We are witnessing a repeat of the 2000 Dotcom Bubble, with one crucial difference — given that tech is at the centre of everything we do today, any correction will be less severe and bounce back quicker.
By Shashi Polavarapu
Hyderabad: Much has happened over the last three months. Stock prices of glitzy tech startups got hammered. Companies started laying off staff in the thousands. Fear gripped people as they followed the endless stream of layoff reports. Only a year ago, the mood at tech companies was celebratory. Professionals have seen their wages double and in some cases triple. Then came the trouble. Meta — the parent company of Facebook — lost over $230 billion in valuation on a single afternoon in February as fears of slowing growth sparked a sharp sell-off. Over the next few months, layoffs spread through the startup land with big names like InVision letting go of 50% staff.
Meanwhile, Indian IT services companies — less glamorous than startups but heavy-weight employers of tech professionals — experienced strong growth all through the year. They hired at a rapid clip bidding up wages as the competition for talent intensified. With demand for tech professionals so high and attrition so rampant, not to say anything about remote work, it was surprising anything ever got done. Of late, growth is finally slowing for them too, with clients holding back technology spending as the prospects for the global economy dim. Several companies now have hiring freezes in place and are cautious about new hiring.
In the 17th century Dutch Republic, people took a fancy to tulips. Though research casts doubt on whether Tulipmania was a bubble in a modern sense, no one doubts that it was irrational to pay 16X the annual salary of an average person for a tulip
It is easy to feel despondent amid heightened media coverage on layoffs and the onset of a recession. But, it pays to turn to history books to understand what is happening. As far as tech startups are concerned, this was exactly what happened during the Dotcom Bubble at the turn of the millennium. Between 1995 and 2000, the Nasdaq Composite Index — a basket of tech stocks — rose 400% as investors poured money into dotcom companies excited by their potential, despite many of them not having viable business models. In some cases, the technology necessary for the startups to make good on their promises was not sufficiently mature.
Soon enough, many startups began to fail, unable to achieve profitability before burning through their cash reserves. Investors realised that the treasure they have been digging for was either simply not there or was worth much less than they estimated. There was no way some of these startups with back-of-the-napkin business models could generate the astronomical returns they projected. This realisation drove investors to promptly take their money out. The aftermath is well-known. The same Nasdaq index fell 78% in 18 months. Even, Cisco lost 80% of its value. The US economy slid into a recession.
We are witnessing a similar sequence of events today, with one crucial difference. Given that tech is at the centre of everything we do today, any correction will be less severe and the bounce back quicker. Let’s look at the numbers. Between 2016 and 2021, the Nasdaq Composite Index rose over 200%. Over the last year, the index has fallen by about 35%. Several established tech companies like Facebook experienced eye-watering drops in valuation, while others like Pollen have collapsed. All this also coincides with the ever-growing strength of companies like Google, Apple, Microsoft and Amazon. Still, there’s no denying that a correction is in the offing in the world of tech.
There is an argument that after the dot-com crash, investors turned to real estate under the belief that it was safer and that house prices would always go up. The bubble burst
There are several lessons here. First, this is an old problem. Bubbles and recessions are an inherent part of the modern economy. Governments and central banks have a well-worn toolbox to deal with them, even if they sometimes pick up the wrong tools. Overall, they have a reasonable record of nursing economies back to health when asset bubbles pop. Second, companies with solid fundamentals survive the straitened circumstances that follow bubbles. They will have to go through painful transformations, and they usually emerge so much the better for them.
How Bubbles Form
Let’s look at how bubbles develop. Contrary to what the early economists argued, man is not a rational actor. Research shows how we regularly make bad decisions, duped by the tricks our brains play on us. Nowhere is this irrationality more heightened than in our dealings with money. In the words of the economist Alan Greenspan, we are prone to irrational exuberance, which is a fancy way of saying we get carried away. This tendency to entertain and chase delusions led to several bubbles in the long history of capitalism. In the 17th century Dutch Republic, people took a fancy to tulips. The price of tulips, which had little use than to decorate gardens, shot up so much during the Tulip Bubble that some of them were more expensive than a mansion on the Amsterdam waterfront. Though later research casts some doubt on whether the Tulipmania was a bubble in a modern sense, no one doubts that it was irrational to pay 16 times the annual salary of an average person for a tulip.
