In the era of crowdfunding, streaming music, and social media, tech startups have never had as much opportunity to turn a profit, nor have they drawn as much interest from investors looking to cash in on their profitability. Some have speculated that the influx of investors and their immense capital against the limited number of viable tech companies has created an incredibly large bubble that’s bound to burst and leave many devastated. For those who have followed economic trends in recent years, this comes as no surprise. Others, however, may be wondering: “What the hell is a bubble and why should I care if it bursts?”
In broad terms, a bubble is created when the price of a product does not justify the long term viability of that product. In this instance, the products in question are youthful startups looking to innovate (or at least try–or pretend–to innovate) a particular area of technology, and the venture capitalists dumping money into those startups act as the hot air being pumped into the delicate sphere of the tech industry. With no understanding of that sphere’s capacity for long-term growth, these investors drastically overestimate how large these businesses are capable of becoming and continue dumping money into them until the inevitable “pop” that leaves the entire industry in shambles.
A classic example of this was the dot-com boom of the late ’90s and early ’00s when a plethora of venture capitalists were investing an absurd amount of money in companies that had no earthly way of returning that investment. For instance, Yahoo’s 1999 purchase of Geocities, a website geared toward allowing users to create their own personal homepages. Yahoo paid $2.87 billion in an effort to cash in on the apparent gold rush of the dot-com industry. However, they were too late to the game and almost immediately saw Geocities’ user rate dwindle, and it continued to do so until 2009 when the website was forced to shut down for good. Bebo, a start-up social networking sight, was purchased by AOL in 2008 for $850 million before eventually crumbling and being sold for a mere $10 million in 2010, causing then-CEO Randy Falco to lose his job (Bebo would go on to declare bankruptcy in 2013).
Mark Cuban, the current owner of the Dallas Mavericks, made his initial fortune during the dot-com era by selling off his website, Broadcast.com, to Yahoo for $5.7 billion. Broadcast.com’s earning potential proved to be wildly overestimated, and this blockbuster purchase ended up costing Yahoo dearly, both in capital and credibility. Cuban, at that time, recognized that he was in the midst of a bubble and timed his cash-out perfectly. He currently acknowledges that we’re in a new, different bubble: the tech bubble, which he claims is even worse than the one that made him a billionaire.
As examples, he cites companies like Twitter, Facebook, and even hospitality services such as Uber and Airbnb. While these companies have seen tremendous success, their current valuations in no way equal their current (or even speculative) revenue. BuzzFeed, for example, drew in a $50 million investment from Andreessen Horowitz last year in exchange for 10 percent of its equity, and in August received a $200 million investment from NBCUniversal. Such investments suggest BuzzFeed’s valuation is now in the echelon of publications such as The New York Times or The Washington Post.
Indeed, the online publication has garnered a growing readership and ranks above The Washington Post in terms of reader traffic (both in the US and internationally), though still falls behind The New York Times. However, whether BuzzFeed will maintain a long-lasting readership as the other publications have, remains to be seen.
That uncertainty is indicative of what constitutes the tech bubble, or any bubble for that matter: the long term viability of the businesses being acquired or invested in is purely speculative, and these businesses oftentimes don’t have any data to show where they will be in the not too distant future. It’s reasonable to suggest it’s unlikely that many of these businesses will struggle to warrant their billion dollar price tags.
This is especially true for small tech startups that sometimes don’t even have a product to offer their investors, much less a long-term business plan. Sometimes, these youthful startups are even more concerned with partying than they are with innovating. But because a particular industry is thriving, investors are willing to spend an absurd amount of capital to stay at the forefront of the industry, and dramatic losses are inevitable. The question is not whether the tech industry constitutes a bubble–the bubble took shape years ago. The question is when will we see the fragile sphere of the tech world finally pop?
Feature photo courtesy of Wikimedia Commons.