion of stock bubbles is complete without a reference to Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds, particularly the first three chapters, on the Mississippi bubble in France, the South Sea bubble in England, both in the eighteenth century, and the tulip craze in Holland, in the seventeenth. Anyone who believes in human progress should read a little of Mackay. The Internet market of 2000 is surprisingly close--despite the immense difference in culture, technology, most of the incidents of daily life-- to the events of the 1630's and 1720's as described by Mackay.
The Mississippi mania was instituted by a Scotsman, John Law, residing in France, who at a time of intense debt, corruption and economic collapse, offered his services to the Duke of Orleans, regent to a seven year old king. Law, after helping to induce the beginnings of an economic turnaround in France, asked for, and received, the exclusive right to trade with Mississippi and New Orleans. Since Law, in a brief time, had established a somewhat unmerited reputation as a financial genius, a frenzy of speculation began in the shares of the Mississippi company, with people who could not otherwise get access to Law engaging in complicated stratagems to see him so they could get on the list for the next issuance of stock. One lady deliberately crashed her carriage in front of him so he would come to her aid. Law, who up until now had been rather conservative about how much stock he would float at a time, had once declared that any banker deserved death who made issues of paper without the necessary funds to provide for them. Driven by the autocratic cupdity of the regent, and also by his own vanity, Law issued notes in the amount of a thousand million livres when his prior issuances had never exceeded sixty. "With a weakness most culpable," Mackay writes, "he lent his aid in inundating the country with paper money, which, based upon no solid foundation, was sure to fall, sooner or later." The street on which Law lived became crowded with speculators, and people paid enormous sums to rent the houses next to his, in the hope of getting in on the action. Finally, Law moved to a residence with an enormous garden, where a stock exchange was created, with the stock-jobbers setting up more than five hundred small tents from which they did business. The price of the shares would sometimes fluctutate ten or twenty percent in the course of a few hours. The regent thought that "a system which had produced such good effects could never be carried to excess."
Early in 1720, a major investor, angered by Law's refusal to include him in a new round at the price he wanted, tried to sell a large number of shares, until the regent intervened to order him to desist. This caused a crisis of confidence. In the meantime, other investors with an unclouded view of the future had been converting their stock to gold and silver and taking it out of the country. Eventually so much coinage had left the country that there was not enough left to ensure the daily operations of business.
At this point, the value of Mississippi shares had fallen so far that an act of theater was thought necessary to restore confidence. Six thousand of the poorest people of Paris were drafted--"impressed"--against their will, outfitted with work clothes and shovels suitable for digging gold in Mississippi, and marched through the center of Paris day after day. They were then sent off to port cities for ostensible shipment to America, but most escaped, sold their tools and returned home. The Mississippi stock rallied slightly. In the meantime the regent continually printed more paper money, to try to cover for the absence of gold and silver coin. Eventually, there was 2600 million in paper money circulating, backed by less than half that in coin. Soon after, the remaining air went out of the Mississippi company, it was divested of its remaining rights and assets, and Law left the country newly impoverished.
Mackay boasts that England handled the South-Seas bubble much better than France did the Mississippi speculation. The facts are very similar, except that there was even less to the story. France at least had access to Mississippi and Louisiana. The South-Seas manipulation was based on rights to trade with Latin American countries which had not actually been granted to the company by the King of Spain, who permitted only one ship a year from the company to visit Mexico, Peru and Chile, and appropriated twenty percent of the profits for himself. A year after the South-Seas company was formed in 1717, Spain broke with England and revoked even this small privilege.
In February 1720, Parliament accepted a proposal from the South-Seas Company to retire the public debt, and the company's stock rose from 130 pounds a share to 300 in a single day. Before the slow-moving legislative process had been completed, the stock was at nearly four hundred. One of the few public figures willing to speak out against the South-Seas scheme was Mr. Walpole, who said that it would "hold out a dangerous lure to decoy the unwary to their ruin, by making them part with the earnings of their labor for a prospect of imaginary wealth." He pointed out accurately that the scheme was not really about trading with Latin America: it was, instead, "to raise artificially the value of the stock, by exciting and keeping up a general infatuation, and by promising dividends out of funds which could never be adequate to the purpose."
