Tech Booms Are Good - But They Do Not Last

It is said that Julius Caesar, when riding in his chariot during triumphal processions following his victories, was accompanied by a slave whose job was to whisper in his ear, 'all glory is fleeting.'

Tech investors would be wise to buy an app that reminds them, 'all booms are cyclical.' JL 

Richard Waters reports in the Financial Times:

Booms bring over-investment in new infrastructure that supports future innovation. Money flowing can be rationalised away by the portfolio effect: it only takes a small number of big winners to make up for the losers. “Me-too” companies abound, as investors who cannot get a piece of the latest hot start-up rush into copycat ventures. History shows that most of these will fail. The longer booms go on, the clearer it is that bad business ideas are being funded.
Technology: is it in a bubble? That question has been reverberating around Silicon Valley for at least two years. But it is the wrong question. It also distracts from a more serious consideration, and one that has assumed new urgency with the China slowdown and global stock market wobble.

This “bubble or not” debate has created a false dichotomy. It implies that either the latest tech dreams are built on sand, or everything is fine and anyone suggesting otherwise is an alarmist.But the real point is that Silicon Valley is experiencing a particularly powerful manifestation of one of its periodic booms. And, like all booms, the question is not whether this one will come to an end (they all do) but when the ensuing bust will come, and how big it will be.

Obsessive talk of a tech bubble is understandable. Even today, the shadow of the last bubble, which reached maximum inflation more than 15 years ago, still looms. However, the generalised condition of overvaluation that prevailed then is not being repeated now. As venture capital (VC) firm Andreessen Horowitz highlighted recently, valuations are not high by historical standards (at least, for public stocks). The whole market may be overpriced, but that is a different point.

That said, localised symptoms of bubbly behaviour are a characteristic of the manias that constantly sweep through the sector. An easing of social media hype has hurt the share price of LinkedIn (down 35 per cent from its peak) and Twitter (off 60 per cent). Silicon Valley’s memory is short when it comes to high-flyers that fall out of favour. Four years ago, Zynga and Groupon were the most hyped “unicorns” — or highly valued private companies — of their day. Now, as public stocks, they are both 83 per cent from their peak.

Still, even if the same fate awaits some of today’s tech darlings, like Tesla to Netflix — along with a fair number of the latest unicorns — it need not point to the pricking of a larger bubble.

Money flooding into tech start-ups feeds a boom-and-bust cycle that has been a highly productive feature of the tech world. It drives an over-investment in new business ideas, accelerating the development of new markets as investors suspend their normal disbelief.

Perhaps even more importantly, booms bring over-investment in new infrastructure that supports future innovation. A massive build-out of uneconomic broadband networks during the 1990s tech bubble left a trail of devastation in the communications industry. But it also laid the foundations for the Web 2.0 revival that followed.To outsiders, the boom periods have always looked deeply paradoxical. On the one hand, the money flowing into companies that turn out to be worthless can be rationalised away by the portfolio effect: it only takes a small number of big winners to make up for the losers.
What makes it irrational, though, is that access to the best investments is not equal. “Me-too” companies abound, as investors who cannot get a piece of the latest hot start-up rush into copycat ventures. History shows that most of these will fail.
Also, the longer booms go on, the clearer it is that bad business ideas are being funded. The flood of “on-demand” companies that are a feature of the current boom — apps that act as marketplaces to supply instant services, from food delivery to home cleaning — look like a case in point. The recent failure of Homejoy, a cleaning app that burnt through $40m in its three years of life, is a sign that new money for these sorts of ventures is starting to dry up.
It usually takes an external shock to interrupt a boom. The 2008 financial crisis was one of those: it put paid to the “greentech” boom, when Silicon Valley poured money into alternative energy and similar investments. By 2009, VC funding in the US was down by a third from two years earlier. In a famous memo to the start-ups it had backed, Sequoia Capital warned: “RIP Good Times”.
So far, the shudder that has just passed through global markets is only an echo of that financial dislocation. It is too early to tell how deeply the market volatility — and the possibility of a worldwide economic slowdown — will affect the psyche of both investors and customers.
But discussions with tech entrepreneurs this week suggest it has become the main topic of conversation. Even if there is no bubble waiting to be pricked, it is a reminder that the boom times will not last for ever.