Regardless of whether techonomics survives, astute companies with real growth potential, and their stakeholders, would be better served by charting a different path.
Neil Desai served in senior roles with Canadian tech company Magnet Forensics and with the federal government. He advises Canadian startups through Rogers Cyber Catalyst and is a senior fellow with the Centre for International Governance Innovation.
The S&P 500 was once dominated by industrial firms, with tangible assets such as land and heavy machinery as well as free cashflow. Now they have been replaced by technology-intensive businesses. In 2020, 90 per cent of the value in the S&P 500 were comprised of intangible assets.
This defined software giants such as Microsoft MSFT-Q, Google GOOG-Q, Amazon AMZN-Q, Meta META-Q, Salesforce CRM-N and, here in Canada, Shopify SHOP-T. They were able to grow their revenue at relatively low cost once they found product-market fit. Their costs for software development were sunk, and their intangible businesses could be scaled up at virtually no additional expenditure.
This enabled these companies to invest in adjacent markets, developing new business lines by hoarding talent and acquiring startups. Such was the “techonomics” model of prioritizing intellectual property and market share, one copied across the board by early-stage tech companies. Profitability took a back-seat to growth. The low interest rates of the COVID-19 pandemic accelerated this trend.
But it all ground to a halt last year when central bankers raised interest rates to address inflationary pressures. Tech company valuations cratered, and most had difficulty raising new capital.
This is an opportunity to learn from history. Regardless of whether techonomics survives, astute, innovative companies with real growth potential, and their stakeholders, would be better served by charting a different path. Companies need to balance growth with profit over a reasonable horizon, as opposed to chasing market share without making money and becoming perpetually dependent on capital raises.
The techonomics model could be rationalized for some software behemoths, given that they were creating and winning sizable, global markets with highly defendable intellectual property and business models. It could reasonably be assumed that, for them, profitability wasn’t a pipe dream but a reasonable trade-off for growth.
Where this economic transformation started to unravel is when it began to be adopted by businesses that didn’t meet the obvious fundamentals to justify it: the opportunity to create or win a large category with a stable, forecastable, reoccurring revenue model, with the potential to eventually do it in a profitable manner.
A case in point is Canadian pizza joint General Assembly, which raised $13-million and then listed weeks later on the TSX Venture Exchange on the prospect of turning their tangible products into subscription services, with little data to support this plan. Another example is Bolt: One of the many e-scooter businesses that dump their hardwire on city streets for would-be users to ride-on-demand through an app with a payment system, it raised upward of US$2-billion.
The global pandemic increased the size of the market for new digital solutions, as more consumers turned to e-commerce to get their necessities and cloud-computing-based applications powered work-from-home. This led to the creation of a rash of new “software as a service” enabled businesses, from mindfulness apps to subscription toilet paper companies. Many investors were directing their portfolio companies to adopt a growth at all costs strategy.
Now, widespread tech layoffs have commenced, as companies try to preserve their cash and search for more sustainable business models. Bankruptcies and opportunistic acquisitions are foreseeable.
In Canada there are wider implications to the carnage that techonomics will leave behind, given how exposed all taxpayers are to the domestic tech sector. Governments at the federal and provincial level invest in R&D and growth companies directly through tax credits, grants, debt and investments with their own venture funds as well as being a limited partner in other venture funds.
The governments’ indirect investments in the tech sector through incubators, accelerators and universities has exacerbated this challenge, as companies continue to be advised by these institutions to pursue techonomics regardless of whether the macro-investment climate will continue to value companies so loosely or whether the companies have the fundamentals to justify this approach.
Techonomics are also being kept on life support in Canada and globally with the breakthrough of generative artificial intelligence. The competitive juices for deal flow in this space has ramped up. Startups are being advised to market their use of generative AI to inflate their valuations in capital raises even if they don’t have proprietary intellectual property or data.
But startups and their founders, as well as investors and government backing such companies, need to accept the fact that overnight success stories are extremely rare. Even OpenAI, the company at the heart of the generative AI craze, was founded several years ago, in 2015.
Companies focused on creating or tackling large, global markets with intangible assets and a long road to profitability should align themselves with smart, patient capital at valuations into which they can reasonably grow.