Imitators began springing up everywhere with their own bubbles, some based on solid business schemes had they been pursued in good faith. "But they were established merely with the view of raising the shares in the market," Mackay writes. "The projectors took the first opportunity of a rise to sell out, and next morning the scheme was at an end." Other schemes were obvious frauds which nonetheless fooled a profit-mad public. One company raised capital for a perpetual motion machine, while a particularly clever promoter--really a postmodernist--issued a prospectus for "A company for carrying on an undertaking of great advantage, but nobody to know what it is." He sold out an initial subscription, made a quick 2000 pounds, and left the country.
In the first week of June 1720, the stock of the South-Seas company rose to eight hundred and ninety,setting off a spate of profit-taking and driving the stock down by 20%. By September it had lost fifty percent of its value, and it was known that the chairman and some other principals had sold all their shares. An attempt by the Bank of England to shore up the company backfired, causing a run on the bank and the default of bankers and goldsmiths who had lent money upon, or made a market for, South-Seas stock, which now collapsed to one eighth of its maximum value.
Mackay comments that bubbles can only grow and burst in an atmosphere of general immorality. "Nations, like individuals, cannot become desperate gamblers with impunity. Punishment is sure to overtake them sooner or later."
Mackay's most entertaining chapter is about the tulipomania. Starting in 1600, the wealthy of Holland, and eventually of all Europe, were caught up in a tulip craze, with traders investing thousands of florin in a single bulb. One merchant invested half his extensive fortune in a rare specimen, not for resale but for his personal admiration and that of his friends. Another hapless collector inexplicably left a recent purchase lying on his kitchen counter, where it was eaten by an ignorant visitor who mistook it for an onion.
Inevitably tulip exchanges were established, where jobbers manipulated the price. No-one any longer bought tulips to plant in the garden, but only for speculation. "It was seen that someone must lose fearfully in the end. As this conviction spread, prices fell, and never rose again." The market collapsed, and many traders could no longer sell tulips even at a fraction of what they paid for them.
The semiotics of bubbles
The first insight gained from a study of bubbles is that the business concept at the center is a sort of placeholder, rather than the actual DNA of a potential thriving company. In fact, the business idea is, in semiotics terms, really only a signifier, which only gains meaning when coupled with a significance, thereby transforming into a sign. Signifiers are relatively empty in themselves. In the case of bubble companies, the associated significance is not "Healthy, profitable company, returning profits to its investors in the long term", but a belief that the acquirer of shares, being a hell of a fellow, can ride an increase in the stock price, then get out in time. The core idea therefore is not required to have enough "legs" to last for any length of time, nor to return profits ever; it is simply required to meet certain minimum standards of persuasiveness, so that someone will buy your shares from you for more than you paid. In other words, as an investor in such companies, you are not gambling that the underlying business will succeed. You are instead gambling that the central idea will remain persuasive to other people longer than it is to you.
The brilliance of the promoter of the secret company thus becomes evident: he was the first, and perhaps the only promoter in history to create a successful company without even the slightest pretense of a business model: a sign without a signifier. The significance was all, but the signifier was absent. I would like to think that after making his two thousand pound score, he became a poet or a novelist.
I have seen first hand a couple of supporting proofs of the thesis that no-one knowledgeably situated to make money cares whether there is a real business at the core. When I was practicing law in the '80's, I represented a tax shelter promoter. One of his shelters was a software company. I had a speciality in computer contracts, and offered to evaluate the company's agreements, create a form of software license, etc. He looked at me as if I were crazy: a company which is a mere placeholder (the significance here was "save taxes", not "thriving software company") does not require strong contracts: paying me to work on them would have been a completely unnecessary expense.
(A pause for a completely irrelevant story about this client. I visited his house one time and his four year old son inquired if he had driven home in the Bentley or the Rolls. A short while later, as we ate dinner, the boy stood by the table with an eight by ten photograph of the client's Cessna, repeatedly crooning, "Look at the plane," then flipping it around and saying, "All gone!" A month later, the client, feverishly lobbying Congressmen all over the country against legislation curtailing tax shelters, ran out of gas and crashed that Cessna on the approach to Atlanta airport, killing himself and his chief operations officer.)