48% of companies created during the Dotcom Bubble years survived the crash and created resources that underpin many products and services we enjoy today
Not just exciting ideas, something as drab as housing can evoke strong enthusiasm. The 2008 subprime meltdown that triggered the Great Recession is a case in point. In fact, there is an argument that after the dot-com crash, investors turned to real estate under the belief that it was safer and that house prices would always go up. This belief was held so dogmatically that it was hard for many to conceive the slightest possibility of a fall in prices. House prices in the US doubled between 1996 and 2006, with about 65% of this increase coming between 2002 and 2006. Several people with below-average credit scores took out loans with higher interest rates to buy houses. Later, as defaults on risky mortgages increased, the global financial system almost imploded.
The makings of a bubble are straightforward. Every once in a while, an asset gains appeal. It does not have to be new or exciting. It must merely stoke the imagination of investors for its perceived value to start rising steadily. This rise draws in more investors, and before long the price of these assets is inflated beyond their intrinsic value or historical average. If the economy offers little else in terms of opportunity, most of the capital will flow into the “rising sector” until it comes crashing down.
Most tech executives are believers in the philosophy of investing—and countercyclical investing. Recession or not, they will keep investing to stay ahead of the curve
When Bubbles Burst
Some bubbles last long, while some enjoy only a brief span. But when they pop, things get worse rapidly. A bankruptcy here and an earnings loss there is all it takes to prick them. Investors mark down expectations and rush for the exits. Those who entered the party late lose a lot of their money. These events force governments and central banks to step in and cool things, which leads to a contraction in economic activity. During the Great Recession, the average US house lost about a third of its value. In the aftermath of a bubble, people lose jobs and struggle to find new ones elsewhere. It takes several months for the economy to recover.
Companies that depend on irrational investor enthusiasm to merely survive are the ones that fall first. For example, Pets.com, an online pet supplies player, went down 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 were able to survive and grow because they had enough cash on their books and were operationally disciplined. In fact, 48% of companies created during the Dotcom Bubble years survived the crash and created resources that underpin many 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 now? The answer is nuanced, which means it is both yes and no. The broader world of tech startups is certainly overheated. There are pockets like crypto that are in a bubble. But, for several tech companies, the gulf between expectations and reality is not as wide as it was during the Dotcom Bubble. For example, Google’s price-to-earnings ratio of about 20 is eminently justified, while Salesforce’s at over 70 may not be. Some correction is in order, but there won’t be a massive blowout of tech companies, even if the economy enters a recession.
Unlike the early years of the millennium, tech occupies a more central role in the world of business. In Marc Andreesen’s phrase, software really is “eating the world”. Businesses are becoming software-defined, which means they are enabling the delivery of goods and services predominantly using software. Take the case of loan processing. Executives now look at it as a digital transaction—what required two or three teams to work together previously is reduced to an interplay between two or three automated services. In another example, Nike builds training apps to engage digitally with customers. It likes to see itself not as a sneakers or apparel company, but as a fitness solutions provider with technology at its core.
Then, there is the ethos of investing in the future at established tech startups. Recession or not, they will keep investing to stay ahead of the curve, benefiting from the easier availability of software professionals freed from unsustainable businesses. The tech scene will, therefore, remain robust.
What Happens to Jobs
There will be layoffs at tech companies, but they will not lead to prolonged joblessness. Tech unemployment is very low and people losing a job can land another one quickly. There will be two exceptions: first, people working on outdated technologies will struggle to find jobs; second, the huge number of non-tech professionals at tech companies (like in marketing or operations, for example) will also have a hard time finding jobs. Otherwise, the tech job market will remain healthy throughout the next three years.
Besides, the market for tech talent has a lot of discontinuities. Companies are rapidly integrating new technologies into their products while throwing out obsolete ones. This means that there are always some skills where demand outstrips supply by a fair measure. The job market handsomely rewards those who look out for the next big thing and build expertise in that area. Today, companies can’t hire enough professionals in areas like machine learning, cloud, cybersecurity and web3. For those who want to learn new skills, self-paced online learning makes it easy to build functional expertise — no matter where they are.
Finally, professionals need to throw out the dangerous idea that we should only be doing what we love. In most cases, it is merely a cover for sloth. They should instead keep an eye on jobs that companies are hiring for aggressively, and if they align with their interests, they should target them. If not, they could launch 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, a Hyderabad-based IT services company)