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Billion-Dollar Babies

The phenomenon that Michael Lewis and Charles Ferguson both seek to describe in their books is the dramatic accumulation of wealth driven by the Internet. Technological and business innovations are the occasion for it, and Ferguson in particular, who tells us how he started and sold his own high-tech company, explains a lot about the workings of the underlying technology. But both of these stories are really about money.

The recent boom in technological advances, formation of new businesses, and personal fortunes is the third, and most dramatic, such wave generated by the computer industry in the last twenty-five years. The first wave involved tangible products—“hardware,” as opposed to the computer programs that constitute software. In the 1960s and 1970s companies in the Santa Clara Valley, between San Jose and San Francisco, produced silicon memory chips for computers—thus the name Silicon Valley. Then they produced silicon logic chips, which direct a computer’s operation. Then many produced computers as well.

The great fortunes from the hardware era include those of the Hewlett and Packard families, of Hewlett-Packard, which started making money in the pre-silicon era, with scientific instruments. The Packard Foundation, with assets of $10 billion, recently overtook the Ford Foundation as the nation’s third-largest private foundation (behind the Bill and Melinda Gates Foundation, at $17 billion, and the Lilly Endowment, at $15 billion). The dominant hardware company of the 1990s is Intel, whose Pentium and other processing chips are used in most personal computers other than the Macintosh. The assets of Gordon Moore, one of Intel’s founders, are estimated to be worth $15 billion, making him the tenth-richest person in the country. Apple, the first famous personal-computer company, is still based in Silicon Valley. So is Sun Microsystems, a hybrid hardware-software company whose products are used to run many Internet sites, and which therefore has been enjoying boom times. Other nearby hardware companies that provide the necessary physical components for the Internet include Cisco Systems and 3Com.

But the largest fortune based on hardware is that of Michael Dell, of Austin, Texas. At age thirty-four, owing to the success of his Dell Computers, he is the fifth-richest man in America, after three Microsoft executives and Warren Buffett, with assets of $20 billion. Theodore Waitt, of Gateway Computers in South Dakota, has assets of $6 billion, one of the largest fortunes built on hardware. (All personal-fortune comparisons here are from the 1999 “Forbes 400.” High valuations of volatile stocks mean that some people have moved up and some down since the Forbes survey earlier this year, but the approximate rankings and magnitudes still hold.)

The second wave of wealth creation involved software—“application” software that people use for work or recreation, like word-processing programs or computer games, and “systems” software used to run businesses or, very often, computer networks themselves. The difference between software and hardware provides a classic illustration of what economists mean by “increasing returns to scale.” Because the cost of producing additional units of software—the “marginal cost”—is extremely low, once you become the market leader in a field, your profits grow astronomically. A copy of Microsoft Office 2000 Professional, the company’s flagship software product for business use, lists at retail for $349 and costs perhaps $20 to manufacture. Microsoft’s total corporate sales in the last fiscal year were just under $20 billion, of which an astounding 39 percent, $7.78 billion, was net profit. By comparison, Exxon’s sales are more than five times greater than Microsoft’s, but its net profit is smaller, $6.4 billion.

Microsoft’s unparalleled profit margin has given it the highest stock valuation of any company in the world, nearly $500 billion. It has created three of the five largest personal fortunes in the world (those of the CEO, Bill Gates; the president, Steve Ballmer; and the co-founder with Gates, Paul Allen). Apart from its effect on the stock market, it has produced an estimated ten thousand millionaires, mainly in the Seattle area. One of Microsoft’s early programmers, Charles Simonyi, has assets of $1.5 billion. Even the company’s head lawyer, William Neukom, who was in charge of the recent unsuccessful defense against antitrust charges, is worth $625 million. The strongest software company after Microsoft is probably Oracle, which makes the database software used to manage information at many Internet sites. Its chairman, Lawrence Ellison, is the eighth-richest man in America, with assets of $13 billion.

But both the hardware and the software revolutions were, in their wealth-creating effects, slow to emerge compared to what is underway now because of the Internet. Less than ten years ago, Tim Berners-Lee, a British physicist working at the research center CERN in Geneva, invented a scheme for linking data on a particular subject, or series of subjects, that were stored on different computers in different places. The Internet had existed for two decades before that, as a communications channel mainly among big computers at universities and research centers. But Berners-Lee took the crucial step in making information on the Internet easy to find and use, through creation of the World Wide Web. The Web—the basis for the graceless abbreviation “www.”—is the system that made possible today’s practice of simply clicking on words or pictures to follow trails of related information. Berners-Lee helped bring this about by writing the specifications for three basic elements of the Web’s operation. One is the “uniform resource locator,” or URL, the exact name for each particular website, no matter where the computers supporting it are located (for instance, http://www.nybooks.com). Another is “hypertext markup language,” or HTML, a way to describe how a website should look on screen, and also a way to build “links” that will take a user to another site when clicked. The third is “hypertext transfer protocol,” or HTTP, which controls the flow of information from the sites to the user’s computer.

