E-volution: New tools for a new age
By Rob Goodfellow and Daniel Lindgren
WOLLONGONG, New South Wales, Australia (JP): Are we looking at things the wrong way? Since the dawn of the industrial revolution nearly 200 years ago, economic theory has accompanied change.
Sometimes, as in the case of Smith, Marx and then Keynes, theory was slightly ahead of practice. What is happening now, with the explosion of e-commerce, is that practice is actually well ahead of theory, and therefore ahead of ways of comprehending and analyzing the effects of transition.
We are living physically in the information age but still thinking in the industrial age.
Nowhere is this more acutely felt than in the way companies are valued. The recent roller-coaster of blue chip reevaluations and the mercurial nervousness of the information technology market has experts shaking their heads. "This does not conform to fundamentals," they cry.
What exactly, then, is the formula for calculating the value of a company? Should this now be challenged?
Since the first stock exchange opened, the market price of a company has been based substantially on a particular concept of value. This was calculated on management performance, total fixed assets and profitability.
The person most responsible for this new reasoning was American John D. Rockefeller. He was someone who understood the nature of business in a period of similarly rapid change. Rockefeller gave birth to imaginative ways of thinking about how companies should be directed by boards, their shares traded and evaluations made.
These components of value have been written into annual reports, tabulated in ledgers and accounted for in balance sheets for the best part of 100 years. They were real and tangible and they worked well, up until now.
E-trade, on the other hand, is measured by factors not generally taken into account on the balance sheets of blue-chip industrials. It includes relative intangibles such as "lifetime customer value", "intellectual property" and "brand equity".
Does value now comprise different components that cannot be easily measured on a balance sheet? Rather, soft assets like "customer loyalty", "product identification" and "lateral thinking" add up to something very different. Could this, in fact, be "virtual value"?
As a possible key factor in virtual value, lifetime customer value came into being with the rise of database technology. This emerged when companies began to accurately track purchase trends for individual customer segments.
The information could then be used to stimulate and predict future buying behavior or, in fact, the behavior of like individuals, provided that companies could develop long-term relationships with individual customers.
If we know what individual customers are worth at any point in time, we can also accurately work out the total present, and future, value of the database. This can then be reflected in the balance sheet and the "virtual bottom line", which is currently not standard practice, but rather seen as "speculative" (which is precisely the way the market sees it).
If you compare an industrial company and an Internet company, for instance, you will find that while traditional companies are partly dependent on databases and strong brands, these features are paramount to the success of Net-based enterprises.
For example, one cannot even log on to a children's web site for a "free screen saver" without surrendering information about buying habits. Information is power -- virtual power and real power. It is just a matter of making the jump from the mass selling features of the Net to mass relationship building --instantly, electronically, and profitably.
The second of the three components of virtual value is intellectual property. It is all about ideas, but it is also about the human resources that nurture an idea to maturity. We can very easily put a dollar value on patents and trademarks but what about human qualities such as motivation, creativity and the ability to think? In the rising IT market, these characteristics have become preeminent. Just look at Microsoft and the hitherto glorious rise of Bill Gates.
The dreams of a new generation of IT specialists have value, but not necessarily because they can be realized in the present. (Rather, because as all of us who have been watching reruns of Star Trek or reading Isaac Azimov for the last 20 years know, it is only a matter time before sci-fi fantasy, no matter how far- fetched, becomes modern day reality).
Similarly, brand equity has also become part of the new virtual balance sheet. The premium people pay represents years of brand building. There is a momentum, in fact a life force, in branding that carries a particular product through thick and thin.
The "Heinz Beans Wars" of the 1980s demonstrated once and for all that while there may be cheaper products around, consumers respond to what is familiar and what can be trusted when making a purchasing decision.
Hassled, time-compromised consumers want choice but they want their choices made simple. This is where a strong brand finds its feet on the Internet. It makes it easier to choose. Therefore it has value.
When shopping over the Internet, convenience is king. With a "virtual shopping list", preselected brands will have an even greater influence than on a supermarket shelf.
E-shoppers only see what they want to see and they want to see is something familiar. Significantly, it is brand equity which has been most recognized as having value in the new IT reality. How to accurately measure it remains the challenge.
There are actually two ways making sense of all of this. The first argument unkindly suggests that many IT companies actually have little measurable value. This has been touted as one of the reasons why investors woke up a couple of weeks ago from their collective dream of hope and greed and started to panic, thus sending the NASDAQ into paroxysms.
The result was widely expected to be hysterical selling -- which it was, before an almost equal period of hysterical bargain hunting. It initially drove some investors back to the good old blue chip.
Most investors, however, could not tear themselves away from their belief in the enduring "potential" value of ITs. The harbingers of doom suggested that this "madness" could cause the world economy to collapse. The bubble did not burst.
Argument two, on the other hand, suggests that virtual value actually has real value, it is just that we do not know how to measure it. Again, this has been demonstrated by the erratic charts of April 2000.
To wax theoretical and try and get some perspective -- if you look at the science of physics, subatomic particles are not considered matter but energy. In what sense are these particles "real"? Physics teaches us that we can make a distinction between what is true and what is real.
Can we extrapolate this philosophical argument to the world of economics at this historical convergence of new ways of thinking about the market?
Right now blue-chip industrials are seen to have "real value". The point is that is the "virtual value" of an IT stock any less real because it cannot yet be measured.
Investors are confused because economics theorists have not done enough serious thinking about what this means. Simply, what is required are new analytical tools for a new age.
Rob Goodfellow is the author of eight books including Getting Paid and Loving it: Your Guide to Collecting Debt with the Muscle of the Mind, (Lilly, Singapore: 2000). His e-mail address is firstname.lastname@example.org. Daniel Lingren is the marketing manager for the Illawarra Mutual Building Society. His e-mail address is DLindg@imb.com.au