The Shape of Bubbles – The Madding Crowd

I posted earlier in the week about my guesses as to how things shake up if (when) the current tech cycle bursts (like a Bubble). And I realized I had forgotten a key component of how things will fall apart once the business cycle turns. I remember this theme from the 1990’s Bubble, and it seemed so obvious in hindsight, but no one seemed to write it until after things had gotten bad. So I want to stake some ground here in the fortune telling business.

One of the key problems with inflationary periods of business cycles is that there is a lot of easy money floating around. This lets entrepreneurs take risks, but it also greatly lowers the barriers to competition. This results in too many companies chasing the same market.

Currently, many start-ups are in ‘investment mode’. They are burning cash today, in order to build a better business tomorrow. Some are trying to build up market share, or seed a market to reach critical mass, there are lots of examples. This is a sound strategy, but the problem is that it is a sound strategy for lots of competitors. When capital is cheap, as it is today, it can be very hard to determine if a business is burning cash because it is ‘investing’ so heavily or if it is stuck in an market with unsustainable economics.

Let me give an example to make this tangible – on-demand meal service. We use Munchery at home, and have really liked their model of delivering meals to our house in under an hour. They are reportedly raising $85 million. The problem is that almost every time I open Twitter I see a coupon for a competitive service. The same is true of  laundry pick-up services, toy-delivery services and many others. There is just not enough room for all of these in any city. We saw the same phenomenon in the 1990’s with a similar sector – urban delivery services, and there are plenty of other crowded fields.

Just to be clear, I do not mean to criticize the management team of Munchery or any of the others. Now is the time to spend money to build market share. There will be a shakeout someday and only one of them will survive. My point here is just that it can be very hard to remember this when the times are good. It is very hard to determine when things will turn bad and just who will survive. There is some strange version of the Prisoner’s Dilemma at work here – everyone is acting rationally but almost everyone will lose in the end.

For those of you who follow the public markets, you can already start to see this analysis working its way through the digital advertising stocks. Many investors want to short Internet stocks. They argue that the combined market cap of Facebook, Google and Amazon already exceeds the total market for advertising, The bears argue that advertising is ultimately a zero-sum game, and you cannot have all these stocks maintain their valuation indefinitely. The bitter irony is that none of the shorts can agree on who is overvalued. Facebook? Google? Apple? Amazon? Some company we have never heard of that is going to become tomorrow’s Unicorn? (While we are on the subject of easy capital leading to too many market entrants, has anyone noticed how many hedge funds there are out there…)

In the end, when the money spigot gets shut off, there will be a fair amount of suffering to go around. One of the biggest multipliers of that suffering will be the extent to which certain markets are over-saturated. Many of the companies in those spaces will have to shut down, and their employees will not be able to bolt to the competition because the competition has shut down too. Support staff will get hit as entire job categories disappear, and we will find odd pockets of pain distributed in unexpected places.

Today all of these look like healthy companies, but someday we will stop measuring the success of a company by ‘growth’ and then have to redefine what a healthy company looks like.

This does not have to be a tragedy or a disaster, just a reversion to the mean of business cycles.

3 responses to “The Shape of Bubbles – The Madding Crowd

  1. Well said. Do any of these seem like online pet food? I agree, the world (or San Francisco) only needs so many food delivery services. Also somewhat lament the amount of venture money flooding into services that remove daily life frictions, but don’t seem to create step function advances in technology or new business categories. Farhad Manjoo had a good article about this. Having said that, which would you invest in? Switchgrass or on-demand food delivery?

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