Before we are able to formulate an academic and logical opinion as the question of the valuation of Internet companies both today and in the past, we must of course first be able to highlights concepts that we would be using in order to develop arguments. After we have done so, we will be specifying our opinion, supported of course by academic reference and other studies related to the field and topic had.
The question that we would be dealing with in our paper is the question of our Internet companies being overvalued or does there immense rise in price reflects their fair market value? In order to answer this, to specify the keywords that are essential. First is how to define an Internet company.
An Internet company, or more popularly known today as a .com company, is a firm word group that does most, if not all of its business, online and in the Internet. Recent innovations in information communication technologies today, more specifically the Internet and high-speed broadband access for many users around the world has allowed for firms to make use of such an industry in order to address a specific good or service that is in demand in the market (Wilsdon, (Organization), & (Project), 2001). In order for these Internet companies to do this, they usually require the institution or a website or a domain, as it is popularly called by business owners (Epstein, 2004). The reason why such companies have been labeled as a.com is is because of the specific Web address which is affixed with a .com in the end of their domain name in order to identify that they are a hyperlink address (Dot.COM). Today, Internet companies like Facebook, MySpace, and other social networking sites, Mint and Quicken, websites that address the market of personal finance management, search giants like Google and Yahoo are all considered as Internet companies for the purpose of this paper would be to make an opinion of the proper evaluation of society of these Internet companies and if the values that are reflected in the stock options of the company are the actual market values using concepts in economics.
However, we must first be able to identify what value is. In the modern and intuitive sense, or in the point of view of the layman, value is simply the price of a good or service. However, the discipline of economics has fairly large literature and research — as well as complicated theories and concepts — in order to specify and affix value to a good or service. This is perhaps captured by the famous economic paradox of water and diamonds. Why are diamonds more expensive than water? Isn’t water more valuable than diamonds because it is required in living? Isn’t a diamond less valuable than water because it’s only conceivable practical application is at best use for industrial mining and at least for decorative purpose? If value is really reflected by the price, then the water diamond paradox of the foundations of economics does not capture this. This is where the concept of scarcity comes in as a measure of true value for goods or services. The price of goods and services reflect the amount in which society is able to acquire it given the limited resources in the world (Mas-Colell, Whinston, ; Green, 1995). In fact, a certain prediction by economists is that if there are just as much diamonds as water, then they would be priced the same, even water being price marginally higher because of its usefulness.
In order for us to identify the value of such Internet companies, we must keep this concept in mind. Economics deals with the valuation of many goods and services notwithstanding the current crisis they have. In a perfectly competitive environment and market situation as had been conceptualized by Aidan Smith, the price of Internet companies would perfectly reflect their value. However, all economists agree that today’s market and economy is far from the perfectly competitive market that the father of modern economics had built his theories on. There are specific factors that differentiate price from actual value (McConnell, Brue, & R, 2004). These factors are called market failures, and again the concept of market failures are important as we go through with the valuation of Internet companies.
The last concept that is important for us to learn before proposing an opinion and an argument for that opinion is the theory of price. At present, again, a layman may think that price is something that is very easy to identify. It is in fact simply a measure of money required in order to exchange for a good or service. However, look at the recent literature and research about price theory in modern economics and you will be boggled at just how much economists are facing problems in determining price and its actual use in the market. Nobel Prize winner Friedman of the Chicago school of economics had made recent research on price theory using traditional methods that have been employed by one of the founders of microeconomics – Marshall (Perloff, 1999). According to such price theories, price is determined by the intersection of demand and supply in a perfectly competitive market notwithstanding market failures. The explanation of supply and demand concepts but not anymore be covered in this paper because it would take volumes and a degree in economics to understand. However, what we would like to point out is that under such conditions, price is the intersection of the willingness to pay of consumers and the willingness to accept producers in the market.
bringing all these concepts into consideration, we are now able to express our opinion that Internet companies do not reflect the actual value that big society. In order to defend this, we would be offering the following arguments.
