How to Make Money by Understanding 'Hype Cycles' in Technology: Part I

NEW YORK (TheStreet) -- The first thing every securities lawyer learns is that emerging technology is a double-edged sword.

On the leading edge, inexpensive innovations that ramp rapidly over a few years lead to thriving businesses that deliver market-beating returns. On the bleeding edge, costly innovations that can't be implemented at relevant scale for years or decades morph into financial black holes that suck the lifeblood out of portfolios and teach a whole new generation of investors about a predictable and unavoidable market phenomenon that the Gartner Group has dubbed "The Hype Cycle."

For better or worse, private and public financing of technology and resource-development projects can't happen without hype cycles that repeat themselves over and over again. Hype cycles are a force of nature, and as inexorable and predictable as the tides.

The first hype cycle in the life of every technology or resource project begins with a "Eureka moment," when an idea takes form or a resource is identified. At that stage the possibilities are limitless because the inventors and prospectors only have enough data to support a conclusion that additional work is justified. It's the riskiest possible class of investing because the odds are very high that the perceived potential will prove illusory as R&D or exploration follow their natural course.

The most common result is a mini-hype cycle where expectations are highest at the outset, but rapidly fade as technical challenges arise, compromises are made, delays are encountered, costs exceed budgets and the true market potential gets clearer. At the end of the process, the R&D and exploration investors either lick the wounds of a failed project or profit handsomely as a new trigger point arrives and the commercialization hype cycle begins.

In their book Mastering the Hype Cycle, the Gartner Group's Jackie Fenn and Mark Raskino explain that the hype cycle "arises from the interplay of two factors: human nature and the nature of innovation. Human nature drives people's heightened expectations, while the nature of innovation drives how quickly something new develops genuine value. The problem is, these two factors move at such different tempos that they're nearly always out of synch. An innovation rarely delivers on its promise when people are most excited about it. Expectations rise quickly and are easily frustrated, while innovations develop slowly, step by step."

In Gartner's model, the cycle starts with an "Innovation Trigger," where a public demonstration, product launch or other event generates press and industry interest. The innovation may have been in development for years, "but at this point it reaches a stage where word of its existence and excitement about its possibilities extend beyond its inventors or developers. More and more people hear of its potential, and a wave of buzz builds quickly as everyone passes on the news."

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