David Magerman
The global economic and political turmoil of the past year has had a meaningful impact on corporate innovation in the technology industry and beyond.
The worldwide battle with COVID, the Ukraine-Russia conflict and the economic fallout of the COVID lockdowns and supply chain disruptions have together created a painful combination of a global recession, global inflation and unpredictable instability in the worldwide economy.
All of these factors have led to belt-tightening in the corporate world, layoffs and hiring freezes and a more conservative investment posture from the investment community. Inevitably, these changes will have a chilling effect on innovation in the years to come.
However, there is perhaps a silver lining when it comes to the prospects for innovation. In some ways, these market forces might actually serve as an accelerant for creativity and advancement in technology.
Short-term impacts
In the short term, the impact of these negative economic trends and the political instability will be felt by the centers of innovation in both the corporate and startup worlds.
Corporations are likely to slash spending on internal and external innovation. That is, they will reduce their research and development budgets and likely focus R&D on projects that can have immediate impacts on profitability at the expense of long-term visionary projects.
Corporations will also spend less on collaborations with other innovators and expensive acquisitions of advanced technology. We expect to see more acquisitions of early-stage companies as they become weaker and corporations look to develop new technologies more cheaply by buying at a discount rather than building from scratch.
Overall, we expect corporations to be more frugal.
In the startup world, mid- and late-stage startups will see disruptions in revenue growth, which in some cases may lead to retrenchment and failure. We are already seeing venture funds raising the minimum revenue metrics for raising Series A, Series B and beyond.
Startups that were expecting to raise fresh money on non-economic metrics like downloads and social media impressions are finding the markets dry. They are faced with either raising money on distressed terms or exploring the M&A markets prematurely.
Startups who raised capital recently are slowing their burn rates and extending their runways. Early-stage startups will need to slow growth plans to survive the winter, which could lead to slowdowns in the pipeline for meaningful technological innovations.
Long-term impacts
While all this sounds like gloom and doom, we think there is a real silver lining in all of these clouds.
Weak startups will fail, but that’s how capitalism is supposed to work, and that’s how the venture industry functioned until the past few years too. However, strong startups will survive, and the absence of the failed companies will leave more market share available for the remaining players.
Labor costs and the lack of qualified candidates have significantly increased the costs of staffing pre-revenue startups, increasing their burn rates at the earliest stages, when cash is most critical. Layoffs will improve the employment market for startups and reduce the high cost of technical talent.
It’s true that companies don’t always lay off their best and brightest first. Nonetheless, talented engineers will be looking for work, and startups will benefit from the availability of experienced talent.
In addition, some of the greatest innovators at big corporations will react to the diminished R&D efforts by branching out on their own to bring their ideas to market. We’ve already seen a spike in companies founded by engineers who formerly held senior roles at the biggest tech companies.
Finally, in the past few years, there has been a lot of groupthink and stagnation in innovation around a narrow set of areas (e.g., data science, AI/ML, cloud infrastructure, blockchain/crypto, etc.). Those markets are flooded with solutions with similar capabilities and little differentiation.
Entrepreneurs looking to be the founders of the next unicorn are going to have to search for more differentiated solutions to harder problems, like quantum computing technology, photonic technology, more practical applications of AI and automation, and scalable edge computing.
Recommendations
In order to respond to these market conditions and thrive in this new environment, we recommend the following steps.
Startup founders: Rethink your plans from first principles
Raise money at a more modest initial valuation and plan to spend it slower as you build your founding team, develop your product and find product-market fit.
Do more research on which problems are mission-critical for prospective customers, and make sure your solutions are need-to-haves and not want-to-haves.
Lastly, make sure you are doing something truly original and not just jumping on a well-populated bandwagon.
Venture investors: Recalibrate your valuation methodology and diligence process
The companies we had to invest in over the past few years at inflated valuations, in order to be in the market at all, are no longer viable. Refine your focus to companies with founders who have the discipline to ride out unpredictable market conditions.
While we used to tell founders to plan for 18 months of runway, we should now encourage them to plan for 24 months or more in the event they need to stretch before they raise money again.
Corporations: Look for bargains
Good and great technologies are at the core of some of the companies that are failing because of bad timing or lack of fiscal discipline. Those technologies might still be incredibly valuable, and they might match with projects in your technical R&D roadmap.
In this climate, it might be easier to buy and integrate, as opposed to trying to build from scratch.
As with most economic crises, this one will also lead to meaningful economic opportunities. We don’t know when the crisis will end, when the markets will stabilize or when the opportunities will fully reveal themselves. That is why now is the time to be cautious, opportunistic and prepared to pounce when the turn-around begins.
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