Later, when I was affiliated with a software services company, a public firm made an offer to purchase us in a stock swap. The banker who was brokering the deal, who had worked with us on other matters, stood in my office and said, with a penetrating stare, "The stock should stay good until the end of the year. Do you understand me? The stock should stay good until the end of the year." I concluded that he knew something and that the stock would not stay good longer than that. He apparently felt some ethical obligation to warn us, even in highly coded terms. A short time later, well before year's end, it turned out that another company recently acquired by our suitor had overstated revenues. This set off a crisis of confidence and the stock we were so close to accepting lost 90% of its value in a few days.
The banker did not, so far as I recall, spend any time telling me that the acquiring company was a good or bad environment, would be or remain profitable, would have the money or the interest to help our business grow within its empire. The suitor, which had seen its core business crumble, was buying a software services firm every month, creating a series of signs of its own future prospects, merely to keep its own price up. Its acquisition of us, from that perspective, would have been equivalent to the Mississippi company parading homeless men with picks and shovels through the streets of Paris.
As far as signifiers go, a tulip is a much better one than the South-Seas or Mississippi companies--there's far more reality to a tulip, which is a tangible object capable of producing a pretty flower.
Ponzi schemes
Mackay comments that after the collapse of the tulip market, the Dutch courts refused to enforce tulip contracts, leaving buyers and sellers wherever they were. "There was no court in Holland which would enforce payment. The question was raised in Amsterdam, but the judges unanimously refused to interfere, on the grounds that debts contracted in gambling were no debts in law."
In accordance with the Second Law of Thermodynamics and the maxim that "trees never grow into heaven," no investment increases in value endlessly. In the preface to the 1980 Crown edition of Mackay's book, Andrew Tobias discusses an "extraordinary popular delusion" unknown to Mackay: the chain letter which asks you to send a dollar to the author, then send it on to some number of other people who will send you a dollar. "Just where all this free money was to come from was not explained. It never is," Tobias writes. At the end of a 1935 chain letter craze in Denver: "Everybody by now had a letter to sell: no one was left to buy."
The stock market, like the tulip market and the South-Seas and Mississippi bubbles, is based on the premise that someone will be left holding the bag. In this sense, each of these is like a classic Ponzi, or pyramid scheme, where the first investors are repaid from the money put up by later suckers, who can never themselves be repaid because the scheme has run its course and there are no more suckers. That most Internet investments in particular were Ponzi schemes is fairly clear today. Any investment in a publicly traded security is a pyramid scheme unless the company itself, and not merely the security, is a source of money. Not free money, as Tobias scoffed, but of value that people worked hard to create. But in order to qualify as a real company, not merely a sign or a placeholder, there must be a real business model in place, not merely "Lets spend $135 to acquire a customer who spends $40," or "Let's create customizable cursors and figure out how to make money later."
Regrettably, the lure of "money for nothing" is so primal that quite reasonable people get caught up in it and willingly suspend judgment about whether the sign that lures them is enough to create wealth for anyone. People even lose sight of which class they belong to--the money makers or the suckers. "Every fool aspired to be a knave," said Mackay. It happened to me-- in a small way, but it was real enough. For years I stayed out of the market entirely because I didn't think I could ever acquire the knowledge or the instincts necessary to make money. Then I concluded that if I bought stock in companies about which I knew something personally--good people, services or products-- I might profit. Then I fell into the trap of believing that by correlating industry rumors with my own instincts for which companies were solid, I could figure out which companies were about to "pop." At the end, I was betting on "pops" regardless of whether I thought the underlying company was solid. I had gone from a long term philosophy--buy Braun Consulting and hold it for three years because its a good firm--to a day trader mindset--buy at 40, hold while it runs up to 80 a few weeks later, then sell. After one or two of these, I thought I was a genius. Just as the market crash started in March, I sold everything--really by sheer luck but again I thought I was very clever. Since I knew very little about the kind of indicators many people track, the obscure charts and systems, I just thought (like most fools do during a bubble market) that I had good instincts for this kind of thing.
When I sold, I was up about $6,000. About six weeks later, concluding the market was at its bottom, I again bought all the stocks I had sold--and today I have a small, moribund portfolio with a semi-permanent $6,000 loss. Stocks I bought at $3 and $7 are trading at pennies and will be delisted from the stock exchange soon.
Who's to blame?
