A Potential Silver Lining from Recent Tech Layoffs

We have all seen the headlines of large technology companies announcing layoffs or hiring freezes recently. Facebook released 11,000 employees earlier in November. Amazon laid off about 10,000 employees and has instituted a hiring freeze in its AWS division. Google introduced a brief hiring freeze in August and has slowed incremental hiring since then, lowering the number of open positions significantly. Even SaaS stalwart Salesforce reduced staff by several hundred employees. And long time networking leader Cisco is cutting 5% of its workforce or 1,500 employees.

Technology companies outside of Silicon Valley have been impacted as well. Stripe laid off 14% of its workforce, affecting about 1,120 out of 8,000 total. They attributed the reason to being overly optimistic about the Internet economy’s near term growth. Their CEO emphasized the need to improve operational efficiencies and to reduce coordination costs across the organization. This posture extended to other companies in the once hot FinTech space, with Brex cutting 11% of its workforce and Chime reducing by 12%. Real estate platforms have been affected as well. Opendoor laid off 18% of its workforce or about 550 employees, while Redfin laid off 13% or 862 employees.

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The once hot crypto market hasn’t been spared either, with a number of exchanges, consumer services and Web3 plays pausing hiring, or even declaring bankruptcy. Beyond the FTX debacle, Dapper Labs, Digital Currency Group and Galaxy Digital all reduced their workforce by up to 20%. Over the summer, Coinbase implemented a cost-cutting plan that impacted 1,100 employees. Other exchanges BlockFi, Crypto.com and Gemini eliminated between 5% to 20% of their workforce.

The biggest difference between layoffs in 2020 versus layoffs in 2022 is cash, potentially a lifeline. Startups raised massive amounts of capital thanks to larger average deal sizes over the past two years; meaning that some of the capital that was once used to sweeten benefits or candidates’ offers may be pivoting to runway.

Techcrunch, May 2022

For companies at the early stage, VC funding has slowed down as well. Start-ups are still getting funded, but not at the frenzied pace that we saw in 2021. According to Crunchbase, venture funding for Q3 2022 was $81B. While that sounds like a lot, it is down $90B or 53% as compared to a year ago, and by $40B or 33% sequentially from Q2. And Q4 doesn’t look much better.

For those private companies that have runway, they are implementing more conservative growth strategies, in order to reduce cash burn and extend their current capital. This has often translated into less hiring. Crypto start-ups are impacted in this arena as well, even reversing the public exodus in 2021 from Web 2.0 companies into Web 3.0. Investors will recall how the mania around crypto reached such proportions that veterans from Silicon Valley’s largest technology companies were publicly jumping ship to join crypto start-ups. As a couple of examples from last year, the CFO of Lyft resigned to join OpenSea. A VP at AWS left to join Unstoppable Domains, which sells blockchain-based domain names.

The poaching from established technology companies became so prolific that the Web 2.0 leaders introduced incentives to retain their staff. These included salary raises, bonuses and additional stock grants. A NY Times article described how Google made retention a C-level initiative and proactively offered new stock grants to retain employees in critical functions.

Crypto’s allure has been so irresistible that some of the biggest tech companies are scrambling to retain employees. At Google, concerns about keeping employees — including not losing them to crypto companies — grew so pressing that the issue became part of the executive agenda discussed every Monday by Sundar Pichai, the company’s chief executive, and his top deputies, two people with knowledge of the discussions said. Google also started offering additional stock grants to employees in parts of the company that seemed ripe for poaching, these people said.

NY Times article, December 2021

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Implications Going Forward

While lay-offs are painful for those affected and the crypto implosion has seriously impacted some investors, there is a silver lining. As the exuberance of 2021 meets the economic reality of 2022, the intense battles for talent will calm down. We will see less inflated compensation packages and SBC grants should moderate. Companies who are still hiring will avoid the frenzied competition for talent from 2021 and can sidestep bidding wars (if they occur at all).

As an example, employees laid off from crypto companies are finding positions in traditional finance, which are looking to slowly build up their own blockchain-based services. Also, employees are returning to the Web 2.0 technology companies that they previously left. A Bloomberg article from September provided a few examples and quoted a recruiter who said that “Salary bidding wars between firms have calmed down a little”. I imagine with the FTX implosion the exodus has increased and bidding wars have calmed down a lot more.

Additionally, expectations from employees for generous compensation packages and a bevy of perks will be dampened. We are already witnessing a bit of a backlash against employee expectations for largesse in office freebies at tech companies. The move to remote work started alleviating this. If employees aren’t in the office as frequently, then the need to provide unlimited snacks, drinks, meals, dry cleaning, massages and all kinds of other expense is reduced. In an environment where supply and demand of tech labor are a little more balanced, companies won’t feel as much pressure to match the perks of the other company down the street. Personally, I recall having to compare the state of our company’s meal programs, commuting allowances and subsidizing of various wellness memberships in order to attract and retain employees.

