You notice that flop sweat the tech industry has been in lately? Welcome to the new economic environment.
In November 2021, in response to inflation, the Fed announced it would hike interest rates. It’s not done, either — the Fed has indicated it will continue to hike until enough of us are unemployed. I’m sure the Mr. Burns-steepling-fingers style the Fed is taking is just a coincidence.
This is a big deal because the Federal Reserve has kept interest rates low pretty much since the 2008 financial crisis. Borrowing money is now more expensive than it’s been in over a decade. That means that a lot of investors aren’t being forced to look to stocks for returns — they can invest in bonds or treasuries instead. And that changes some things for the tech industry, which boomed in the low interest rate environment.
Some of the changes we’re seeing aren’t just because of interest rates. Most tech companies are heavily reliant on advertising — and ad budgets are shrinking because it seems like no one really knows what’s going on with the economy. But low interest rates were a crucial part of what shaped the industry for the last decade.
How low interest rates made the VC-driven tech boom happen
While interest rates were low, it was dead simple for venture capitalists to raise money. Firms such as SoftBank and Andreessen Horowitz amassed mega funds. Companies like Uber could afford to bleed cash in the hopes of driving competitors out of the market. This strategy, known as blitzscaling, was made possible by this era of easy money. Adam Neumann’s tequila-soaked, hotboxed tenure at WeWork was also a product of this era, as was WeWork’s investment in a company that makes wave pools.
VCs will doubtless be riding companies’ management to spend less money
WeWork could successfully masquerade as a tech company because a lot of people had a mandate to invest in tech while the interest rates were low. Car service? No it isn’t; it’s got an app. Mattress company? No it isn’t; it’s tech because it’s direct-to-consumer sales! Subscription food service? No, it’s tech because, um, because it advertises on Instagram?
VCs expect to get a 3x return on their investment portfolio, says Robert Eric Siegel, a lecturer in management at the Stanford Graduate School of Business. So if you have a billion-dollar fund, you gotta return $3 billion. And because most startups fail, a couple have to really succeed, giving the VC a bonanza exit. That’s much harder now!
So VCs will doubtless be riding companies’ management to spend less money. Blitzscaling is probably out. There will probably be some failures, though obviously not every startup will fail, says Itay Goldstein, a professor of finance at Wharton. “Once investors are not putting in new money, then all startups will have a harder time surviving,” he says. “You’re going to see some firms going out of business and some funds closing, and so on. Hopefully it won’t be as bad as people fear, but I think you will see some of this downtown.”
What happens when corporate debt becomes expensive
Because borrowing was cheap, companies such as Netflix, Tesla, and Dell were able to take out massive debt. As of its fourth quarter earnings, Netflix had $14 billion in gross debt; the company made sure to reassure its investors that that was fixed rate, so it wouldn’t suddenly have to pay even more money back.
Netflix took out that debt to supercharge its streaming strategy, pumping out original content and pivoting its business from DVDs in the mail to original shows. That was necessary to enter the streaming wars — because when Netflix was borrowing, it couldn’t pay for its business expenses and new content. The strategy allowed it to race out ahead while Hollywood lagged behind, but in 2021, the company said it would no longer take on more debt.
Currently, the company is focused on maximizing its revenue, which explains why there’s now an ad-funded version of a Netflix subscription. It also explains why Netflix is cracking down on password sharing: it desperately needs more free cash flow, says Charles Kane, a senior lecturer at MIT Sloan.
What the high interest rate future looks like for consumers
So what does this mean for you, the average consumer? Other companies will be trying to maximize their profits, just like Netflix is doing — and you’ll probably start to notice. Maybe that’ll look like more interstitial ads or maybe audio or video quality will drop. Maybe you’ll start seeing a lot of weird little money grabs in the form of pop-ups.
With fewer people interested in speculation, the question becomes what else cryptocurrency is good for
A lot of businesses were born during this period of low interest rates, and they may be in for a rocky adjustment. The cryptocurrency world, for instance, was a reaction to 2008 and has never existed in a normal interest rate environment. Now that investors have more options for returns, will as many of them be interested in crypto? The creator economy, where people built businesses based on YouTube advertising or Instagram sponsorships — where will that go?
It depends on how valuable those things actually are, Siegel says. Crypto was often a way for people to engage in rampant speculation. Julian Wadsworth, a cultural critic who also goes by Lil Internet, described his “sincere autofictional” experience of cryptocurrency trading in a podcast episode for New Models. In it, he described “pumponomics”: where the details were not as important as the emotion. (In fact, a detailed project that was underway was less likely to pump because it was possible to some extent to determine its value.) Now, with fewer people interested in speculation, the question becomes what else cryptocurrency is good for.
The creator economy, much like the tech industry at large, is heavily reliant on ad rates. That may mean your favorite creators will ask for subscription-type revenue more frequently as ad rates drop. It may mean some people leave the creator economy altogether. It’s also possible that creators may benefit from changes in advertising budgets — since they’re likely to be cheaper than TV ads, for instance.
The change in the economy isn’t going to destroy the tech sector — after all, Apple, Google, and Amazon were all born in periods of normal interest rates. But it will probably change things for the people who work there. Less VC money makes startups less attractive places to work. And as consumer spending tightens up, there may be less of a market for gadgets — particularly if the Fed gets its wish and more people are unemployed.
Meanwhile, VCs have started flogging the idea that AI can replace people, doing their jobs more cheaply. Cost reductions are hip in the new economy, and maybe some companies will even buy into it. But having been on the phone with CVS Pharmacy’s auto-refill system, I think I know how it will go: a worse customer experience; fewer cost savings than companies had hoped; and a lot of broken dreams. I mean, just ask CNET: the future is unevenly distributed, and it’s experienced the crash after the hype already.