First. The measurement of value is not reflected on the price in cases of non-perfect market situations. In fact, when one thinks about it from the approach of theoretical economics, there is no market in the world which captures the perfectly competitive market as visualized and as constructed by many neoclassical economic theorists. The only reason why they use such perfect market models is in order to identify the non-perfect ones. These non-perfect market models are called it perfectly competitive markets. These are what we call monopolies, oligopolies, monopsonies, and the like (Mankiw, 2001). Some literature regarding the topic of Internet companies are pointing towards such Internet companies to be in a perfectly competitive environment. The reason they cite for this is because they are plenty in nature. However, we must remember that before a firm or an industry may be considered perfectly competitive, there are 4 very specific rules that must be followed. The first is perfect information. The second is many small firms within a large industry. The third is not differentiation of goods and services. The fourth is zero transportation cost. Any industry in today’s market, even if it is under the umbrella of the Internet, cannot be considered an industry that has perfect information or lack of information asymmetry. I’ll so, even if there are many firms in this industry, some firms are large as compared to others. Also, the goods and services that are provided by these companies are differentiated in nature — that is the reason why they accumulate profit in the 1st Pl. Therefore, in that consideration, we may be able to classify Internet companies as a perfectly competitive markets which are able to command price. Mathematically and geometrically speaking, they face a downward sloping demand curve when the demand curves of the industry are aggregated. Having a downward sloping demand curve, they will also eventually have a downward sloping marginal revenue curve. In a two dimensional graph, these firms may be able to charge a higher price when they decreased quantity. To capture disk, one just has to think of DeBeers diamond industry or even the various countries that export oil. When they decreased the quantity of the goods that they release into the market they are able to command a higher price equal to the intersection of their marginal revenue curves. This results in extensive imperfect profits for the firm. Again, extensive knowledge of economics is required in order to understand this concept, however, for our purpose, we may be able to state that Internet companies charge prices depending on the quantities they are able to provide to their consumers. By doing this, the valuation of society to their services do not reflect the actual value that is involved in the production of these same services from the site of the suppliers (McConnell et al., 2004).
Another argument that we may be able to put forward is that these companies do not reflect actual fair market value because it is difficult to estimate fair market value in the 1st Pl. At least in many goods and services in the market, market value is determined by the intersection of supply and demand. However, such Internet companies face a difficult valuation method with respect to society because of many imperfections in the market they operate in — just one example is the argument that we have already stated above. As a result, the pricing scheme that is used by these companies are usually valuation methods that are used by accountants, economists, and statisticians. Advanced valuation methods such as the Hedonic pricing model and the shadow pricing method are used. However, econometric techniques have a large error term with respect to estimation. This error term alone, when multiplied to a billion-dollar industry, is indeed a large sum of money and could not conceivably claim to capture actual fair market value.
An argument that is put forward by the opposite side on claiming that Internet companies reflect actual market value is that they use cost valuation methods. This means that the companies estimated the overall costs that are involved in their delivery of goods and services to the consumers, and compute their actual net worth. However, even the method of costing is very difficult to grasp. An accountant, or at least the discipline of accounting, may be able to capture actual costs. However, as economists have often pointed out, accounting costs does not necessarily reflect real costs. There are such concepts such as opportunity costs which are not measured by the inflow of debit and credit in the books of accountants (Perloff, 1999).
Also, especially for the Internet industry and Internet companies as a pool which generally reflect economies of scale through geographical agglomeration, which have downward sloping average cost curves, we could not conceivably be able to say Internet companies show fair market value in the pricing of their companies because of the underlying fact that there are distortions in the market which would be difficult — if not impossible — to accurately measure to the cent.
There are many other arguments on defending our side and opinion that Internet companies do not reflect in their prices the actual market value in the industry. However, the arguments that we have presented above are the strongest case because they are solidly grounded in economic theory and in the determination of what value is in the 1st place.
Epstein, M. J. (2004). Implementing e-commerce strategies (p. 208).
Mankiw, N. G. (2001). Principles of Microeconomics.
Mas-Colell, A., Whinston, M. D., & Green, J. R. (1995). Microeconomic theory (p. 981).
McConnell, C. R., Brue, S. L., & R, C. R. (2004). Microeconomics.
Wilsdon, J., (Organization), F. F. T. F., & (Project), D. F. (2001). Digital Futures (p. 228).
Perloff, J. M. (1999). Microeconomics.
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