What it means
For much of the twentieth century, wealth came from factories, mines and farms, and a company's value was tied to its physical assets. The new economy idea suggests that this has shifted.
Today, many of the most valuable companies depend on software, data, brands and talented people. Digital products can be copied at almost no extra cost, so growth can be very fast once the first version is built.
Network effects, where a product becomes more valuable as more people use it, can lead to a few dominant platforms. Work can also be done remotely and sold globally, which opens markets to small firms.
For finance professionals, this changes how a business is judged. Intangible assets, such as software code, customer data and intellectual property, are often worth more than buildings or machinery, but accounting rules do not always show them on the balance sheet.
Analysts therefore look at metrics such as recurring revenue, customer acquisition cost and user growth in addition to traditional profit measures. The term has a history of overexcitement.
In the late 1990s, many believed that the old rules of valuation no longer applied, and share prices of internet companies climbed far beyond their earnings. When the bubble burst in the early 2000s, many young firms failed, which showed that new business models still need to make money in the end.
The label is also used less precisely today, and many economists prefer terms such as the digital economy or the knowledge economy. The old and the new are mixed together, since a modern retailer still needs warehouses and lorries, and a manufacturer relies heavily on software.
A sensible manager treats the new economy as a set of trends and not as a separate world with different rules. For a manager, the main practical effect is on how growth is financed and measured.
A business built on software or data may need little equipment but heavy spending on engineers and marketing, which accounting rules usually treat as an expense. That can make a fast-growing firm look less profitable on paper than the underlying economics suggest.
In practice
Real-world examples.
Example
A software company with 40 employees sells subscriptions to customers in 30 countries. Each new customer adds revenue of $1,200 a year at almost no extra cost. The founders grow revenue from $2,000,000 to $8,000,000 without opening a single office abroad. Its main costs are salaries and cloud hosting, so each extra customer adds profit quickly.
Example
A clothing retailer builds an online platform and uses customer data to personalise offers. It finds that 35% of sales now come from the app, while stores are used mainly for returns and brand visibility. The finance team begins to measure profit by channel. It also tracks how many app users go on to buy in a shop.
Example
An investor considers two businesses: a steel producer with $500,000,000 of machinery and a data analytics firm with $20,000,000 of assets. The analytics company is valued higher because of its expected growth and contracts. The investor reviews recurring revenue and retention to judge whether this makes sense.
Case study
Seen in the real world.
Brightpath Learning is a fictional online education company, and this illustrative story shows the opportunities and risks of the new economy. It launched an app that offered language lessons for $10 per month and attracted 500,000 users within two years. Investors valued it at 20 times annual revenue because of the rapid growth.
When growth slowed and many users cancelled after the free trial, the company found it was spending $60 to win each customer who generated only $45 of lifetime profit. Its board cut marketing, improved the product and focused on keeping customers longer. Within a year it reached break-even, and the founders noted that the fundamentals of unit economics apply as much to a new business model as to an old one.
The founders also learned that investors were more patient when they could see clear metrics on retention and payback, and less patient when they heard only about user numbers.
Watch out
Common mistakes.
- Believing that profits no longer matter in the new economy. Every business needs to make money eventually.
- Assuming that traditional industries are irrelevant. They remain essential and are increasingly combined with technology.
- Valuing companies on user numbers alone. Users must turn into revenue and profit at a sensible cost.
Questions
People also ask.
Where did the term come from?
It was widely used in the 1990s to describe the rise of the internet, information technology and globalisation.
Is the new economy the same as the digital economy?
They overlap heavily, though digital economy is now the more common term.
Why do intangible assets matter?
Many modern firms create value through software, data and brands, which accounting rules may not fully capture on the balance sheet, so analysts often adjust for them when comparing a technology firm with a traditional manufacturer.
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