Ruminations on tech industry cycles - Part 1

Predicting the direction of the tech industry is notoriously tricky. As the Yogi Berra quote goes, "it's tough to make predictions, especially about the future". However, history can help us understand patterns that tend to repeat. For example, we know the industry is deeply cyclical. Human nature drives these cycles and causes them to repeat. And human nature is essentially unchanging. These patterns can help us evaluate scenarios we are likely to see soon.

Cycles

Cycles are the central feature of the tech industry. During booms, a ton of capital flows into the sector, causing heavy, capital-burning competition in new segments. Competitive pressure makes becoming a clear winner in these segments is difficult and expensive.

Due to the abundance of capital, booms are a period of core technology building. Flush with capital, VCs fund a lot of risky and ambitious ideas. Money pours into saving expensive technological problems, and the industry makes a ton of progress. For example, during the dotcom boom, fiber installations and improvements in networking created massive bandwidth capacity. These developments paved the way for the bandwidth-hungry applications running today.

A rising tide lifts all boats. The free flow of capital causes companies to buy each other's products, pushing up the growth rates of even incumbent players. High demand for products also helps to keep prices up, creating a virtuous cycle.

Booms inevitably lead to busts. Several of the ideas fail. Capital gets scarce. The weaker players and the ones with high capital needs get kneecapped. Consolidation happens, resulting in large players emerging. Absent cheap money, growth rates fall considerably. Overcapacity and buyer reluctance causes prices to fall. Busts set a new normal for the newly emerged segments in growth rates, pricing, and competitive structure.

Entrepreneurs persevere through busts. The ones that manage to raise capital during hard times have the market to themselves. While capital is scarce and gaining customers is hard, resources are plentiful and cheap, including talent, real estate, and software. When the next boom arrives, they benefit greatly from new capital spending. This phenomenon gives rise to big winners in the industry.

Complete Products

There is a reason why many of the challenging, ambitious ideas funded during boom times fail - incomplete products. For a new product to gain mainstream adoption, it needs to offer end-to-end usable value. In the case of MP3 players, this includes the device, content in songs, and software to manage the song library. While they were mp3 players before, Apple provided the complete product in a very user-friendly form with iPod + iTunes. Complete products refer to the whole offering, including distribution, revenue model, and pricing.

Often, promising startups tackling challenging problems fail to provide the complete product. This failure can happen due to 1, constrained resources or time 2, lack of expertise in one or more areas of the complete product 3, dependence on other parts of the ecosystem that have yet to adapt to the new technology.

However, these startups solve many of the hard problems needed for the complete product. After they fail, new players later emerge, building on their progress to add the remaining pieces. They then become the winner in a massive market with the complete product. The winning player often starts during the downturn and grows to be a giant.

Where are we now?

We are in one of the most extended boom cycles. This boom correlates to falling interest rates for 30 years, unprecedented government stimulus, and an incredibly long bull market. There are ambitious efforts in many areas, including AI, crypto, space flight, self-driving cars, flying cars, VR/AR, etc.

However, while still abundant, we see markets start to withdraw capital. Growth expectations are coming down along with stock valuations. The big question is - when do we enter a bust?

Regulatory Pressure

As technology becomes a critical part of our lives, society will impose new controls to mitigate risk. A unique feature of the present cycle is regulators are beginning to get involved. New regulations could alter the trajectory of the bust, creating opportunities for new winners in some areas while also entrenching incumbent players in other areas.

In part 2 of this series, I will apply these patterns to evaluate the prospects of some emerging technologies.