Of course, if you are a kind, naive person, its easy to think that we all got body-slammed together--the rich and the poor, the bankers and the day traders, the knaves and the fools. Certainly we have some examples of people who were riding high and aren't, in particular the entrepreneurs who were millionaires on paper and whose stock now isn't worth anything. But what we suckers never realize, and the entrepreneurs sure don't, is that the latter are largely destined to be members of the sucker class from the start.
The dividing line between knaves and fools is that the knaves get their money out early, like the chairman of the South-Seas company who sold out while still aggressively touting the stock to the public. The founders of Internet companies, by this definition, were fools, because the knaves universally imposed on them what is called a "lock up" agreement. No investment bank will take you public unless you sign such an agreement, which says that you promise to hold your shares for at least six months after the public offering. By comparison, the bankers themselves aree getting their money out the first day--they are buying the shares from you at the offering price and reselling them to the first day purchasers at the market price.
Not that many years ago, you expected the bankers to make a dollar or two per share, and if they made more than that you were angry, but there was nothing you could do about it. For example, the company I helped take public in 1997 opened at $9, the price the bankers paid us for the stock, and when it traded to $12 the first day we felt they had set the price a little too low, and made a bit too much on the transaction. During the Internet bubble, we had the spectacle of companies going out at ten and trading up to more than $100 on the first day--with the spread of ninety or so dollars going entirely into the pockets of the bankers and the first day institutions, and not to the company.
Who are the first day purchasers? If you have ever tried to get first day IPO stock, you found out it was almost impossible. You could get some only if you had a relationship with an insider allowing you to get into a "friends and family" program, or if you traded so many millions of dollars through your broker that she had to throw you some first day stock from time to time to make you happy. During the Internet bubble, Web-based brokerages started making promises--which were largely false--to democratize this market by giving small traders access to IPO stock. These brokerages themselves failed to get access to as many shares as they expected. They claimed to assign you shares on a random lottery system. In several months of trying, on two different systems, I never got any IPO stock. One friend of mine had an account with one such brokerage for two years, applied for every IPO, and never got any. A fairer algorithm might have tracked whether a particular customer had ever received an allotment, and made sure that everyone applying got at least a few shares every year. Instead, these brokerages were unable or unwilling to deliver on their promises and created significant dissatisfaction among customers who were again reminded that they formed part of the sucker class.
In most IPO's, the investment banks line up ten to twenty large institutions--their regular customers--who subscribe for the entire first day allotment. Stock reaches small investors on the first day only if some of these institutions flip their shares. During the Internet bubble, the public--supposedly the central concept in "initial public offering"--bought new offerings only at the Ponzi price, the maximum price after which there are no more buyers.
The company which all the fuss was ostensibly about, ended up with $90 or $100 million in its coffers (it is remarkable to think that companies touted soon after as having billion dollar valuations made only $100 million, with the rest of that wealth going into the pockets of the bankers and the institutional investors). However, the founders, most of them entrepreneurs who had taken substantial risk, didn't share in this cash. Under the lock up agreements, they got stock they couldn't sell. For those lucky enough to see the six month deadline expire before their stock price crashed, they still couldn't sell more than a minimal number of shares every quarter under applicable securities laws (rule 144). For most company founders, the moment of liquidity, which occurs for the bankers on the first day, does not come until the secondary offering, at which everyone understands that the founders of a company which has now proven itself will sell a substantial chunk of their stock. But for most companies caught up in the Internet bubble, the secondary never arrived.
This raises an interesting moral question: were the people who founded Internet companies with no clear path to profitability fools or knaves? Did they sincerely believe their companies would ultimately be profitable, or did they merely think they would get their money out before the Ponzi price was achieved?
I think there were Internet entrepreneurs who fell into either category. The most cynical were the investment bankers who jumped to the entrepreneurial side. Bankers and entrepreneurs are completely different life forms; a banker is someone who understands that there is more money to be made feeding on entrepreneurs than in being one. A banker who became one during the bubble probably did so to architect a better signifier than his clients were capable of. Otherwise its a rather passive profession, waiting for businesses to be swept into your teeth which, by accident and unbeknownst to them, meet your nutritional requirements (plankton and krill don't aspire to be tasty to a whale).