Why am I harping on all this? Because this rebalancing of the tech labor force stands to reduce costs for the industry going forward. For most software companies, these personnel expenses make up the majority of operating costs. If salaries normalize or even recede a little, it can have a big impact on operating margin. Similarly, growth in SBC as percent of revenue will come back down to earth. Companies will feel less pressure to stretch compensation packages to compete with other start-ups in their space. They won’t need to proactively goose the compensation of top engineers and salespeople for fear of poaching from crypto companies or start-ups flush with money from VC’s or token offerings.

While a lot has been made of the lay-offs and hiring freezes at FAANG in particular, I view this as a breath of fresh air. The tech behemoths were the worst offenders in creating cushy compensation packages and limitless perks, setting a high bar for the rest of the technology companies to match. The absurdity reached a crescendo with the widely viewed “day in the life” TikTok videos, including an example from a product manager at Meta. This provided ample ammunition for investors to press Meta to take a serious look at their expenses and rapid hiring over the past two years.

It is a poorly kept secret in Silicon Valley that companies ranging from Google to Meta to Twitter to Uber could achieve similar levels of revenue with far fewer people,” Gerstner contended. “I would take it a step further and argue that these incredible companies would run even better and more efficiently without the layers and lethargy that comes with this extreme rate of employee expansion.

Altimeter CEO, Brad Gerstner

Personally, I am happy to see the big tech companies lambasted for their wasteful moonshots and inflated compensation packages. These sucked the labor oxygen out of the market for many years and increased costs for smaller software companies trying to grow profitably.

Take-aways for Investors

To bring this back to investing, most of the companies in the software infrastructure space that I cover are still hiring. Even if they have slowed hiring, they need to retain the employees they have, without doling out additional stock grants, retention bonuses or other perks like paid sabbaticals. The release of talent from the larger tech companies, crypto firms and start-ups is creating a substantial hiring pool. While it’s helpful to have many candidates to pick from, I think the bigger benefit will be in expectations for compensation. Costs will always be high for tech talent, but I think the extreme compensation packages and public bidding wars will recede for now.

Additionally, when fewer private companies are going public or turning into unicorns, pressure to maximize SBC grants is released. During industry downturns, employees put less value on the SBC grant, usually asking for a bit more salary or just ignoring that component. This is a natural outcome when fewer of their peers are bragging about cashing out IPO stock options. As the industry doesn’t have uniform standards for stock grants or pay, levels in a competitive environment are often set by “what my friend at xyz start-up got”.

And, gripes about perks will diminish. In a tough economic environment, employees won’t demand that the company provide all their high-end, niche beverages for free. Water, coffee and tea will be deemed as acceptable. Vending machines may even make a come back. In my own personal experience, I remember having to suddenly purchase sodas out of a vending machine at a new job in 2005 after having an unlimited supply for free in 1999-2000. How ever it plays out, companies should be able to cut back on the extras that don’t really benefit employee productivity.

While the economy has contributed to most of this, the industry culture is shifting as well. Say what you will about Elon Musk’s take-over of Twitter, he has rooted out a lot of waste, including giving visibility to the claim that free lunches were costing Twitter $400 per employee. While this observation may have been exaggerated, the point hit home. Twitter is already cutting back on the types of food served and moving to an employee paid model. While the pendulum of employee perks swung to the extreme over the last 10 years, I think we will see it swing back a bit as companies get employees focused on leaner operations, reducing costs and productivity.

And, of course, companies want to retain the talent they have. A looser job market for tech talent helps. With lay-offs usually targeting the employees with lower tenure, job hopping should slow down. With fewer prospects and less poaching by recruiters, employees are more likely to stay in a role for longer. Employee churn is very costly for software companies, requiring additional recruiting and training costs, in addition to the loss of tribal knowledge. As churn decreases, it will also contribute to operational efficiency.

We are already seeing the impact, as one Bloomberg article shares. Employees have been quickly rattled by accelerating lay-offs at various tech companies. Late in 2021 and into the first part of 2022, workers felt comfortable job-hopping for better salaries and benefits. Now, those same employees are staying put.

People are going to hire through this, but it’s not going to be quite as much as a candidate market as it was in 2021.

Peter Walker, head of insights at Carta

As these trends play out over the next year or two, they should provide a tailwind to operating margins for software companies where employee compensation and support costs make up a large percentage of operating expense. This could provide a bit of relief for profitability even as growth is pressured by the macro environment.

NOTE: This article does not represent investment advice and is solely the author’s opinion for managing his own investment portfolio. Readers are expected to perform their own due diligence before making investment decisions. Please see the Disclaimer for more detail.