The internet business is doomed ... to mediocrity.

I'm not saying the internet itself is doomed to failure or anything, because it isn't. More people and more business will continue getting hooked up to the net, and it'll keep trundling along under the weight. It'll get bogged down at times, but it won't fail.

The business of the net, well, that's another story. The internet business, by which I mean dot-coms, service providers, and backbone carriers, is going to fail to succeed wildly. The companies that are on solid enough foundations will stick around, but they'll be permanently hamstrung by the poor decisions they're making today. They're going to be playing a perennial game of catch-up and looking for places to land the blame, but it's pretty obvious that they're not going to fix what's broken. They don't even realize it's broken.

It all boils down to one thing:

If your company's most valuable asset is its stock, you're dead.

The stock market has encouraged internet businesses, old and young, large and small, to focus on short term stock price instead of, well, everything else. Management is rewarded for "success" with stock, which adds to this death spiral in several ways:

• Dilution. The value of each existing share, on an open market, should and eventually will drop if more shares are added. Some companies have already seen this happen. More will. Your company's market cap shouldn't just magically rise every time you issue more shares, and eventually that practice is going to catch up with you.
• Instability. In today's world, employees - even management - don't tend to stick around very long. When any given employee leaves, what reason does he have to hold onto the stock? The answer is, of course, none, so he's probably going to sell it off. He's going to sell it off even faster if he's seen from the inside how poorly the company is run. In this day and age, every share that's sold is seen by day traders as a sign, and a large enough block of shares (such as was dumped by a departing manager) will cause a sell-off. There goes your market cap.
• Negative feedback. Giving a manager stock will encourage him personally to seek to "increase shareholder value," since he owns shares himself. This is synonymous with, "think in the short term only," or, "don't spend any capital to make serious improvements." The idea of "increasing shareholder value" is misguided at best, fatal at worst, and is magnified by the number of shares owned by management.

It's that last one that's the biggest problem. It encourages managers to see the stock as the company's most valuable asset, which is so amazingly, appallingly wrong I'm shocked that nobody's caught up to this yet. I know why nobody's caught up. That's an easy one. As long as the stock price is artificially high, it's "good for everybody." We get to watch the economy sail along on inflated stocks, every little guy and day trader is encouraged to buy stocks in the industry, and that cash is indeed necessary to fund growth. That's why stock existed in the first place. The problem is, management can no longer see the value forest for the stock price trees. This is true across the entire industry. Decisions are repeatedly made which consider only the short term stock price, and not the stability or viability of the company that stock is attached to. And the bottom is going to fall out.

There are three things that are more valuable than stock. If this list doesn't cause you to say, "well, duh," then you are part of the problem:

• Customers. This should be terribly obvious but it isn't. If companies realized that their customers were important, they'd have actual customer service. They would train their support staff better, they'd monitor them more, they'd survey their customers and find out how they were doing (and pay attention to the results), they would take new business to the customers instead of waiting for the customers to come to them. They would increase value to the customer instead of to their shareholders ... which would have the effect of increasing the value of the company, since a happy customer is one who not only is a repeat customer, but one who refers his friends.
• Infrastructure. This is the company part of the company, the actual physical assets. This means the servers in the case of a service provider, the network in the case of a bandwidth provider, and the inventory system in the case of a dot-com merchant. It also means making sure you have enough phone lines for customer service, enough bandwidth that customers never get locked out, enough warehouse space and inventory in order to fulfill orders in a timely fashion, and a plan that makes sure you have more capacity than you need at all times. Infrastructure requires investment, investment requires capital expenditures, and capital expenditures have a negative short term impact on the stock price. The going wisdom is, never mind that if you don't have the infrastructure you're going to drive away your customers, the only goal is to "maximize shareholder value." This will backfire when companies that don't have enough capacity fail to deliver services to their customers, driving those customers to the competition.
• Employees. None of this can be done if your company isn't holding on to its employees, training them, and keeping them happy. Treating employees as expendable, easily replaced, liabilities - instead of assets - will assure that your company never has an adequate employee base to make continued success possible.

Now, the saving grace here, the thing that makes me say that the industry is doomed to mediocrity but not failure, is that in spite of themselves the companies in the internet industry are managing to deliver something, most of the time. Customers who get fed up and find different providers discover when they get there that the grass wasn't greener on the other side of the fence after all. So what's going to happen is that customers will become less and less enamored of their vendors, and in lieu of actual service (which none of the vendors seem to be focusing on) will ask for, and get, lower pricing, rebates, refunds, SLAs. They will be forced to get by with less, because the vendors haven't bothered to focus on actual value. But since there aren't any companies that actually have focused on actual value (possible exception here of Amazon, although I've heard horror stories about their customer service) what the customers will find is that it's pretty much the same everywhere. And the steam will run out of the industry. Revenue growth will drop off, the stocks will level out at something resembling a P/E ratio, and the expansion phase of the internet will be done. At that point the logic will be, "we already have a mousetrap, why should we build another one?"

There is a way for internet companies to perpetuate the growth they're seeing now, but it goes against the logic by which they all seem to operate. It's an older rule of thumb than the internet, though:

You have to spend money to make money.

Internet companies should be spending all the capital they can get their hands on right now. They should invest it in customer service, infrastructure, and most importantly, their employees. I'll admit they shouldn't spend this money indiscriminately, but they should be trying very hard to end up each fiscal year with most of their cash spent. It'll pay for itself as they build up extra capacity, expertise, and customer base, and as those customers stick around because there's nobody else who provides them that level of service. It'll also pay for itself when they have employees who have been there for a while and who are happy to work for a company that treats them well. It'll pay for itself when their existing customers sign up for new services and refer new customers. All of those are things that will make sure that the long-term stock price is high, which is where everybody wants it to be anyway.

(2000-05-07)