structure for those e - commerce firms that use electronic means to distribute tangible goods, such as books, apparel, and toys, appears to mirror more conventional business models. the network costs for these firms reflect the well - understood high fixed cost and low marginal cost model of the electronic world. however, the economics of fulfillment - - that is, providing and servicing the goods - - still depend on these businesses'ability to achieve efficiencies and low unit costs for materials, storage, distribution, and after - sales service. the story of the demise of one prominent internet - only retailer may be instructive in this regard. news reports indicate that the company had to build and maintain a web site costing about $ 40 million annually, the high fixed cost element of e - commerce, which it thought was required to achieve the desired revenue in the national market it hoped to serve. besides this new economy cost, this retailer decided to build a proprietary distribution network, an old economy cost that, according to public sources, raised its investment in property and equipment to more than $ 100 million, a fourfold increase in one year. analysts indicate that this equaled around 100 percent of the firm's 1999 revenues. as a benchmark, for land - based retailers a comparable number would be 20 percent of annual revenue and for catalogue retailers, who often subcontract distribution, the comparable number would be 12 percent to 13 percent. finally, because of low barriers to entry to the internet market and the low cost to customers of switching from one seller to another, internet - only firms appear to face high costs to obtain and retain customers. again, published reports indicate that the retailer increased its budget by 30 percent in one year as new competitors moved into its market. clearly, appropriately scaling the cost model to the market potential is another key lesson in the world of e - commerce. on the demand side, the so - called network effect is extremely important for some e - commerce businesses because the value of some services increases as the number of customers using them increases. the most obvious example is an on - line auction site, in which the more buyers and sellers using an auction site, the deeper the liquidity - - that is, the greater the number of opportunities to trade and the greater the likelihood that trades will occur. for these firms, which include those that support the " auction " of equities as well as collectibles, high volume is critical to their success, and volume expectations appear to

influence investments in these firms. i have already referred to economies of scale. auctions and chat rooms provide an example of how network effects and scale economies can be mutually reinforcing, making high transaction volumes critical to both the supply and the demand sides of the market. here let me also note that, for those for whom advertising is a key source of revenue, there is a virtuous cycle as a large customer base attracts more advertisers, which in turn finances more and better content and attracts even more users. the need for scale or volume appears to create an advantage for the first business to achieve critical mass in any market in which there are strong network effects. understanding this dynamic and taking advantage of it appears to be another lesson from the early experience with e - commerce. the evolution of investment in e - commerce firms, particularly web - only firms, continues to receive attention in the press. needless to say, rational economic behavior suggests that investors would require a high return to invest in unproven but potentially profitable endeavors. after all, some innovations struggle but succeed, while others arrive too soon for the technology, arrive too soon for the market, or are not commercially successful for a wide variety of other reasons. the rapid reassessment of the business prospects of some e - commerce firms during the course of last year is a reflection of this reality. of course, the equity securities of these firms were revalued to reflect these changing assessments. are stocks today overvalued, correctly valued, or undervalued? i certainly do not know, and i am not aware of anyone who does. as a result, i believe that it would be unwise - - and indeed impossible - - for the federal reserve to target specific levels of valuations in equity markets. however, valuation methods that are appropriately sensitive to the obvious business risks of e - commerce, as opposed to being driven by the assumption of the most optimistic outcomes for every concept, are key. in the long run such approaches should provide a healthy base for maintaining a reasonable and sustainable pattern of growth and investment in the e - commerce segment. costs of capital that reflect risks accurately are critical to a well - functioning economy. therefore, with respect to observations and lessons, it appears that the basic rules of economics, commerce, and finance continue to apply. though some macroeconomic conditions have changed importantly because of the technology investments that underpin e - commerce, the laws of economics have not been repealed