I consult, write, and speak on running better technology businesses (tech firms and IT captives) and the things that make it possible: good governance behaviors (activist investing in IT), what matters most (results, not effort), how we organize (restructure from the technologically abstract to the business concrete), how we execute and manage (replacing industrial with professional), how we plan (debunking the myth of control), and how we pay the bills (capital-intensive financing and budgeting in an agile world). I am increasingly interested in robustness over optimization.

Wednesday, April 27, 2011

The Tech Bubble, Four Months In

Earlier this year, we looked at the boom in the US tech sector and what it means for people running tech businesses and captive IT. Four months later, the tech sector has gained momentum. Buyers and sellers of tech services must deal with rising costs and tighter margins, respectively. This is a function of tech wage inflation (Google's 10% across the board pay increase is indicative of this) and increased recruiting and retention pressures (tech employees offered career advancement with other firms).

This is a far cry from where the tech sector in the US was just 3 years ago, so it's worth looking at the near-term durability of the tech sector bull market.

US corporate spending on tech is at its highest since 2001. This is being driven by extraordinarily high corporate profitability and a surge in US manufacturing. This, in turn, is being fueled by a cheap US currency. Meanwhile, the tech investment frenzy continues, with Silicon Valley venture capital fundraising up 76% in Q1 2011 from a year earlier. The demand for tech is very robust.

There are a number of things on the horizon that might affect this. But are any of them serious threats to tech?

  • QE2 ends in June, but even without a QE3, there is no shortage of liquidity.
    Sufficient liquidity means there's ample high risk and low risk capital, a lot of which will find its way into tech.
  • Interest rates can only go up, but they don't look to be going up soon. For one thing, US inflation is being sanitized by high US unemployment. For another, US house prices remain moribund. An increase in interest rates will chase buyers and create more downward pressure on housing.
  • The US fiscal future is being debated. S&P rattled sabers by issuing a negative outlook for US Treasurys, but the bond market largely ignored it.

What this means is that in the absence of a seismic event, the tech sector bull market does not have to cool off any time soon.

Now, like anything else, tech is a fickle business. Even if all these things turn out to be true, US tech faces its share of risks.

  • A US currency rebound. This could be caused by any number of factors. For example, Greek sovereign default would weigh on the Euro, which could have the effect of driving money into traditional safe haven of US Treasurys, stimulating dollar purchases. The stronger dollar cuts US exports, which cools the US economy.
  • Signs of US inflation or bond market vigilantes cause Fed to increase interest rates. An increase in rates will likely cool business investment, which will slow tech spending.
  • Failure from within the tech sector itself. Those cartoonishly high valuations don't pan out for one reason or another (e.g., eyeballs don't convert to revenue) and we get another round of dot-bombs.
  • Tablet/smartphone revolution fails to live up to it's hype. One critical difference between today's mobile revolution with that of personal computers and the mainframes/minis they displaced was that you can code solutions for a PC on a PC. You can't code solutions for a smartphone on a smartphone. Subserviating the mobile device to the PC could unintentionally impair solution design: by being preventing smartphones from being truly independent devices, their evolution could be stunted. (Which raises the point that perhaps Motorola is onto something with their ATRIX product, but that's another blog post for another day.) Also, tablets are fantastic output devices but they're still not brilliant at input. The point is, if tech underwhelms in the short term - much as home computers failed to live up to their hype in the early 1980s - the tech sector will cool until the capabilities emerge.

Of course, there are many more risks, most of which may not be obvious now but any of which will seem clear as day after the fact.

In the meantime, tech's bull market credentials don't look to be at risk for now. For the tech exec, that means expecting supply constraints and inflation in labor and services to last for some time.