Unless you have been living under a rock in the most impenetrable depths of the Amazon rain forest you have heard a something about the current economic downturn. It is not just Wall Street that is under siege, markets as far flung as Japan and Australia have taken hits as well. You may be familiar with the butterfly effect in chaos theory…a butterfly fluttering its wings in one place creates a tornado in another. It is an overly simplified way of illustrating the idea that the minutest changes to an intricately connected system may result in larger scale occurrences in another part of the same system. Though the butterfly does not literally cause or prevent climate change its action contributes to a myriad other factors that when combined become more than the sum of their collective parts. Well the inescapable fact is that no nation’s economy is an island; instead all are linked in a complex web of codependency and bad trades in one place can lead to indigestion in markets across the globe. And this rule applies to other sectors as well. It is not just Wall Street and Main Street that are feeling the squeeze, not just retirement funds and housing prices taking a nosedive, there is a domino effect that touches everything and the tech industry is not immune.

Some may recall (and I realize that I am dating myself here) the dotcom crash of the late 90’s. This was the time when after stratospheric growth the values of upwardly mobile websites came crashing down to earth and caused such collateral damage that it took years for the industry to recover. No sane investor would go within 100 feet of an Internet stock and the sock puppet mascot of pets.com became a cautionary symbol of what happens when hubris is not matched by experience. You see the young Turks at the wheel of the most high flying web companies of the 90’s, the ones who were playing around with hundreds of millions of dollars and promising improbable returns had no experience running anything more involved than an operating system, let alone publicly traded multimillion dollar companies. Some notable exceptions slipped through and became legendary, names like Google, Yahoo, Amazon and EBay, which to this day remain testaments to what is possible when a good idea marries good management.

After the bubble burst things were quiet in the sector for a while then the explosion of social networks, wireless connections, smart phones, web-video and user generated content ushered in the new tech boom. MySpace, YouTube and Facebook became the yardsticks by which Web 2.0 success was measured and suddenly the race was on to uncover the next big thing. The money was irresistible. MySpace’s sticker price of $580 million paid for by Rupert Murdoch’s News Corp was soon eclipsed by the acquisition of YouTube by Google ($1.65 billion in stock) and the $6 billion in cash that Microsoft paid for digital advertising house aQuantive. The perceived values of hot companies that had yet to make public offerings were even higher, case in point Facebook. After Microsoft paid $246 million for a 1.6 % share the college based networking site suddenly had a valuation of an astronomical $15 billion. Huh? While the majority of these new Internet stars had impressive page views almost none had articulated a concrete plan to monetize their traffic and turn those million clicks into real dollars. One problem was the demographic that they catered to. They were too young to own credit cards, too accustomed to getting things for free (courtesy of file sharing) and notoriously desensitized to advertising. Nevertheless in their rush to not be left on the wrong side of a potential windfall, investors brushed such concerns aside. Am I alone in getting a disturbing sense of déjà vu?

Ok I am going to play devils advocate here and postulate a theory that our depressing economic situation may not be an altogether bad thing for the tech sector. Before you raise a mob to storm the castle and condemn me to death by a thousand paper cuts for blasphemy take a moment to hear me out. The instability of the markets has caused a mild panic and wariness among the moneymen. These venture capital and angel investors are the lifeblood of the tech industry pumping hundreds of millions into ideas that they think have potential. They are the same gamblers who funded the last tech boom and who subsequently lost their shirts when those businesses failed. For years they would not even consider web investments but money has a short memory and gambling is an addiction.

Suddenly everything related to Web 2.0 was hot and some truly awesome ideas received support but the flipside of the coin was that a barrage of “me too” sites were popping up everyday. I mean seriously how many social networking sites does one really need? At last count Wikipedia had some 130 listed along with the note that this was not an exhaustive list but merely some of the more notable ones. And then there are the video sharing sites, the blog hosting services, the search engines and news aggregators. Some like Joost, Word Press and the Huffington Post have added much to the online experience by identifying a need and filling it with a quality service. But mostly we have also been subjected to increased clutter from sites that do essentially the same thing in sharply decreasing competence. Ten years ago none would have seen the outside of the college dorm room that conceived them now an environment flush with cash meant everyone with half an idea had a shot at a meeting and seed money.

But that is quickly becoming past tense. Some major investment firms like Sequoia Capital and Benchmark Capital made news when they sent dire email warnings or convened emergency meetings with their portfolio companies cautioning them to reign in spending and bring accounts into control for the months to come. Translation; companies that had already secured financing were safe for the most part since venture investors are in it for the long haul not the quick buy and sell like traders but how those companies used their money would be more carefully scrutinized. It also meant that for new comers, the chances of being funded would be slimmer since investors were more cautious and less likely to immediately jump onboard an idea that already had several similar executions. It was mostly posturing on the part of the investors but many of the “safe” sites took this sign as the first horseman of an imminent apocalypse and decided to hold a pink slip parade. They figured the most immediate way to placate their backers and send a visible message to a nervous market that they were making an effort was to trim the fat by throwing less essential personnel overboard.

Among these was Zillow, a once red-hot real estate site that was cooling as rapidly as the housing markets that started this whole economic mess. Zillow’s gimmick was that it allowed you to estimate the value of your property by taking into account factors like location and recent sales in your neighborhood. The Seattle based company announced it was slashing 25 % of its work force even though according to their CEO, site traffic was actually 42% higher than it was in the same period last year. Though Zillow amassed a formidable war chest in investor funding ($87 million) it has still not turned a profit and realtors felt schadenfreude since the website threatened to make them obsolete. A rival Seattle based real estate site, Redfin also cut 20% of its employees. Another website on a diet is SearchMe, a relative newcomer to the search engine wars. It shaved off 20% of its worker bees. SearchMe eschews the boring old text and underlined links that are the standard format for search results and instead uses a cover-flow display reminiscent of iTunes. It is backed by Sequoia and has $40 million in the bank.

Even the giants buttoned in anticipation of a long financial winter. Superstar Google has seen its stock plummet more than 48% this year a loss of about $333.48 per share. Always thinking outside the box it has found a creative way to cut costs. The company renowned for many employee perks like it’s free all-you-can-eat employee buffets went on a diet in the cafeteria of its New York offices announcing shorter hours, a trimmed down selection and new rules as regards feeding guests or taking some grub home with you. Every penny counts apparently. So far this is confined to its Manhattan bureau but if things keep heading south in the stock market, the policy may spread company wide and leave employees at Google’s Mountain View, CA headquarters quoting Oliver Twist asking, “Please Sir can I have some more?”

I tend to take the more dramatic predictions of doom with a large pinch of salt because the stock markets are by their very nature a system that ebbs and flows, rising and falling and ultimately finding a balance. So a recession could happen but I will not hold my breath waiting for a depression. So much money was flowing into the new tech companies that things were bound to come to a head. Although the bubble has not quite burst it has been deflated somewhat and this may be positive in retrospect. In order to receive financial backing new entries can’t merely be clones of other websites, they will need to present fresh ideas that fill genuine needs, have long term plans for monetization and this would benefit the industry as a whole. Darwin’s theory of evolution applied to the Internet. So hold off on writing off this admittedly rocky period as “Dotcom Crash” part deux. But when brokers run screaming and tearing their clothes from the New York Stock Exchange and the Hoovervilles are resurrected in Central Park. I’d start to worry.