ECONOMICS OF INFORMATION AGE AND EFINANCE

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ECONOMICS OF INFORMATION AGE ANDE-FINANCE

• Yvette M. Bendeck, Ph.D., CCM
• Dept. of Finance and Economics
• SBPA
• University of Houston-Clear Lake

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The Big Picture

• Internet technologies and applications has grown
  more rapidly than anyone could have envisioned
• Emerging internet economy is similar to the
  Industrial Revolution of 18th century
• Three fundamental differences
• Information
• Knowledge
• Speed

3
Greatest Engineering Achievements of the
Twentieth Century
Source National Academy of Engineering, 2000.
4
Internet Facts

• 56 percent of U.S. companies will sell their
  products online by 2000, up from 24 percent in
  1998.
• Cisco Systems Inc. is selling more than 32
  million in products every day.
• Small businesses who use the Internet have grown
  46 faster than those that do not. (American City
  Business Journals)

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Internet Facts

• Small and home offices spent 51.1 billion on
  high-tech goods in 1998. (IDC)
• Forty-four percent of U.S. companies are selling
  online 36 more say they will do so by the end
  of the year. (Association of National
  Advertisers)

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What is the growth of internet economy?

• Internet economy grew 68 from the first quarter
  of 1998 to the first quarter of 1999
• Accounts 2.3 million jobs
• UT projects the internet economy grow to 507
  billion by 2000

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Why do we care about the growth of internet
economy?

• It is important to analyze what new business
  opportunities are created
• It is important to identify the impacts on
  physical economy
• Growth rate is the most important factor in any
  economy and relates to the total output produced
  within an economy (i.e.GDP or GNP)

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Why do we care about the growth of internet
economy?

• Is internet economy creating new output or
  substituting part of the physical economy?
• Probably the large portion of internet economy
  will come at expense of physical economy through
  substitutions

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Why do we care about the growth of internet
economy?

• In short, we need to think of internet economy in
  a more comprehensive manner
• We should include characteristics such as input,
  output, size, vale added, efficiency and labor
  productivity

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What is internet Economy?

• It is made up of companies directly generating
  all or some part of their revenues from internet,
  internet-related products, and services.
• It is not just a collection of high tech companies

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What is internet Economy?

• Companies within internet economy can be
  classified in three groups
• 1) Internet Infrastructure and Applications
  Companies
• 2) Companies selling the goods and services over
  the internet
• 3) Electronic intermediaries or middleman

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Internet Infrastructure and Applications Companies

• It includes
• companies whose products and services make
  feasible to use the internet for electronic
  commerce
• ExampleIBM, Dell, HP, Oracle, Microsoft, and Sun
• IBM sells servers
• 3Com sells modem
• Cisco sells routers

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Companies selling products and services over the
internet

• Pure internet sellers conduct entire business on
  internet Ex Amazon.com, eToys.com etc.
• Traditional brick-mortar companies they conduct
  part of their business on internet. Ex LL Bean,
  Alaska Airlines

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Electronic Intermediaries and Middleman

• Companies acting like middleman to facilitating
  the interaction between buyers and sellers
• Ex eBay, Egroup etc.

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How does internet impact the variables in
physical economy?

• Unfortunately, we do not have consensus among
  economists about the impacts of internet on
  economy
• The profession is divided on the impact of
  internet on the economic variables
• We can get a better feeling about internet
  economy by analyzing the impact of internet on
  each of the following variables

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How does internet impact the variables in
physical economy?

• Market Structure
• Efficiency and Productivity
• Producer Cost
• Output Level
• Prices
• Firm Profits/Consumer Benefits
• Demand/Supply
• Employment

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Market Structure

• Internet increases number of firms and
  competition
• It will move economy closer to the textbook model
  of perfect competition, which assumes that
  abundant information, zero transaction cost, and
  no barrier to entry

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Market Structure

• Internet reduces the optimal size of the firm,
  implying that barriers to entry will fall
• The number of software firms has quadrupled from
  375 to 1500 in five years.

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Efficiency and productivity

• Improvements in the flow of information between
  buyers and sellers increase market efficiencies
  ensuring that resources are allocated to their
  most productive use
• The growth in economy is largely due to increase
  production efficiencies
• Increase in output as a result of B2B e-commerce
  will be around 5

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Efficiency and productivity

• Unlike railways revolution, internet is applied
  a larger portion of economy including service
• B2B internet applications are also expected to
  reduce cost further and boost productivity

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Producer Cost

• Internet reduces the cost INFORMATION so it has
  reduced the cost of production
• Intense competition in the market forces firms to
  be cost efficient in order to survive

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Producer Cost

• B2B cuts companies costs in three ways
• it reduced procurement cost (easier to find
  cheaper suppler)
• it allows better supply chain management
• it makes inventory control tighter

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Producer Cost

• Examples
• it is estimated that firms saving from
  purchasing internet vary from 2 in coal industry
  to 40 in electronic
• Ford, GM and Daimler-Chrysler are setting up a
  joint exchange to purchase components from
  suppliers over the internet

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Output

• The carriage of freight by rail over a couple
  decades added 10 overall American output
• Now, computer software count about 12 of
  Americas total capital stock
• High tech economy counts for one-third of real
  GDP growth

25
Output

• Information technology has advantages over
  previous technological revolutions
• applied to a broad sector of the economy,
  including services
• adoption rate higher due to faster decline in
  technology acquisition cost

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Prices

• One side of prediction that internet will reduce
  the inflation (increase in price level)
• Others argue that inflation is solely determined
  by money supply
• Decrease in production cost, more competitive
  market structure and availability of information
  would reduce prices

