Saturday, December 24, 2022

2022 Tech downturn

Tldr; The market is going through a period of downturn as a chain reaction of the world's economy. Lavish startup life is over, lean time is here. Product-market fit will be tested. But tech is here to stay and top engineers are highly sought after.

2022 was not a great year for tech. The industry was plagued with widespread layoffs, weak earning calls, plummeting stock prices, and an investment market that shifted from equity to debt. It was another link in a chain reaction of the world's economy: pandemic aftershocks, the war between Russia and Ukraine, oil prices, energy concerns, and weaker buying power. It just happened that this link hit me the closest.

How exactly did the tech sector get tangled in this whole mess? I think firstly that is what you get from a flat world (not earth), everything is more connected than ever. The very definition of "tech" or "big tech" is ambiguous. It can be anything from social networking companies to EVs and phone makers. Really, the concept of the tech sector is no longer as relevant as it used to be because every company is a tech company to some degree. The whole world economy didn't do well and tech was an integral part of it.

Secondly, the industry has operated with a free flow of cheap money for decades. Since the collapse of the housing bubble in 2008, the FED had kept a low interest rate for almost a decade - an unprecedented event in the 60-year-plus history of the organization. Even the increase in 2015 was described at the time as "a vote of confidence in the American economy". For a long time, the availability of cheap money meant there were strong cases for borrowing money from banks and making profits via investment, including tech ventures. The high ride however ended with the interest rate hike as the FED tried to control the US inflation. I however entered the workforce in 2010, as so did many other startup founders and workers. We thought tech as an infinite source of growth was a norm. We have never experienced a real lean time before. 

The third point, the greater force of macroeconomy throws much of future forecast out of the window. Boardgames such as Agricola or Splendor, or computer games such as Factorio are known to be resembling what it is like to run a business. And in all of them, a common theme is that the move you want to do now must be planned a few turns ago. Much of what a business does today relies on what it is expected to deliver in the future. So when the future prediction is skewed, it drags the businesses into the mud.

And oh boy are we bad at predicting 2022. I mentioned no one was expecting a war between European countries in the 21st century but there were more. Social isolation throughout the pandemic yielded great returns for tech companies in 2020 and 2021. But then the demand dropped as the world reopened. Turned out, it took more than a pandemic to alter behavior. E-commerce and food delivery offered great convenience and indeed enjoyed a higher adoption rate compared to pre-pandemic but they didn't replace traditional means. Working from home didn't become the dominant working mode. And consuming power was limited to necessities as the world braced for economic difficulties.

The combination of cheap money and an over-focus on future delivery means most startups had chosen growth over profit for a long time. It had always been about acquiring the biggest slice of the market pie and only then turning to increase the profit margin. You had to because all your competitors were doing the same. There would only be a little room to grow if you had a tiny slice of the market regardless of how healthy your margin was. The cheap money guaranteed that if slow and steady was your strategy you would end up in a hostile takeover. That also means sometimes companies found themselves running faster than they should have. The widespread layoff we saw was the direct response to a decline in forecast demand and a need to reduce the cash flow till a better time.

It was easy to pick up a sage voice and describe the crazy world that was 2022 with much hindsight clarity. Being on the ground, running a team of 100+ head counts, and experiencing the first lean time sucked monkeys balls though.

Alright, so that was how we got here. Where do we go from here?

The last time tech recessed in the 2000s, it went down in a blast. NASDAQ was tech-heavy and it took 8 years to climb back to where it was previously. Yet there are reasons to believe this downturn wouldn't be as bad. During the dot com bubble, we were in the exploration stage. There was this internet thing that was supposed to be a new era but nobody was quite sure what it could do so everything went. Great ideas mixed with crazy evaluation fueled by FOMO money. was arguably the most famous flop. Kozmo and Webvan burned through billions of dollars as their grocery delivery models were not sustainable. Think Tools AG evaluated at CHF 2.5B without having a product. The noise was so bad that after the burst people believed the whole internet thing would just fade away, contributing to the long recovery. 

The time around, other than the crypto scene which is going down the exact same path, the rest of the market is a lot more mature. Companies stay much closer to reality, solve real problems, and have clear plans for monetization (at least I hope so). Tech is here to stay and people are just preparing to weather the storm.

That being said, 2023 is not going to be a great year to raise equity. People who set out for a funding round would be less likely to receive favorable evaluations and terms. The formula used to be that you can plan for a round every 18 - 24 months, one led to another on the basis of momentum, and hope that Tiger or SoftBank will come in with a massive Series C or D and allow you to have some sort of secondary exit and just build the momentum, and maybe a SPAC will you liquidity quickly. Didn't work out quite well for Grab and Sea.

At the same time, the general decline in demand across B2B and B2C remains a threat. The product-market fit (pain killer vs vitamin) is once again brought to the forefront. Startups solving more critical problems are more likely to survive. Long-term strategic product programs might be put on hold to make room for initiatives contributing immediately and directly to the bottom line. Some unfortunately will run out of time before things got better. While others are presented with a unique opportunity if the product-market fit is good in the new reality.

Interestingly for startups to remain competitive, they need to invest in technology. The performance of a tech team grows slowly, depends much on ad-hoc knowledge management, and is the bottleneck of any innovation. Even though layoffs were spreading, the core of tech teams was protected. Ones that do not spend in the near term will undoubtedly fall behind in the medium term and risk not being around in the long run.

The spending pattern might change. Software development in particular has always been one of those fields where the performance gap between top and average performers is tremendous. The term 10x engineer has been saturated to the point now it is more of a meme, but there is a kernel of truth there. In sports, running 1% faster than the next guy results in 10x compensation. But that's it, if a 1% gain costs 10x more, might as well get 10 of the slower ones. Engineering is different. A top performer can provide solutions that bad ones can't come up with, regardless of how many of them, and doesn't cost 10x as much. Then computer automation and scalability come in to multiply this productivity difference many magnitudes more. With cash flow running lower than before, recruitment is no longer a number game. Companies would pay top dollar for a few strategic positions but otherwise not double their team size any time soon.

The startup boom has lasted for a decade. It has also faced so many scares, each time more money and power were poured in. But maybe it really is different this time.

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