I can’t pity John. He considers his dismissal totally unjustified and if one listens to him one is almost tempted to agree. He argues that nobody of reputation realized that there was a bubble and since it wasn’t obvious that there was a bubble he should not be punished for having lost money in it.
Sure, what is true for all bubbles was also true for the second internet bubble. That is they are easy to detect in hindsight. Some pundits claim, though, that it was indeed more difficult to spot. Well, let’s see. In contrast to the first internet bubble where most of the companies with sky high valuations did not earn any money this time was different. Companies did make money and a lot in fact. Finally internet companies had figured out how to monetize site traffic and the key to this was advertisements. Any web site be it a news site, a social media site or an online app that managed to attract a lot of users was also able to attract a lot of advertising dollars. Through personalization of the ads users could be targeted very effectively. Online advertising dollars became thus much more effective than traditional advertising dollars spent on mass advertising campaigns on TV, billboards or in papers. Consequently online advertising was grabbing market share from traditional channels at supersonic speed.
What investors seem to have missed were two things. First, as global internet advertising spending expanded its market share it soon dominated global ad spending. By attracting new segments of SME advertising the global advertising budget could initially be expanded along with market share. But saturation effects started to kick in nevertheless. The second problem was a decreasing multiplier. Advertising space on the most popular sites got very expensive. While increasing prices for premium adverting space benefited internet companies it lowered the effectiveness of every dollar spent.
It’s not clear what triggered the trend reversal. Companies tend to keep their marketing strategies secret. But it is rumored that Rolex was the first to observe that their brand was strong enough so that less permanent advertising presence was required to keep the brand at the top. By cutting back on advertising they were able to significantly boots profitability. It didn’t take long for other global brands to follow. They all reacted accordingly and within twelve months total internet advertising revenues dropped by 80% as prices for ad space as well as volumes dropped at the same time making the majority of internet companies worthless.
Those who claim that this bubble was more difficult to detect argue that the mechanism was more subtle. That is, it were not the internet companies that were the problem but other parts of the economy that expected an ever growing effectiveness of online advertising. But that is like looking at house sizes to detect a housing bubble. Fact is that more and more money was inefficiently invested in online advertising and John wasn’t the only one to profit from this misallocation. A misallocation that sooner or later had to backfire.