We are witnessing a repeat of the dot-com bubble of 2000, but with one key difference – given that technology is at the heart of everything we do today, any corrections will be less severe and rebounds will be quicker.
Posted Date – 12:36 AM, Sunday – 12/4/22
Illustration: Guru G
by Shashi Polavarapu
Hyderabad: A lot has happened in the past three months. Shares of glitzy tech startups have been hammered. Companies started laying off thousands of people. As people focus on the endless reports of layoffs, fear grips them. Just a year ago, the mood at tech companies was buzzing. Salaries for professionals have doubled, and in some cases even tripled. Here comes the trouble. Facebook parent Meta lost more than $230 billion in valuation in a single afternoon in February as fears of slowing growth sparked a sharp sell-off. Over the next few months, layoffs spread throughout the startup, with major companies like InVision laying off 50% of their workforce.
Meanwhile, Indian IT services companies — not as flashy as startups, but heavyweight employers of tech professionals — have experienced strong growth throughout the year. As competition for talent intensifies, they hire fast at a pace that drives up wages. With technology professionals in such high demand and attrition so rampant, let alone remote work, anything is surprising. Their growth has finally slowed recently, too, with customers reining in technology spending as the global economic outlook dims. Several companies have now frozen hiring and are wary of new hires.
In the Dutch Republic in the 17th century, people took a fancy to tulips.While research questions whether tulip mania is a bubble in the modern sense, no one disputes that paying 16 times the average person’s annual salary for a tulip is unreasonable
It’s easy to get frustrated amid mounting media coverage of layoffs and the onset of a recession. But it’s worth turning to the history books to see what’s going on. In the case of tech startups, this is exactly what happened during the dot-com bubble of the millennium. Between 1995 and 2000, the Nasdaq Composite — a basket of technology stocks — rose 400 percent as investors poured money into Internet companies excited about their potential, even though many of them had no viable business models . In some cases, the technology required for startups to deliver on their promises is not yet mature enough.
Soon, many startups began to fail, unable to turn a profit before depleting their cash reserves. Investors realized that the treasure they had been digging either didn’t exist or was worth far less than they estimated. Some of these paper towel business model startups are unlikely to generate the astronomical returns they predict. This realization prompted investors to quickly withdraw their funds. The consequences are well known. The same Nasdaq has lost 78% in 18 months. Even, Cisco lost 80% of its value. The U.S. economy is in recession.
We are witnessing a similar series of events today, but with one key difference. Given that technology is at the heart of everything we do today, any corrections will be less severe and the rebound will be quicker. Let’s look at the numbers. Between 2016 and 2021, the Nasdaq Composite rose more than 200%. Last year, the index fell about 35%. Several established tech companies, such as Facebook, have experienced dizzying declines in valuation, while others, such as Pollen, have collapsed. All of this also dovetails with the growing strength of companies like Google, Apple, Microsoft and Amazon. Still, there’s no denying that there’s an adjustment coming in the tech world.
There is a theory that after the dot-com bust, investors turned to real estate because they believed it was safer and that prices would always go up.bubble burst
There are several lessons here. First off, this is an old question. Bubbles and recessions are an inherent part of modern economies. Governments and central banks have an antiquated toolbox to deal with them, even if they sometimes choose the wrong tools. In general, they have a reasonable track record of nursing the economy back to health when asset bubbles burst. Second, companies with solid fundamentals can survive post-bubble distress. They’re going to have to go through painful transitions, and they usually get better.
How Bubbles Are Formed
Let’s see how bubbles are created. Contrary to what early economists believed, people are not rational actors. Research shows how we often make bad decisions, being tricked by the tricks our brains play on us. Nowhere is this irrationality more pronounced than in our dealings with money. We are prone to irrational exuberance, in the words of economist Alan Greenspan, which is a fancy way of saying we get carried away. This penchant for entertainment and chasing fantasies has led to several bubbles in the long history of capitalism. In the Dutch Republic in the 17th century, people took a fancy to tulips. Tulips, used for little other than to adorn gardens, skyrocketed in price during the tulip bubble, with some costing even more than a mansion on Amsterdam’s waterfront. Although later research cast some doubt on whether tulip mania was a bubble in the modern sense, no one doubted that paying 16 times the average person’s annual salary for a tulip was unreasonable.
