The Internet will change the way that a lot of companies do business. The majority of investors would probably agree on that. But there is widespread debate about whether the corporate sector as a whole will prosper from the process.
It is generally accepted that producers of goods and services will be able to use the Internet to reduce costs. But three questions are still up for the debate: How big will those savings be? Will all sectors of the economy be affected or a select few? And will producers be able to hang on to those cost cuts or be forced to pass them on to consumers?
Martin Brookes and Zaki Wahhaj of Goldman Sachs have attempted to answer some of these questions by comparing the rise of the Internet to the growth of electricity usage in the early 20th century.
As Mr Brookes and Mr Wahhaj point out, electricity affected the manufacturing sector in two ways.
The first was to lower the cost of power in the factory. But the second, and more important, impact was to allow companies to redesign their factories to produce goods more efficiently. There are similar hopes for the Internet. As well as allowing producers to cut costs (by making it easier to find the lowest cost supplier), the Internet should allow companies to operate more efficiently. Productivity did rise sharply in the 1920s, as electrification enabled the likes of Henry Ford to improve workplace efficiency. But what about the effect on corporate profits and the stock market? This was much less significant.
Goldman Sachs found that the industrials sector experienced profits growth below that of nominal GDP growth over the period 1890-1935, when electrification was occurring. And the share prices of electric utilities peaked in 1900, beginning a 20-year period of share price under-performance that was matched by a fall in the sector's earnings over the period. The real gains were made not by the utility groups but by the electrical equipment manufacturers.
The reason for the poor performance, says Goldman, was a rise in competition in the electricity supply industry. So what does all this imply for the Internet sector? There has been a significant improvement in US productivity and the US economic growth rate in recent years. As Goldman points out, however, the market appears to have taken future productivity gains on trust. It calculates that the rate of profit growth implied in current global equity valuations is almost 1.5 per cent above the long-term consensus GDP growth rate.
The implication is that the Internet is going to need to be at least as significant as electricity in transforming the economy. That seems a stretch. And anything less could prove disappointing for investors.
