We live in a reactionary world. As is typical in the deflation of an asset bubble, we see the usual Hollywood stories unfold – weird-haired guys running multi-billion dollar cryptocurrency frauds in the Bahamas, megalomaniac billionaires laying off thousands in an attempt to save failing companies, and recent IPOs losing 70% of their value.
Strong innovation trends are often accompanied by investment bubbles. It’s part of human nature. But when the tide goes out and things get real, that doesn’t mean the innovation stops. It simply means, as Warren Buffett says, “You see who’s naked when the tide goes out.”
Try not to read too much of today’s news. These types of dramas are typical in the aftermath of valuation bubbles that occur when central banks feed entrepreneurs free and easy money. As in 1999, the cloud technology bubble will dissipate over time and innovation will resume. And as growth and investment pick up, the cloud will once again be front and center as companies around the world are still in the early stages of modernizing their businesses.
Traffic and buffets are back
We have been through a few years of unprecedented twists and there have been some clear messages: companies need to pursue their modernization projects as well as diversify their supply chains. The pandemic crisis, followed by the printing of trillions of dollars in stimulus, was complicated by Russia’s invasion of Ukraine and the subsequent geopolitical and economic consequences of an energy crisis. All of these factors have shaken up interest rates, supply chains and the global economy.
The good news is that parts of the world, including Silicon Valley, are returning to some semblance of normality after the pandemic shutdowns.
After spending the last week visiting friends and contacts in Silicon Valley. Traffic was back on the roads and there were traffic jams. I’ve been to work lunches where people chatted over kebab buffets and talked excitedly about building the future.
I came away with the following outlook: things are pretty normal and people are optimistic. That’s the magic of Silicon Valley: optimism and innovation under the Californian sun.
Of course, I haven’t seen Sam Bankman-Fried or met Elon Musk. Apparently they were busy.
All things considered, we should be thankful that the unemployment rate is only 4% and most people still have jobs. To me, it’s remarkable that the economy is as healthy as it is.
As things realign, I have come to some major conclusions about the global economy:
- The economy is returning to normal as interest rates are rationalized, which is why it seems painful. After all, Treasury rates have always been closer to 5% than 0%. As long as the pace of interest rate increases slows and inflation begins to subside, the modern economy should be able to absorb these shocks. And as the world moves away from authoritarian risks, we may have learned that more businesses should be paying decent wages rather than depending on sweatshop labor.
- With technologies seeking to diversify their supply chains, organizations will reduce risks from geopolitically unstable or unpredictable regions such as Russia or China. This will lead to more offshoring or near-offshoring – but after all, it should result in a more resilient supply chain.
- The pandemic has woken up boards around the world – organizations realized they weren’t nimble enough to respond to the crisis. They have no choice but to pursue these investments no matter what Sam Bankman-Fried does with Tom and Gisele’s money.
Nobody said it was easy. In 2000 the internet and telecom bubble burst and people like Bernie Ebbers and Jeff Skilling went to jail. But Amazon is now one of the five most valuable companies in the world. Capitalism is a messy business.
The cloud will survive
I confess that I am not a crypto hipster. I always hang around with old-school technology and infrastructure builders who point out that we are still in the early stages of a digital transformation. They are more likely to talk about open source network protocols and Terraform than FTX.
One of the lessons of the pandemic is that most businesses were still stuck in analog mode. They need to modernize and digitize. This precipitates new thinking about digital transformations, as we will demonstrate in a few examples below with Walmart and Chipotle.
Walmart is considered by many to be a low-end retail brand, but it’s actually one of the most digitally sophisticated retailers on the planet. It has built its own private hybrid data cloud that processes petabytes of data per hour. In just one example, he uses his cloud to process up to 40 petabytes per week of sales data to examine trends.
Chipotle is one of the leading fast food chains with strong popularity among young people. The pandemic has prompted the company to move into the cloud, where it is among the most successful in digital ordering and delivery. The company processes 98% of its workloads in the cloud, according to CTO Curt Garner.
The fact that FTX has crashed and mortgage rates are at 7% means absolutely nothing to a company pursuing a long-term digital transformation strategy. These plans are in place and will take years to complete. Real-time analytics, automated supply chains, and customer experience are long-term investments that need to be made.
“Economic factors are slowing metrics like capital and valuations in the tech industry, but they haven’t slowed the migration of mission-critical applications and workloads to the cloud,” Steve Mullaney, president, wrote to me. and CEO of Aviatrix. when I asked him about the economic climate. “A few years ago, enterprises made the all-inclusive decision to go cloud-based and are now adding scalable and business-critical applications such as SAP S/4HANA to the cloud. The train left the station on the cloud, and the technological slowdown is accelerating this movement.”
I heard similar comments on a trip last week. A technology customer told me about a healthcare customer who needed to quickly implement a more secure, cloud-based networking system to exchange data with their partners, e.g. radiologists, to replace file transfers using obsolete technologies such as messaging!
Here is some additional data from recent revenue calls in the digital cloud space:
- Snowflake, a poster child for overpriced IPOs, continues to push forward on the corporate side, riding the digital wave. In its latest results, it reported 83% year-on-year growth. The stock price has gone down but the growth is still there.
- Confluent said its cloud revenue grew 112% year-over-year (y/y) to $57 million.
- Datadog’s revenue increased 61% year-over-year. CEO and co-founder Olivier Pomel attributed the results to “strong adoption of our products and strong opportunities with new customers.” Datadog is now profitable, earning $74.8 million in the third quarter on a non-GAAP basis.
- GitHub’s Octovere report (GitHub is owned by Microsoft) recently reported that 97% of products use some form of open source product. There are 94 million developers on GitHub, with 94% of Fortune 500 companies using the platform.
These growth numbers show that innovation is alive and well, despite what you might see on your investment statement or read in the newspapers. Whether Snowflake is worth $100 billion or $10 billion is up to the stock market bettors to debate. The thing is, the company is still in the early stages of its evolution, as it provides cutting-edge data tools for digital transformation.
Figures from GitHub show that Fortune 500 companies are accelerating, rather than receding, their digital transformation efforts by committing more development resources to the system.
Much of the correction in cloud tech growth stocks is not so much a projection of future prospects as a reflection of the excess valuations created by artificially low interest rates. It was a similar bubble but less extreme than in 1999-2000. As 1999 and 2021 have both taught us, you should never confuse valuation bubbles with projections about the future of technology. Speculation is part of the process. Cloud technology and many companies that provide the key building blocks have a bright future. The cloud is building another Amazon right now.