48% of companies created during the dot-com bubble survived the crash and created the resources that underpin many of the products and services we enjoy today
It’s not just exciting ideas, something as drab as housing can inspire intense enthusiasm. The 2008 subprime mortgage crisis that triggered the Great Recession is a good example. In fact, there is an argument that after the dot-com bust, investors turned to real estate because they believed it was safer and that prices would always go up. This belief is so dogmatic that it is difficult for many to imagine the slightest possibility of a price drop. US home prices doubled between 1996 and 2006, with about 65% of the increase occurring between 2002 and 2006. Some people with below-average credit scores have taken out loans with higher interest rates to buy a home. Later, the global financial system nearly collapsed as risky mortgage defaults increased.
Foam formation is simple. Every once in a while, an asset gains traction. It doesn’t have to be new or exciting. It just has to spark investors’ imaginations before its perceived value begins to rise steadily. This uptick attracts more investors, and before long the prices of these assets are inflated beyond their intrinsic value or historical average. If the economy offers few other opportunities in terms of opportunities, most of the capital will flow into the “up industry” until it crashes.
Most tech executives embrace the investment philosophy and countercyclical investing.Recession or not, they will continue to invest to stay ahead
when the bubble burst
Some bubbles last a long time, while others only last a short time. But when they pop up, the situation can quickly deteriorate. Bankruptcies here and lost income there are enough to sting them. Investors lowered their expectations and rushed to exit. People who joined the party late lost a lot of money. These events forced governments and central banks to step in and cool down, causing economic activity to contract. The average American home lost about a third of its value during the Great Recession. After the bubble, people lost their jobs and struggled to find new jobs elsewhere. It will take months for the economy to recover.
Companies that survive on irrational investor enthusiasm are the first to fall. For example, online pet supply company Pets.com collapsed in 2000, nine months after its $82.5 million IPO. The company failed to generate meaningful revenue or profit growth and eventually filed for bankruptcy. During the same period, Amazon and eBay survived and thrived because they had plenty of cash on their books and were operationally disciplined. In fact, 48% of companies created during the dot-com bubble survived the crash and created the resources that underpin many of the products and services we enjoy today. The remaining half? No one talks about them.
what’s different this time
So, are we in a tech bubble right now? The answer is subtle, meaning it’s both a yes and no. The wider world of tech start-ups is definitely overheating. There are pockets like cryptocurrencies that are in a bubble. But for several tech companies, the gap between expectations and reality isn’t as wide as it was during the dot-com bubble. For example, Google’s P/E ratio of around 20 is very reasonable, while Salesforce’s P/E ratio of over 70 may not be reasonable. Some adjustments will be necessary, but even if the economy enters a recession, there won’t be a massive blowout in tech companies.
Unlike the early millennium, technology is playing a much bigger role in the business world. Software is literally “eating the world,” in the words of Marc Andreesen. Businesses are becoming software-defined, meaning they are able to deliver goods and services primarily using software. Take loan processing as an example. Executives now see it as a digital transaction—work that previously required the cooperation of two or three teams is now reduced to an interaction between two or three automated services. In another example, Nike developed a training app to engage with customers digitally. It doesn’t like to think of itself as a sneaker or apparel company, but a provider of fitness solutions with technology at its core.
Then there is an ethos of investing in the future among established tech startups. Recession or not, they will continue to invest to stay ahead, benefiting from easier access to software professionals liberated from unsustainable businesses. So the tech sector will remain strong.
what will happen to jobs
Tech companies will lay off workers, but not long-term unemployment. Technical unemployment is very low and unemployed people can quickly find another job. There will be two exceptions: first, people working on outdated technology will have a hard time finding work; and second, the large numbers of non-technical professionals in tech companies (such as marketing or operations) will also have a hard time finding work. Otherwise, the tech job market will remain healthy over the next three years.
Additionally, there are a lot of discontinuities in the tech talent market. Companies are rapidly integrating new technologies into their products while phasing out outdated technologies. This means there are always skills that are in short supply to some extent. The job market rewards those looking for the next big thing handsomely and building expertise in the field. Today, companies cannot hire enough professionals in areas such as machine learning, cloud, cybersecurity, and web3. For those looking to learn new skills, self-paced online learning makes it easy to build practical expertise – no matter where they are.
Finally, professionals need to dismiss the dangerous idea that we should only do what we love. In most cases, it’s just a cover for laziness. Instead, they should focus on positions that companies are actively hiring for, and if they match their interests, they should target them. If not, they can start their own startups and create “jobs that people love.” Although, those who fail at the former rarely succeed at the latter.
(The author is co-founder of Lexys Technologies, an IT services company based in Hyderabad)
