The high-tech industry is getting a reality check - which is a good thing
Forget about Teslas in the parking lot, fancy parties and inflated valuations. Reality is forcing the high-tech industry to shift its focus from growth to profitability, giving rise to a stronger sector across the board.
Lately investors in the high-tech industry have been asking companies for one thing: to face reality. Or in other words: "Stop growing, start talking about profitability."
After five years of upsurges, including two years (2020-2021) of wild peaks in the amount of money entering the industry as well as in capital raising and IPOs, the picture has shifted dramatically. With the shift, companies and startups need to make significant behavioral changes at multiple levels.
1. The product level. Unlike in the past, companies today have to present a profitable product. To this end we need to talk about unit economics, an important metric representing the profit from a single user over the customer lifespan, versus the amount invested to obtain that user. In this new situation, companies have to show positive unit economics, meaning that profit exceeds the amount raised. If negative unit economics was once common, back when the focus was on company and product growth, today it’s forbidden to even mention it.
2. The company level. Companies themselves need to reach profitability, too. When unit economics is positive, the road to profitability is shorter. When it’s negative, the path to profitability simply doesn’t exist. On the contrary, the more product the company sells, the more it will lose. Sound strange? It happens a lot when companies try to grow and enter the market at any cost, while actually bleeding money. So yes, it’s important to expand market share, but only through positive transactions.
How is that done? Companies with a product need to analyze the market and run a campaign with a positive outcome, and not at any price. They need to use their marketing budget properly and to focus on certain geographical areas without dispersing. It’s important to remember that each entry into a new geographical area costs a lot of money. In addition, they need to re-examine their business model, so it fits the product, while being based on the market and its customers – with the goal of achieving a profitable model. This is done by cross-selling: offering additional company products, extending partnerships and more to existing customers.
3. The budget level. Companies have to tighten their budget. Yes, it’s also about what you see on those WebOS skits from Eretz Nehederet: talking about vision without a product, throwing flashy parties with investors' money and giving employees extravagant perks (in short, they were dead-on). So yes, companies still have to fight for quality people, but they shouldn’t overdo it. Each company has to carefully examine its workforce and decide how much it really needs. This doesn't necessarily mean layoffs, but it does mean less hiring, less partying and fewer glitzy vacations.
4. The customer level. Development of the next product brings doubt. Companies understand that products have to be developed from profits, not from investor funds. If the product is selling well and the company is at a loss, it needs to carefully consider whether to hold the product and the people around it. It needs to focus on what works. This can lead to significant operational savings, which is exactly what happens in Amazon, Wix and Tesla. Wix, for example, has 200 million users, but only 5.5 million of them (about 2.7%) are paying customers. So Wix's goal is not to add users, but to turn existing customers into paying ones.
On the ground, companies are currently fundraising at levels reminiscent of 2018, before the peak. This means that their valuations are declining – and sharply. Many companies that, at the peak, conducted early-stage fundraising according to a high valuation will find it very hard to raise at similar or higher valuations in the next stages, and will have to settle for lower funding.
And what about investors? Some of them will continue with their current portfolios, focusing mainly on the companies in which they’re already invested, and some will keep looking for investment opportunities in new companies.
The bottom line is that the new situation forces the entire industry to focus. Until now, the high-tech industry wasn’t focusing, simply because no one made it. It was possible to recruit and develop endlessly – and everything went out of balance. The new situation is very good. Whoever survives the new reality will end up stronger, with a better product and better finances. The Israeli market will also benefit from better and stronger companies that know how to orient themselves toward profitability, and from fewer unprofitable companies at unreasonable valuations.
Aviad Sorek is CEO and Co-Founder of Peak Ventures.