(2020-04-22) When Tailwinds Vanish

John Luttig: When Tailwinds Vanish. The Internet tailwinds that propelled Silicon Valley’s meteoric growth for decades are stalling out. The ripple effects will jolt the tech industry.

In the late 1990s, the tailwinds began when Internet usage surged from a nerdy hobby on the West Coast to a global household necessity

As market tailwinds grew at 20%+ CAGR, the market dynamics shifted so quickly that incumbents couldn’t react, leaving room for startups to emerge. When SaaS spend grew 50% per year, it was hard not to find green pastures as a new software startup. And consumers doubling their Internet spend and smartphone usage simultaneously

assume continued exponential market expansion. But if you look at these supposed tailwinds today, a gloomier picture appears: they are not exponential functions, but logistic functions with plateauing growth rates (s-curves).

Like any mature industry, Silicon Valley must battle to maintain growth in the face of immense economic gravity. For the first time in Internet history, startup growth will require a push from the company and not a pull from the market.

Unlike the organic pull that drove many of the dotcom-era successes, today’s Internet startups need to fight for growth by investing more heavily into sales, marketing, and operations.

Competition: an acceleration of zero-sum games

Software companies founded today are competing less with pen and paper than with other Internet-first incumbents. Put another way, as happens in every maturing industry before it, Internet company revenue will become zero-sum

When there are massive economies of scale – a marketplace or a social network, for example – the blitzscaling approach works well. The first to critical mass wins. Does this strategy still work today?

today, true network effects-driven business models are rarer than ever.

Hiring: a shift from R&D to SG&A

As we experience CAC inflation across industries due to more people bidding on static ad inventory, Internet startups need to invest more into SG&A than ever to maintain growth.

To run a thought exercise: what would happen if you needed to reduce your startup’s operating expenses by 50%?

If Google were to fire half of its employees, there would be large reorgs and engineers would be stretched thin, but the financial outlook would be fine

As an enterprise software company, on the other hand, your growth would slow as you fire AEs, and churn would increase as you shrink your customer success team.

Internet companies have spent the last 20 years capturing opportunities with the highest margins, lowest operational complexity, and strongest market pull: search, social networks, CRMs, ecommerce.

As the Internet growth tailwinds subside, what’s left? Harder problems

This could mean companies with an atoms component, or with a tougher sales process, perhaps stemming from a weaker market need or more robust competition. This often means higher marginal costs to sell and provide services

To pose the inverse of the opex reduction question: if you had an extra million dollars for your startup, where would you spend it?

In the immature Internet era, a consumer Internet company would likely invest this money into R&D by hiring engineers, product managers, or designers

The dominant startups today tell a different story. As a marketplace with a physical component – say, food delivery or ridesharing – you might spend this money on local ops and supply acquisition

Growth: higher SG&A spend means more predictable growth

There is a silver lining: as Internet companies invest more into SG&A, they’ll have a clearer understanding of their growth levers.

For SG&A-heavy companies that dominate today’s startup ecosystem, headcount is now more causal than resultative of growth.

Financial operationalization: Sand Hill Sachs

*As a prospective founder, don’t be scared off by the increasingly zero-sum nature of Silicon Valley. This dynamic presents an opportunity to build the financial layer of tech, similar to what Goldman Sachs did for the rest of corporate America.

What is Goldman Sachs? Goldman is a financial layer on top of corporate America, helping to fuel its growth.*

VCs: take risk on vision, not on numbers

VC dollars should be reserved for R&D, not S&M or G&A.

If new Internet startups are increasingly competing with Internet-first incumbents, what would a promising Internet startup founder look like today? There will certainly always be value in fresh perspectives from industry outsiders. But on a relative basis, founders with 1) experience in growing online businesses, or 2) pre-existing distribution advantages will have a premium that didn’t exist before.

In the 1990s and 2000s, computer science was the dominant major by almost any metric: financial success, career impact, social capital

In a maturing Silicon Valley, what career paths will be rewarded?

We may see a reacceleration in fields like biology or mechanical engineering as we build platforms beyond the Internet.

Perhaps ahead of the curve, many of the CS majors at Stanford no longer want to be engineers. Being a product manager or chief of staff is the new post-college status symbol.

Boris Mann: When tailwinds vanish

When Tailwinds Vanish has been a baseline article that I've shared with a lot of people

I've picked out a bunch of quotes below that fit my thesis of deep tech startups, because that's my interest and preference and the path we're following with Fission.

The focus of this article is on venture funded startups. I think the corollary is that a recurring revenue B2B SaaS startup is more likely to be in a long tail of software small business

This also supports the IndieVC hypothesis.

Jan'2024 Boris Mann: I think more software businesses will be small business (SmallCo, Micro-SaaS) rather than venture fundable... funding deep tech innovations is a hard problem... Things like the Venture Studio have applicability to both deep tech and execution focused businesses.