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Lessons from North First Street

August 25, 2003

Part I: The Gurgaon Factor

Having played a minor role in the late nineties boom of North First Street and now again, as I get involved in the Gurgaon boom -- it's perhaps appropriate to inspect what I learnt from the first boom. Mistakes were made aplenty, but some did stand out:

Poor Investments and Decisions: A telecom company near my house has gone from 97,000 employees down to 36,000 in just about 20 months -- in its heyday, this telecom company was looking far and wide for investments, such as buying up an enterprise software company. For the technology uninitiated, this is almost akin to Ford Motors buying a life-insurance company (No Ford never has bought an insurance company, to the best of my knowledge). I know of companies that spent $600 million acquiring a company that they disbanded for a total loss, within 18 months. Capital was cheap and it showed in the decision-making.

'The myth was that there was no price that was too high for a good tech company,' says Ed Keon, director of quantitative research at Prudential Securities, himself a reformed advocate of high-priced technology stocks. But 'eventually, there is a price that is too much to pay even for a fabulous stock such as Cisco Systems or JDS Uniphase," makers of communications equipment used in building the Internet.' -- Wall Street Journal.

Not preparing for the next phase: Everything in the technology industry goes and comes in phases -- this is not a surprise. After all, the mainframes were followed by PCs; next came a small recession and then the dot-com boom. But, none of the companies believed that the gold-rush of the nineties was going to end -- so, stoking up stock prices at the expenses of growing the customer base or revenues was in. Buying up large, expensive office space in stead of growing customer channels or intellectual property. Everybody knew that things run in phases, but the attitude was 'this time things will be different,' but as Browning and Ip put it

'…tech fans ignored the fact that even companies involved in a revolution eventually face market forces. Most early auto makers failed to survive. Radio Corp. of America and General Motors Co. were two of the hottest stocks of the 1920s, but that didn't prevent both from crashing along with the rest of the market in 1929. RCA eventually lost 98% of its value.'

Inadequate governance: Yes, even in the US -- poor governance did show up. The SEC and other regulatory organizations simply did nothing to stop what I'd call 'gold rush behavior.' In other words, the lure for money was strong enough to create quite a few Enrons, spurious buy recommendations and in general large scale bilking of the small investor. The regulators were looking the other way. So, now that the SEC and other regulators have started taking some action (much belatedly, if you ask me), we frequently see headlines like:

Star of Dot-Com Boom Arrested
Quattrone handled's IPO
AP - 04/24/03 - A former star investment banker with Credit Suisse First Boston was arrested and charged yesterday with witness tampering and obstructing U.S. federal criminal and civil securities probes by directing the destruction of evidence.

Putting all eggs in one basket: Silicon Valley believed that an innovative idea was good enough -- no operational efficiencies needed, no customers required. Innovation in itself, was good enough to make successful businesses.  Management teams, good products and real technology were replaced with hype -- in fact, that's the only egg that counted. Oh! for those, who would like a more formal phrase for this -- it was called 'projected earnings.' Long term technology areas were often ignored in favor of yet another pet-food dot-com. Projected earnings, in stead of revenue, as we were told repeatedly:

'In February, Jeffrey Warantz and John Manley of Citigroup Inc's Salomon Smith Barney unit published a report claiming that the huge gains in tech-stock prices were reasonable because the growth in projected earnings has been equally impressive… The facts weren't wrong. But this view didn't take into account that the price of tech stocks had grown so fast that the stocks had become "priced for perfection," as the sceptics like to put it. Any false step and the stocks would plummet. Nor did this perspective on the market take into account a historic reality: No matter how good a company is, it can't maintain as a large organization the same growth rate it had when it was much smaller. -- Wall Street Journal.

In the end, in spite of the tremendous experience it has in managing the business of innovation, US-based venture capitalists and entrepreneurs could not manage the explosion caused by the innovation of web technology.

Part III: Lessons for India Inc


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Arindam Banerji

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