The tech sector is heading for a bubble. Why? Because everything will get too expensive, and competition will become too intense
Unlimited maternity and paternity leave. A $70,000 a year minimum salary. No one tracking how much holiday time you take. A $2,000 annual travel allowance. Freezing your eggs so that you can postpone having children as long as you want. A free massage every Friday.
It might sound like a list of standard employee benefits for local council recycling officers once Jeremy Corbyn become Prime Minister and Diane Abbott is safely installed in Number 11. But in fact, they are all policies that have been introduced in the past few months at some of the biggest and most successful technology companies in the world.
The tech industry is on a mighty roll. As our smartphones keep us plugged into the internet 24 hours a day, and as more and more traditional industries get turned upside down by innovative start-ups from Shoreditch to Silicon Valley, the value of internet companies is soaring to levels not seen since the peak of the last bubble 15 years ago. The Nasdaq is at all-time highs, and there are so many billion-dollar start-ups that a new term has been created for them – unicorns. For investors, piling as much cash as possible into Apple, Amazon and a few others, along with venture capital funds, has been by far the smartest way to make money in the past decade.
At yet, amid so much success, there is also a whiff of hubris – of which the lavish treatment of employees is just one symptom. Valuations are rising to stratospheric levels, at a time when the costs of technology companies are rising rapidly, and competition is becoming ever more intense. Technology will certainly be the future. But that doesn’t mean there won’t be some spectacular crashes along the way – and the next one may be closer than most people realise.
There are plenty of signals of how stretched valuations have become. The Nasdaq has always been the key technology index, home to the likes of Apple and Google. In 1999, it peaked at a fraction under 4,000, and then collapsed over the next two years. But even if you were unlucky enough to buy into the market right at the top, you’d now be back in the money – it has long since overtaken that, and has now surged past 5,000. It has been powered by the likes of Amazon and Google, and newer tech stars such as Netflix, the TV streaming giant, which is up by 110pc in the past year alone, and Tesla, the manufacturer of electric cars, which is up by close on 50pc. In 1999, at the peak of the tech bubble, the index doubled in a single year. It hasn’t been that extreme yet, but it is getting close.
The venture capital market is even more over-heated, with investors competing to get in early on the next big star. Right now, there are more than 80 “unicorns”, that is, start-ups worth more than $1bn, according to research by CB Insights. The numbers are growing – and the values are ever more eye-watering. Airbnb, the room sharing site, is worth more than $2bn. Uber, the taxi sharing site, is valued at more than $50bn. Sure, empowering ordinary people to turn their spare room into a hotel, or do some freelance cabbing, are both great ideas. But $50bn? You don’t have to be Warren Buffett – who at one stage shunned tech stocks because he couldn’t understand them – to think that may be a little rich.
Of course, there are reasons why it is different this time. The economics of the internet are a lot clearer than they were in the last bubble. Firms like Google and Apple make huge profits. Not many companies are scratching around for a “business model” anymore. Outside of the media, it is easy to see how to make money on the internet. From shopping to streaming to financial transactions, consumers have become relaxed about paying small sums of money for digital products. Nor can it be dismissed as a flash in the pan. The internet is here to stay – and from broadcasting to banking, there is still a lot of “disruption” to come.
That doesn’t mean it won’t turn into a bubble. Why? Because everything will get too expensive, and competition will become too intense.
There are plenty of signs of that happening. One clue is the lavish treatment of staff. The list above – in case you are wondering where to send your CV – comes from the following companies.
Netflix announced this week that its staff could have unlimited parental leave. Gravity Payments introduced a $70,000 minimum salary. introduced an open holiday system. Airbnb gives its staff an annual travel allowance. Facebook pays for its staff to freeze their eggs.
No one objects to the employees getting a good deal – these are all very successful businesses. But is a sure-fire sign that the competition for people is so intense that the only way to keep them is to keep pushing up pay, and throwing in more and more extras.
Costs for tech companies are spiralling as they scramble to find the programmers, engineers, designers and marketeers to create that cool app or sharing site, and then pay for the office space to house them all. Office rents in Silicon Valley and San Francisco are close on $100 a square foot, three times the national average for the US. The average salary for tech companies in that area is $195,000 and rising by 20pc a year. Getting into the technology business is not cheap anymore.
At the same time, competition in many sectors is becoming intense. With venture capital money being sprayed around, and with companies such as Apple sitting on more cash than most small nations, any popular idea immediately attracts a swarm of imitators. How many music streaming services do we need to compete with the fabulously successful Spotify, for example? Not as many as have been expensively launched, that is for sure. There are a whole host of taxi and room-sharing apps being set up – and that’s before Apple or Facebook decide to burn through a few billion launching their own. Brutal competition drives down prices and margins. That’s great for customers, but it makes life very hard for new companies that have yet to turn a profit.
True, over time, technology will always triumph. If you’d invested in Amazon even at the height of the dotcom madness of 1999 you’d still have made a lot of money. But there are going to be some big bumps along the way – and don’t be surprised if one of those is right ahead.