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Will start-ups change when the winter passes?
Start-ups that have found their way to profitability are the ones that will survive the winter, while those that have not only have a minuscule chance.
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he year 2023 is less than two months old, but the burst of layoffs in tech companies seems to have reemerged after a short slowdown at the end of 2022. Even household names in the tech industry have released announcements of big layoffs: Alphabet, the parent company of Google, reduced its headcount by 12,000; Microsoft by 10,000; Salesforce by 8,000; and Amazon by 8,000 following 10,000 layoffs in November 2022.
Just recently, Dell cut its employment by 6,650, which makes its total tech layoffs near 100,000 in just five weeks in early 2023, a dramatic spike compared with 159,000 tech layoffs in 2022.
If we trace back to how this massive layoff occurred, we encounter three major factors that intertwined and significantly contributed to the creation of a big blow that hit the tech startups hard, namely the slowing down of the economy, disruption of the flow of investment from venture capital and massive hiring sprees during the pandemic.
According to the latest Global Economic Prospects report issued on Jan. 10, the World Bank predicts that global growth will slow from 2.9 percent in 2022 to 1.7 percent in 2023, citing higher inflation followed by a tighter monetary policy and rising geopolitical tensions as the main contributors.
Meanwhile, the International Monetary Fund in its January 2023 World Economic Outlook estimated that global growth will fall to 2.9 percent in 2023 but rise to 3.1 percent in 2024, driven mostly by rising interest rates and the war in Ukraine.
Inflationary pressures that occurred almost evenly throughout the world, especially in the United States and Europe, forced central banks to dampen it through simultaneous increases in interest rates. The interest rate hike has led to major changes in the global investment landscape. Low-interest funds that have been employed to fund various risky investments through various investment channels and financial instruments, such as speculative stocks, hedge funds, cryptocurrency and also startups through venture capital, have turned around the direction and anchored in safe-haven assets such as hard currency, gold and defensive stocks.
While the value of the US dollar and gold peaked at new record highs, the flow of funds to startups worldwide shrank to a low record. According to CB Insights research, total funding provided by venture capital to start-ups worldwide, including to Indonesia, in 2022 was US$415.1 billion, a decrease of 35 percent compared with $638.6 billion in 2021. In the US, the place with the highest population of start-ups, total venture capital funding also fell by 37 percent from $314.9 billion in 2021 to $198,4 billion in 2022.
Meanwhile, other metrics of tech's funding activities, such as the number of venture capital deals signed, number of global tech IPOs, number of tech merger and acquisition deals, number of SPAC deals, and number of new unicorn births, also declined in 2022 compared with the previous year, which signifies that the winter had come to tech start-ups already.
The early and immediate response of start-ups when the perfect storm swept the start-up industry in mid-2022 was to execute mass layoffs, either in one shot or in stages. The strategy was to reserve resources to keep afloat. Many projects that still needed time to nurture before being commercially launched were put on hold, including high-profile projects like Metaverse, which cost Facebook $10 billion in 2021 alone. Next, a series of activities from business refocusing to cost efficiency was undertaken.
In the corporate world, we are familiar with terms of turnaround activities, when loss-making and near-collapse companies turn to be efficient and profitable ones by turning the direction and reformatting the whole structure of the company, if necessary. Investors and advisors advised start-ups to make savings here and there in operational activities, including scrapping things like free-flow meals and other perks and even asked founders to adjust their expectations.
But by doing all of that, could it be possible to save the start-ups, or is it possible to change the startups fundamentally?
Start-ups are different from ordinary companies, meaning applying the same metrics as ordinary companies in running start-ups will not work. Therefore, compelling startups to do so will not only limit the start-ups' capacity to deliver explosive growth as targeted but it would gradually kill the startups. Start-ups are the place to invent and develop new technologies or new ways to do business and systematically introduce them to the target market to be commercially accepted.
If we remember Bell Laboratories or Xerox Research Centre, which around the seventies successfully invented many new technologies, then start-ups are the current version of those two famous labs, but not funded as a cost center of the big tech companies but by investors and venture capital. Hence, the only destination for start-ups is either success or failure.
As mentioned in the Harvard Business Review, most start-ups do not succeed, while more than two-thirds never deliver a positive return to investors. Meanwhile, according to a survey carried out by Statista among start-up owners, the two main reasons for business failure among start-ups are running out or disruption of the flow of investor's funds (38 percent) and no market need (35 percent).
Therefore, the disruption in the flow of funding to start-ups, as has recently happened, will only accelerate the demise of start-ups. Those start-ups that have already found their way to profitability are the ones that will survive the winter, while those that have not have only a minuscule chance. Nonetheless, once the ice melts and winter passes, it is unlikely that start-ups will be fundamentally changed. Start-ups still need a structure to incentivize founders to dedicate their time, attention and effort to inventing and nurturing new technologies or new business models.
Investors, through venture capital, will keep coming to fund start-ups once the interest rate declines and the risk-return profile of investing in start-ups exceeds that of investing in safe havens.
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The writer is a financial market specialist and a technology and social communication researcher at PT Tripod Engineering Services. The views expressed in this article are his own.