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Prices

• Internet would improve the functioning of price
  mechanism
• Examples
• Prices of goods bought online, on average, are
  10 cheaper
• Transfer between bank accounts cost
• .127 if done by bank teller
• 27 cents with a cash machine
• 1 cent over the internet

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Prices

• Nonexistent profits of many e-retailers makes the
  evidence inconclusive

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Firm Profits/Consumer Benefits

• Cost savings clearly will increase future profits
  But..
• As competition increases, it is likely to see
  that profit margin would be squeezed, so passing
  the benefits to consumers

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Firm Profits/Consumer Benefits

• Reduction in search cost and increase in the flow
  of information, internet seems to be shifting
  power from producer to consumer, so that profits
  are more likely to be squeezed

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Demand/Supply Framework

• The impact of internet on economy can be analyzed
  in standard demand/supply
• The economy is at equilibrium at the point where
  demand curve D1 and supply curve S1 intersect at
  price P1 and quantity Q1
• Supply curve would shift down (or left) as a
  result of a cost reducing development
  (introduction of internet)

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Demand/Supply Framework
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Demand/Supply Framework

• Innovation is always a source of economic growth
• Example railways, electricity
• A downward shift in supply curve will translate a
  price decline and output increase as lower cost
  encourages firms to produce more at any given
  price level
• RESULTS ON SUPPLY SIDE IS LOWRER PRICES AND
  HIGHER OUTPUT

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Demand/Supply Framework

• There is also impact of internet on demand side..
• If equity investors expect faster growth in
  output and profits, this will boost the
  household wealth and encourages them to spend
  more as a result
• the demand curve will also shift from D1 to D2

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Demand/Supply Framework
D2
Q1
Q2
Q3
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Demand/Supply Framework

• This what is happening in the US lately..
• Greenspan, FED Chairman, argues that productivity
  growth could boost demand via share prices
• The risk is that shift if D may be larger than
  shift in S, so that inflationary pressure could
  rise in the short run.

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Employment

• Change in the structure of US employment figures
• 1900-- 82 of workforce in production
• 1999-- 41 of workforce in production
• what happened to these workers?
• 1900-- 10 of workforce professional/ technical
• 1999-- 33 of workforce processional/ technical

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Employment

• Software companies employs about 1 million
  workers and employment in the industry is growing
  by 13 compared to 2.5 in the rest of the
  private economy

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Other Impacts

• Capital Spending Increasing sharply and now
  accounts more than 15 of GDP

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Conclusion Who are the Winners?

• Consumers
• Old economy firms that focus on B2B e-commerce to
  reorganize themselves

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How will the Internet influence corporate
structures?

• Vertically-integrated firms became less efficient
• Creation of partnerships and strategic alliances
  in lieu of the vertically integrated companies
• Supply chain management and customer relationship
  management becomes critical

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dot.com in trouble

• Low prices due to competitive pressures
• High customer acquisition and retention cost
• Lack of capital to operate
• Example eToys

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dot.com which benefit

• those who transfer their brick and mortar
  business models that have proven to be successful
  to the internet
• Example Frontera.com

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FIRM VALUATION

• How do you value an high-tech company?
• Traditional P/E ratio will not work
• Can behavioral factors explain stock prices?
  (house-money effect)
• Concept Stocks investor buys companys shares
  because they like its business concept and future
  prospects
• past earnings and high price do not justify great
  expectations

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FIRM VALUATION

• Price-to-sales ratio is used to value concept
  stocks
• Example
• VerticalNet runs B2B commerce sites on the
  internet
• market value 7.01 billion
• share price 197
• Price-to-sales ratio 312
• Average market price-to-sales ratio 2

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Dot.com Valuation Crash

• VerticalNet stock price today is 3
• Nasdaq Composite index hovering around 2000 down
  from5000 last year.
• Circle of blame
• entrepreneurs
• venture capitalist
• analysts
• day traders
• investors

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ONLINE BANKING

• Services offered
• How do you make a deposit?
• A withdrawal?
• Transfer funds?
• View your account details?
• Pay Bills
• Products Offered
• Checking, Saving, CDs, and Mortgage

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ONLINE BANKING

• Rate Comparison
• Organize Expenses
• FDIC Insurance
• WEB BANKING DEMO
• www.everbank.com

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ONLINE INVESTMENT

• Investment Choices
• Trading ways
• Accounts types
• Rates and fees
• Trading tools
• Example
• www.ameritrade.com

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MORTGAGES

• With online mortgages you can search loans,
  compare lenders, find the best deal and save
  money through lower fees and commissions.
• Only 1 of Americans borrow for residential
  mortgages online
• Mortgage market size is 972 billion (1 of this
  is a lot of money)
• Expected to increase to 10 by 2003

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MORTGAGES

• Reasons for not using online mortgages
• Mortgage is a complex process
• homeowners are concerned with confidentiality and
  security
• variety of government regulations
• sample web site
• www.e-loan.com

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HIGH TECH FINANCE

• Mergers and Acquisitions Big increase is
  observed in high tech industry
• Table 17 and 18
• IPOs and BUYBACKS Record level of IPOs in
  technology and communications in last 4 years
• Figure 18

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CONCLUSION

• Internet has changed the way the business is
  conducted
• Economic variables are largely influenced we
  have more productive use of resources, lower
  production cost, more competitive market, lower
  prices, and higher employment and output level

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CONCLUSION

• Consumers benefit from these developments
• E-finance potential has not been fully utilized
  but the growth in use of internet in banking,
  investment, and in other financial services has
  been increasing sharply.