Representative image
Representative image

Tech pitfalls: Years of easy money yield to hard times

Rock-bottom rates were the secret engine fuelling $1 bn start-ups and virtual attempts to conquer the physical world. In 2023, reality bites.

NEW YORK: Eighteen months ago, the online used car retailer Carvana had such great prospects that it was worth $80 billion. Now it is valued at less than $1.5 billion, a 98 percent plunge, and is struggling to survive.

Many other tech companies are also seeing their fortunes reverse and their dreams dim.

They are shedding employees, cutting back, watching their financial valuations shrivel — even as the larger economy chugs along with a low unemployment rate and a 3.2 percent annualized growth rate in the third quarter.

One largely unacknowledged explanation: An unprecedented era of rock-bottom interest rates has abruptly ended. Money is no longer virtually free.

For over a decade, investors desperate for returns sent their money to Silicon Valley, which pumped it into a wide range of start-ups that might not have received a nod in less heady times.

Extreme valuations made it easy to issue stock or take on loans to expand aggressively or to offer sweet deals to potential customers that quickly boosted market share.

It was a boom that seemed as if it would never end. Tech piled up victories, and its competitors wilted. Carvana built dozens of flashy car “vending machines” across the country, marketed itself relentlessly and offered very attractive prices for trade-ins.

“The whole tech industry of the last 15 years was built by cheap money,” said Sam Abuelsamid, principal analyst with Guidehouse Insights. “Now they’re getting hit by a new reality, and they will pay the price.”

Cheap money funded many of the acquisitions that substitute for organic growth in tech.

Two years ago, as the pandemic raged and many office workers were confined to their homes, Salesforce bought the office communications tool Slack for $28 billion, a sum that some analysts thought was too high. Salesforce borrowed $10 billion to do the deal.

This month, it said it was cutting 8,000 people, about 10 percent of its staff, many of them at Slack. Even the biggest tech companies are affected.

Amazon was willing to lose money for years to acquire new customers. It is taking a different approach these days, laying off 18,000 office workers and shuttering operations that are not financially viable.

Carvana, like many start-ups, pulled a page out of Amazon’s old playbook, trying to get big fast. Used cars, it believed, were a highly fragmented market ripe for reinvention, just the way taxis, bookstores and hotels had been. It strove to outdistance any competition.

The company, based in Tempe, Ariz., wanted to replace traditional dealers with, Carvana said grandly, “technology and exceptional customer service.”

In what seemed to symbolize the death of the old way of doing things, it paid $22 million for a six-acre site in San Diego that a Mazda dealer had occupied since 1965.

Where traditional dealerships were literally flat, Carvana built multistory car vending machines that became memorable local landmarks. Customers picked up their cars at these towers, which now total 33.

A corporate video of the building of one vending machine has over four million views on YouTube.

In the third quarter of 2021, Carvana delivered 110,000 cars to customers, up 74 percent from 2020. The goal: two million cars a year, which would make it by far the largest used car retailer.

Then, even more quickly than the company grew, it fell apart. When used car sales rose more than 25 percent in the first year of the pandemic, that created a supply problem: Carvana needed many more vehicles. It acquired a car auction company for $2.2 billion and took on even more debt at a premium interest rate. And it paid customers handsomely for cars.

But as the pandemic waned and interest rates began to rise, sales slowed. Carvana, which declined to comment for this article, did a round of layoffs in May and another in November.

Its chief executive, Ernie Garcia, blamed the higher cost of financing, saying, “We failed to accurately predict how all this will play out.” Some competitors are even worse off.

Vroom, a Houston company, has seen its stock fall to $1 from $65 in mid-2020. Over the past year, it has dismissed half of its employees.

“High rates are painful for almost everyone, but they are particularly painful for Silicon Valley,” said Kairong Xiao, an associate professor of finance at Columbia Business School.

“I expect more layoffs and investment cuts unless the Fed reverses its tightening.” At the moment, there is little likelihood of that.

The market expects two more rate increases by the Federal Reserve this year, to at least 5 percent.

The easy money era had been well established when Amazon decided it had mastered e-commerce enough to take on the physical world. Its plans to expand into bookstores was a rumour for years and finally happened in 2015. The media went wild.

According to one well-circulated story, the retailer planned to open as many as 400 bookstores.

The company’s idea was that the stores would function as extensions of its online operation.

Reader reviews would guide the potential buyer. Titles were displayed face out, so there were only 6,000 of them. The stores were showrooms for Amazon’s electronics.

Being a showroom for the internet is expensive. Amazon had to hire booksellers and lease storefronts in popular areas. And letting enthusiastic reviews be one of the selection criteria meant stocking self-published titles, some of which were pumped up with reviews by the authors’ friends. These were not books that readers wanted.

Amazon likes to try new things, and that costs money. It took on another $10 billion of long-term debt in the first nine months of the year at a higher rate of interest than it was paying two years ago.

This month, it said it was borrowing $8 billion more. Its stock market valuation has shrunk by about a trillion dollars.

The retailer closed 68 stores last March, including not only bookstores but also pop-ups and so-called four-star stores.

It continues to operate its Whole Foods grocery subsidiary, which has 500 U.S. locations, and other food stores.

Amazon said in a statement that it was “committed to building great, long-term physical retail experiences and technologies.”

Traditional book selling, where expectations are modest, may have an easier path now. Barnes & Noble, the bricks-and-mortar chain recently deemed all but dead, has moved into two former Amazon locations in Massachusetts, putting about 20,000 titles into each.

The chain said the stores were doing “very well.”

It is scouting other former Amazon locations. “Amazon did a very different bookstore than we’re doing,” said Janine Flanigan, Barnes & Noble’s director of store planning and design. “Our focus is books.”

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