Is Silicon Valley currently in a bubble? Is the party over?
Some very smart people are arguing yes.
Others are saying no.
But what’s clear is this: we’re at the peak of this ~10 year cycle, and every boom comes with a bust. The players in the game (mainly, VCs and startups) have already began bracing for this cycle’s bust by raising as much money as possible and storing it away, drastically reducing funding for risky investments, and negotiating punitive term sheets that would save the VCs in case the startup vaporizes, among other protective measures. Investors like Bill Gurley think we’ll see a couple dead unicorns this year. And he’ll be right.
Once a few of those unicorns implode, panic will set in. Investors will pressure startups to start generating revenue instead of focusing on customer acquisition, and will completely cut funding for businesses that don’t have the potential to bring in high profit margins. As First Round Capital’s Rob Hayes pointed out, a game of musical chairs will begin around this time: employees, suddenly unsure of the prospects of the startup they’re working for, scramble to get their old jobs back at Google or Facebook. Except there won’t be a lot of chairs left.
BUT… if you have a legitimately disruptive startup (one that isn’t a service based simply off the idea “what can’t I get my mom to do for me?”), you shouldn’t worry. Here’s why.
Startups that are disruptive tend to upend the existing model not because they’re necessarily better (although they do get better with more time and cash infusion), but because most of the time, they’re more convenient and less expensive.
Think about Starbucks: the coffees/lattes/mochas served at Starbucks are definitely not better than the ones served by, say, a high quality boutique café somewhere in the city. But what Starbucks brings to the table is convenience (it’s everywhere), affordability (compared to the prices that could vary between individual boutique shops) and consistency (yeah, the drinks they serve may not be as great, but at least you know what you’ll be getting, every single time). Because of that, Starbucks has more or less dominated the coffeehouse industry.
Now, during a downturn, people are looking to save money. They want the cheapest product or service that they know will serve them reliably. Does your startup do that?
Uber does that: Uber X is cheaper than most cab rides. Uber X cars are not only nicer and cleaner than most cabs, but its drivers tend to be more polite too (kudos to the rating system; think about how important this can be during a frustrating time like an economic downturn!), which makes Uber’s value proposition all the more advantageous.
Airbnb does that: hotels are expensive, and its prices fluctuate wildly during peak seasons. A traveller can potentially save hundreds, if not more, by renting an apartment on Airbnb (also, as an added bonus, most Airbnbs are much bigger than hotel rooms — for the same price, or even less).
Xiaomi does that: people want the best phone, without the price tag. Xiaomi offers just that: the Mi Note, for example, has build quality and specs that rival Samsung’s Galaxy Note at roughy half the price.
Netflix does that too. I recently watched Hitman in theaters; the ticket cost me $12.15. Netflix, in contrast, offers a ton more movie options and unlimited viewing for less than $8 a month.
In all of the examples above, each company focused on driving down one thing — the one critical thing that everyone thinks about during an economic downturn: the price. Most of them did so without reducing the quality of services/products offered. Now that is real disruption.On the other hand, if your startup does neither of those things, but instead provides a service that’s “nice to have” when money is flush, get ready for winter. Already, we’re starting to see some of these “nice to have” services go under: Homejoy is the one that immediately comes to mind. It’s the quintessential “what can’t I get my mom to do for me?” service. After raising close to $40 million in financing, it imploded because users did not want to pay $85 for the service after its first-time promotional price of $19. The service made cleaning the house more convenient, for sure, but not at a price where users were able to justify the costs. Homejoy targeted the masses, when really, only the ~5% of elites could justify the cost.
There are, of course, still many startups like Homejoy out there. One of them, Instacart, has raised more than $270 million at a $2 billion (!) valuation from several respectable VC firms. That’s great for Instacart… but when crunch time comes, will its current users still want to pay someone to buy their groceries for them when they could do it themselves? What about when Amazon inevitably pours more money into its Fresh project, which offers same-day and early morning deliveries? Will Instacart still be able to retain its users? Now, take this with a few grains of salt, but some investors in Silicon Valley have already begun worrying about Instacart’s finances out loud.
And it’s not just Instacart that may be in deep trouble: GrubHub, Postmates and Seamless’ livelihoods could be threatened after Amazon announced its Flex service just a few days ago. Traditionally, companies either focused on wide-breath but shallow offerings (i.e. Walmart), or short-breath but deep offerings (i.e. Apple). Amazon is the very first company of its kind: it offers a wide-breath of product, but still manages to go deep on every vertical. If Amazon could pull off the development of Fresh and Flex like it did with all of its other projects (and there’s no reason to doubt it), GrubHub, Postmates, Seamless and its ilk of services may, in the best case scenario, be acquired, in the worst case, vaporize. History may not repeat itself, but it sure does rhyme!
(See also: BuzzFeed News’ investigation into WeWork’s shaky finances, where phrases like “profits look less certain when you read the fine print” and “WeLive is expected to supply 21% of the company’s overall revenue by 2018 — even though it has yet to launch” appear way more often than any investor should be comfortable with. The published forecasted revenue and earnings growth is also something to marvel at.)
Of course, there’s still room for optimism: some of the best services which we use today came out of the economic downturn. Facebook, Google (sending Yahoo! into a tailspin), Salesforce (to compete with Oracle), eBay and Netflix (effectively shutting down Blockbuster) all emerged as victors after brutal economic downturns, killing the previously dominant businesses in their industries.
This time around, there will be victors too: products built today that our grandkids may continue to use. But don’t forget how many startups had to die before the smoke cleared, showing a clear picture of the true victors.
To the VCs who are asking for data instead of “anecdotal evidence”:
- What’s the point of comparing the data to previous bubbles when pattern matching is almost completely useless and misleading? (More people are online now than before, global economy has changed drastically, etc.)
- Just because it’s not as bad now as it was in 1999/2000 doesn’t mean that it’s not going to be ugly when the bubble bursts.
- There is, however, one pretty big difference between this bubble and the 1999/2000 bubble: the number of investors proportionate to the number of companies. Back in the 1999/2000, the general public who usually doesn’t care about technology are investing because it made sense to. This time around, however, VCs and investors stand to lose the most since the inflation of the bubble is largely contained within those two sectors.
- How can one be sure that there’s a bubble? It’s quite easy: when products and services — some without even a path to profitability — are valued astronomically almost on a daily basis (the rate at which startups are inflating and deflating to become unicorns — or not — is almost equal). Or when VCs/investors prop up startups with massive amounts of cash because they fit some sort of profile of companies that previously got acquired.
- Data usually makes a lot more sense… in hindsight.
An interesting tangent: Valent’s crash shows that companies with no real economic purpose will fail in the long run. Startups that don’t provide real value can only hide under the covers provided by VCs for so long.