Berners-Lee’s innovations have led within this decade to hundreds of billions of dollars in other people’s fortunes. But he circulated his specifications without asking for payment in the early 1990s, and he did not form a company or apparently prosper himself. He has been on the book promotion circuit discussing his memoir about the Web’s origins, Weaving the Web.1

Six years ago, the first commercial “browsers” to aid navigation through the World Wide Web appeared. A stillborn effort called Mosaic was followed by Netscape Navigator. A browser allows you to move easily from one website to another, and to see the contents of each site. If you type in a Web address (or URL) at your computer, or click on a displayed link, the browser displays the information from that website, so that you can read it and use it. Less than five years ago, in May 1995, Bill Gates suddenly recognized the way the Web might change the computer business and sent a memo called “The Internet Tidal Wave” to his lieutenants at Microsoft, saying that he now gave the Internet “the highest level of importance.” The company’s strategy for developing products shifted within months, to create a browser that could compete with Netscape’s and to make its other programs “Web-friendly.” For instance, after this change Microsoft’s word-processing program, Word, allowed users to save documents as normal text files on a personal computer—or as pages that could be posted for others to view, with their browsers, on the Web.

Then, in August 1995, Netscape had the initial public offering for its stock, the beginning of the subsequent Net IPO boom. It is hard to think of the four-plus years since then as making up a distinct historic era, but most of the great Internet fortunes have been amassed during just that period. These include the holdings of Jeff Bezos, creator of Amazon.com ($7.8 billion); David Filo and Jerry Yang, of Yahoo ($3.7 billion each); Jay Walker, of Priceline.com ($4.1 billion); Pierre Omidyar and Margaret Whitman, of eBay ($4.9 billion and $960 million, respectively); Joe Ricketts, of Ameritrade ($2.4 billion); Robert Glaser, of Real Networks ($2.4 billion); and Steve Case, Barry Schuler, Robert Pittman, and Ted Leonsis, of America Online ($1.5 billion, $750 million, $725 million, and $675 million, respectively). John Doerr and Vinod Khosla, two of the most influential Silicon Valley venture capitalists, have holdings of $1 billion each.

The only thing more remarkable than how quickly these fortunes have arisen is how inexplicable some of them seem. Only a few Internet ventures have anything quite as crude as a business model in which revenue exceeds expenses. America Online—which gives access to e-mail and the Internet—generates profits because it charges subscribers $21.95 a month. The on-line auction site eBay is also profitable, because it charges a commission each time buyers and sellers conclude a deal on its site. But most of today’s Internet companies have substantial short-term losses, which stock market investors typically assume will turn into profits in some never-quite-arriving “Year Three” of the business plan.

Theories vary about where these profits will come from. Perhaps from on-line advertising—if anyone can figure out how to make it as attractive as ads in glossy magazines, or as unavoidable as ads on TV. Perhaps from some system of “microroyalties,” which will overcome the marked reluctance of Web users to pay for information they retrieve. Perhaps by a new version of the Ponzi scheme, in which a money-losing site is kept going just long enough to be bought, for a high valuation, by some bigger company that wants to expand its audience rapidly. (I know three people running sites on just this principle.)

Thin as these rationales for profitability may ultimately prove to be, so far they’ve been sufficient to make many people very rich. Last year Amazon.com’s valuation by the stock market soared into the tens of billions as its annual loss exceeded $120 million. The IPO economy that is centered on the Internet has flattened somewhat this year, but it is still driven by two primal forces: the lottery-like knowledge that some of these bets will pay disproportionate returns, and the momentum of the wealth that’s already been amassed, and that must be invested somewhere.

Virtually all of this wealth consists of tech-company stock, and ten years from now some or much of it may have melted away. (One economist has said that the future statistic he most wishes he knew, in order to assess the health of the Internet economy, is the number of ex-billionaires in 2002.) But there is so much new wealth that some will remain. And there will be so much left over after even the wildest personal-consumption fantasies have been satisfied that it could eventually have great public impact. A few of the tech leaders feel confident enough in the performance of their wealth to have formed personal foundations and started making grants. (The Bill and Melinda Gates Foundation, for example, recently announced a very am-bitious program to support advanced scientific and technical educations for 20,000 Americans from minority groups.) But it is not yet clear whether the new Internet elite will choose to have the lasting legacy that earlier moguls did. Will the Internet billionaires do what it takes, through philanthropy, to be remembered the way Rockefeller, Carnegie, Mellon, Guggenheim, Morgan, and Ford are? Or will their model be Jay Gould?

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    Harper San Francisco, 1999.

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