Copyright 1998 The Financial Times Limited
Financial Times (London)
July 21, 1998, Tuesday LONDON EDITION 1
One-track minds: Investors in the internet should remember the 'extravagant excitement' that
accompanied the birth of the railways
The internet represents the greatest transformation of economic life since the railway. It will be the central
nervous system for world commerce. Companies that exploit it will reap untold wealth; those that fail to do so are
doomed.
These are the commonplaces of investor opinion. They explain the stratospheric valuation of stocks tenuously
related to the internet. They fuel belief in the "new paradigm" of inflation-free growth. And they are profoundly
dangerous.
The risk lies not in the possibility that these comparisons are false, or exaggerated beyond all reason. The danger
for investors is if the comparison with the railways proves to be true.
If the internet is like the railways, it will indeed produce a transformation of economic life - but extremely mixed
rewards for its financial backers.
Consider the lessons of history. In Britain, the railway mania of 1845 led directly to the financial panic of 1847.
James Wilson, the founder of The Economist (then incorporating among its many sub-titles that of The Railway
Monitor) warned repeatedly of the dangers posed by "the universality of the character of this speculation".
When the boom had run its course, he said, the reckoning would be terrible. "From domestic servants, footmen and
butlers, to titled spinsters and church dignitaries, running through all ranks and professions, the suffering will be
more general than on any former occasion. It will be like a universal general affliction." And so it proved.
In time, the gloom passed and British railways again became plausible investments. But they never recovered their
glamour status; and most of the funds invested at the height of the boom were irretrievably lost.
The problem in Britain was partly the huge over-investment in lines that could never realistically expect to make a
profit. In the United States, a much larger country, the pattern was somewhat different. It took generations, not
merely decades, for the potentially lucrative opportunities to be exhausted. And the "land-grant" system, which
gave railroads access to large amounts of cheap land alongside their newly built lines, provided a second stream of
revenues.
Yet the profitability of railroads was still mixed. Continuous expansion and the depressions of the 1870s and 1890s
prevented many from rewarding investors. In 1895, for example, only 30 per cent of railroad capital stock was
paying dividends. In the next decade-and-a-half profitability rose sharply, and 68 per cent of railroad capital was
paying dividends by 1911. This was the railroads' moment of glory, as reflected in the creation of such grandiose
terminals as New York's Pennsylvania station (modelled on the Baths of Caracalla in Ancient Rome).
Yet the writing was on the wall. Government regulation, sharply rising labour costs (three times the level of
railway workers' pay in the UK) and competition from the automobile ended the railroads' golden era. Total track
mileage in the US reached a peak in 1916, and declined steadily thereafter. The brief moment of profitability was
over.
What are the lessons for the internet investor? First, that it is easy to succumb to speculation - or "extravagant
excitement" as Wilson described it in The Economist. Second, that investment in the construction of the internet
infrastructure will be pushed beyond the limits of profitability - leading to ruinous price wars as managers exploit
the low marginal costs of their sunk investments.
Third, that the internet has its own equivalent of the "land grant" acres. You do not have to build the physical track
to exploit it; all you need to do is to create acreage that is favourably placed in users' minds. The battles to
establish internet brands, to create "portals" or frequently visited sites that give easy access to the rest of the
internet's facilities, are part of this process. But the great majority of the land grant acreage never proved of much
value; the profits came from the relatively small proportion that contained minerals, or turned out to be the
downtown areas of newly developed cities. Similarly, of the millions of dollars being ploughed into creating internet
land-grant acreage, some will be valuable and most will be worthless. Distinguishing between the two will not be
easy.
But the real profits of the railway boom were made not by the heroic engineers or even the enthusiastic
developers. They were made by the promoters, the stock-waterers, the exploiters of bankrupt lines, the
manipulators of freight rates, America's Jim Fisk or Britain's George Hudson. Stock regulations today are far
stricter; straightforward swindling is much less common. But though Wilson's footmen and titled spinsters have
passed into history, extravagantly excited investors remain. There is lots of money to be made from the birth of
new global nervous system. As with the railways, however, it is unlikely to accrue to those who take the long
view. |