It is an interesting side note that, in the Internet bubble and the technology bull market which preceded it, company profitability and "tastiness" became almost unrelated to each other. Founders of old fashioned businesses, such as consulting and recruiting firms, where it is easy to make money on tried-and-true models, were frequently told in the mid-90's that their businesses weren't sexy enough to go public. It was apparent from around 1997 that bankers wanted mystery, and the bubble companies of 1999-2000, with business plans involving buying millions of "customers" at a loss, served this need. Though we seem to have stopped short of the ultimate mystery of the "undertaking of great advantage, but nobody to know what it is."
Most business founders probably thought they had something which could last a while, and which served other needs (pride, community) as well as the desire for riches. Here the role of the banker is frequently to stroke the entrepreneur into thinking he had something more than he does. In the 1990's, you needed five years of operating history, and at least one of profit, to go public. The company we took public in 1997 met those criteria, but still wasn't ready; it didn't have a sales and marketing machine that would ensure it could continue to meet or exceed it projections and create 40% growth a year. But, never having done this before, we had no clue that an IPO was premature. The bankers who took us public, being experts, had the last clear chance to tell us we weren't ready.
Back then, we relied on the idea that bankers, though they made their money the first day, cared what happened to the company afterwards, if only to maintain their reputations. If a banking firm was responsible for too many broken stocks, no company would select the firm to take it public, and institutions wouldn't buy the stock.
In a more perfect world, this would have worked. But, as the Internet bubble accelerated, the bankers found several ways of evading responsibility. First, there was a general weakening of standards, a sense that none of the usual rules applied (a phenomenon Mackay also notes in his accounts of the two earlier bubbles). Instead of five years of operations and one of profitability, companies were going out after just months of operations, with substantial losses and no clear plan for profitability. Secondly, the bankers frequently sold their own companies during this period. Companies which had been proudly independent for more than a century suddenly merged with large banks and brokerages, creating a break in the moral continuum which allowed the new owners to say, "We weren't there" and the original members to claim "That's no longer us".
Finally, when the price of every Internet stock gave way, the bankers were able to present it, with significant support in the media, as a mysterious storm that broke over everyone's heads, that could not have been predicted or avoided by anyone. I believe this is a lie--like the banker who told me about the stock price which should "stay good til the end of the year," I suspect most bankers knew pretty well when the market would collapse. Because bankers, unlike day traders, do not believe trees grow into heaven.
A really simple solution would be for bankers to sign the same six month lock-up as the founders. An investment banking firm which bound itself to stay in for as long as company management would find itself with a radically different view of the company's affairs. This easy requirement would greatly diminish the number of junk IPO's in the market.
Shooting ponies
What about the venture capitalists, the people who bankrolled the Internet startups? Unlike the investment bankers, they are probably not walking away clean; they lose millions of dollars every time they force a company to fold. Some of the publicly traded "accelerator" firms (like CMGI) appear to be in some trouble themselves.
VC's only expect about one out of every seven of their companies to succeed, and these successes pay for all the rest. So, despite the bloodbath among Internet startups, the VC's are only in trouble if the collapse of the Internet bubble is changing their ratio. It probably is, but its hard to say, as VC's do not trumpet these statistics to the world.
Like investment bankers, VC's prefer to see the collapse of the market as a storm which hit everyone unexpectedly, an act of God, really. This is an uneasy response to the fact that people's lives are being profoundly affected: even during Christmas week, dotcom employees all over this country are being called in by their bosses and told that they no longer have a job.
Sure, one way of looking at it is that that's the risk you take, in return for your stock options, when you work for an Internet company. The problem that I have with that approach has to do with the reliance factor. Getting people to come work for you in a start-up company--I have done it--is like persuading them to sell their houses and join your wagon train. Once they've uprooted themselves in reliance on you, you have something of an obligation to see it through. When the wagon train is less than 200 miles on its four thousand mile journey, you can't just say, "Never mind, I'm no longer interested," and send them all back home.
But this is exactly what the VC's are doing. Do capitalists have an obligation to pour additional millions into a business model in which they no longer have confidence? From a moral standpoint, yes: either that, or don't get a bunch of people to quit their jobs and join it in the first place. VC's, who distance themselves from their companies in many ways, including legal structure, psychological measures, and the clever use of rhetoric, avoid the truth, that in the Internet economy, they played with people's lives in a really frivolous way. Today, there are hundreds of thousands of jobless people who trusted an entrepreneur who trusted a VC.
