Paul Graham “had a front row seat for the Internet Bubble”; he worked at Yahoo. In What the Bubble Got Right, he explains how Yahoo was an unintentional pyramid scheme:
What made our earnings bogus was that Yahoo was, in effect, the center of a pyramid scheme. Investors looked at Yahoo’s earnings and said to themselves, here is proof that Internet companies can make money. So they invested in new startups that promised to be the next Yahoo. And as soon as these startups got the money, what did they do with it? Buy millions of dollars worth of advertising on Yahoo to promote their brand. Result: a capital investment in a startup this quarter shows up as Yahoo earnings next quarter — stimulating another round of investments in startups.
But it wasn’t all flash:
Even at the morning-after valuations of March and April 2001, the people at Yahoo had managed to create a company worth about $8 billion in just six years.
The first thing the Bubble got right: retail VC:
Taking a company public at an early stage is simply retail VC: instead of going to venture capital firms for the last round of funding, you go to the public markets.
The second thing: the Internet:
Recognizing an important trend turns out to be easier than figuring out how to profit from it. The mistake investors always seem to make is to take the trend too literally. Since the Internet was the big new thing, investors supposed that the more Internettish the company, the better. Hence such parodies as Pets.Com.In fact most of the money to be made from big trends is made indirectly. It was not the railroads themselves that made the most money during the railroad boom, but the companies on either side, like Carnegie’s steelworks, which made the rails, and Standard Oil, which used railroads to get oil to the East Coast, where it could be shipped to Europe.
The third: choices:
In the “old” economy, the high cost of presenting information to people meant they had only a narrow range of options to choose from. The tiny, expensive pipeline to consumers was tellingly named “the channel.” Control the channel and you could feed them what you wanted, on your terms. And it was not just big corporations that depended on this principle. So, in their way, did labor unions, the traditional news media, and the art and literary establishments. Winning depended not on doing good work, but on gaining control of some bottleneck.
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First, the Internet lets anyone find you at almost zero cost. Second, it dramatically speeds up the rate at which reputation spreads by word of mouth. Together these mean that in many fields the rule will be: Build it, and they will come. Make something great and put it online. That is a big change from the recipe for winning in the past century.
He makes seven more points.