The CEO of an incubator firm which had just closed several dotcoms recently spoke of "shooting the sick ponies in the stable". There is so much wrong with this casually brutal formulation I could devote an entire essay to it. While in ordinary times VC's expected to stay in a company for seven years or more, this year we saw the spectacle of VC's closing down companies in which they had invested only four months before.
Given their sophistication (each of them probably owns a copy of Extraordinary Popular Delusions, a perpetual favorite on Wall Street) it seems improbable to me that the VC's thought that companies hawking customizable cursors or free faxing would be profitable. Instead, they were probably knaves who became fools, because they thought the bubble would last longer than it did.
The inadequacy of law
"Don't we have laws to protect us against the promoters of bubbles?" These laws seem themselves to be more sign than reality. They provide a procedural safe harbor: if you have taken certain steps--provided audited financials and a list of extremist-sounding risk factors--you can still create a bubble company. The real moral of the story is human greed; every company that has now closed its doors had a prospectus or business plan which said that it was not profitable, had no plan for profit, that the investor might lose the entire investment, etc. And yet there was no shortage of fools aspiring to knavedom, to buy the stock.
The Internet as sui generis
Every new technology tends to be regarded as sui generis, as if it bore no similarity to what has come before. Yet the provocations and problems of every new technology are eventually dealt with by analogy to what has been done before. For example, one day the Supreme Court realized that the telephone was like a telegraph which carried voice, and sixty years later, it realized that movies are rather like novels.
This confusion about when analogies work, and when they break down, was exploited by bubble promoters who expected to benefit from a perception that Internet businesses don't have to play by the rules of traditional companies. It seems quite silly today that anyone bought this argument. In general, businesses which worked well off the Internet will in some cases work as well on it. Some never will. Some will work a little better, because the Internet removes the obstacles. But there will be very few absolutely new business models that can exist only with the Internet.
A bookstore is a very good Internet-based business if you have modest expectations. Books are commodities, and if you know what you are looking for you don't really need to flip the pages. If you are not certain what you want, reader reviews, recommendation engines and the like can help you decide. The economics are simple, so long as you make the customer pay the shipping. Bookselling is one of those businesses which can work better on the Internet. Years ago I stopped ordering books at my local store, and waiting six weeks to get them, when I could order them on Books.com and then Amazon and have them in days.
The reason Amazon is losing money is because of "expectation inflation", another evil handed us by the bankers and VC's. Internet businesses have to be sexy and mysterious, and a highly profitable bookstore isn't. Therefore, its necessary to have Z-shops and auctions and to sell everything else including lawn furniture. In the Internet economy, the more capital investment you received, the worse your chances became (if someone hasn't already named this idea, I modestly suggest calling it "Wallace's Law"). This was because the burden of capital forced you to set the bar so high, you could never jump it. A bookstore could bootstrap itself to profitability, or do so on a one million dollar investment. But a bookstore that had accepted forty million dollars would need to pull off a hat trick to justify it, beyond the power of any bookstore.
An example of a business that may have made little sense on the Internet is Pets.com. The company had a strong brand, informative content, great selection, and was very convenient. Its sock puppet spokesman was clever, memorable and highly entertaining. Yet in the year the company existed, I made one sixty dollar purchase there, while I spent hundreds of dollars in local petstores. Why? Because you tend to buy pet food when you are running out, which means that you are in a hurry and can't wait a week to get it. Also, some pet food you want to inspect before buying, unlike books.
Internet-only concepts like customizable cursors may remain forever mysterious. Certainly there will be a few businesses which will only exist because of the Internet, the way gas stations depend on our highway system. But if you can't say, "Its similar to _____ before the Internet" and know how to fill in the blank, the business model is probably problematic. Gas stations are, after all, what replaced public stables, where you could feed your horse or have it worked on.
Everybody got run over
My favorite Thoreau quote provides a good thumbnail history of the Internet bubble.
Men have an indistinct notion that if they keep up this activity of joint stocks and spades long enough all will at length ride somewhere, in next to no time, and for nothing; but though a crowd rushes to the depot, and the conductor shouts "All aboard!" when the smoke is blown away and the vapor condensed, it will be perceived that a few are riding, but the rest are run over,--and it will be called, and will be, "A melancholy accident."