The tech downturn: How long and how bad?

We interviewed more than 20 executives, venture capitalists, and bankers to see what they think. While there's little consensus, one thing's for sure: they're plenty worried.

Jim Kerstetter Staff writer, CNET News
Jim Kerstetter has been writing about the high-tech industry since the 1990s. He has been a senior editor at PC Week and a Silicon Valley correspondent at BusinessWeek. He is now senior executive editor at CNET News. He moved back to Boston because he missed the Red Sox. E-mail Jim.
Jim Kerstetter
9 min read

Silicon Valley venture capitalist Ron Conway sent a sobering e-mail on Tuesday to the 130 start-up companies he's invested in: now is the time to hunker down.

Ron Conway
Credit: Joi Ito
"You better rely
on your own
proactive action."
-Ron Conway

"In 2000 and 2001, the companies that hunkered the fastest were the companies that survived," said Conway in an interview with CNET News. "Get costs under control; make sure you have plenty of runway."

While that admonition from Conway, a noted investor who over the years has put early money into tech giants like Google and up-and-comers like Digg, was timely, it's hard to imagine that any tech executive who's been paying attention to the news needs to be reminded that rough economic conditions are most definitely ahead.

How bad those conditions will be and how long they'll last is anyone's guess. The CNET Technology Index, which tracks 66 publicly traded tech companies, dropped for the third straight day Wednesday to hit its lowest level in more than three years. Even the healthiest of companies are seeing their stocks being sold en masse. Google, for example, finished trading Wednesday down 2.28 percent to $338.11 per share; that's a new 52-week low and less than half the asking price for a Google share in November 2007

Bad news persists in the overall economy as well, despite continued attempts at government intervention. The Dow, Nasdaq, and S&P 500 indexes all continued to slide Wednesday; the Dow has now dropped 35 percent from its high a year ago.

CNET contacted more than 20 tech executives, venture capitalists, and industry gurus Wednesday to ask "How long and how bad this will be for the tech industry, and what should companies do about it?" Not so surprisingly, there was no consensus. While nearly everyone interviewed is concerned about the economy, their reaction to it and their plans to deal with it are across the map. Experienced investors like Conway and venture capitalist Larry Augustin of Azure Capital Partners are cautious, while some executives (at least in their public comments) are downplaying the risks to their businesses.

Tech stocks
Credit: Susan Dove/CNET News

"We think there will be some impact on our business," Sprint Nextel CEO Dan Hesse said during an event to launch the company's new 4G wireless broadband network in Baltimore on Wednesday. "But compared to most other industries, we are relatively well insulated."

Geoffrey Moore
"This is categorically
different from prior
downturns... There
is no place to flee."
-Geoffrey Moore

So who's right? Enterprise software maker SAP, which is particularly vulnerable to end-of-quarter deal cancellations, has already run into trouble, as have other notables such as Sun Microsystems and Netflix.

But it's not yet clear what will happen to consumer sales and online advertising. The monthly CNET-Consumer Electronics Association consumer confidence index showed surprising bullishness in late September. Internet Advertising Bureau statistics for the first half of the year showed surprising strength, but the IAB data did little to shed light on what will happen in the fourth quarter.

This should give people in tech reason to pause: the normally upbeat Geoffrey Moore, author of popular tech industry books such as Crossing the Chasm, worries it could take years to restore some sense of "equilibrium" to the economy. That's bad news for the tech industry.

"This is categorically different from prior downturns because the industry going into the tank supplies a fundamental staple to all other industries. There is no place to flee. It is not about tech at all," Moore said. "Established franchises with strong cash flow have a huge competitive advantage in downturns. But even these folks better plan for a major overhaul before we reach the other side of this chasm."

The money men
Nonetheless, where there's chaos, there's also opportunity. Azure Capital's Augustin expects a faster pace of acquisitions because start-ups right now don't have initial public offerings, or IPOs, as an exit strategy, and smaller companies may not have enough cash on their balance sheets to weather the storm.

Larry Augustin
"I think there
probably are some
bargains to be had
-Larry Augustin

"I think there probably are some bargains to be had here," Augustin said. Having an IPO option can help increase start-ups' valuation, and without that option, acquisition price tags will be lower. "If you have a strong balance sheet, maybe you want to spend some there... I think tech companies will be in a good position to leverage this downturn."

The present climate also means venture capital will be harder to find, Augustin said. "Without an IPO market in the venture capital world, you don't have any exits. And if you don't have any exits and you're not returning any capital to people (who've invested), you don't have new capital flowing in. That means the venture financing climate is going to slow down," Augustin said

But the cautious Augustin declined to forecast how long the downturn will last. "It's already deeper than I thought it would be," he said. "I thought maybe two weeks ago we had seen some of the worst and the rescue plans the government had put together would stabilize financial services, and it hasn't."

Ron Conway said he has spent time on the phone with probably six CEOs in the past 24 hours. "They say, 'I'm not as prepared as I should be; walk me through the steps I should be taking,'" Conway said. Conserving cash and cutting costs are a must, he said, because bigger companies aren't acquiring as aggressively as many would hope.

"It would be great if more companies were acquisitive, but a lot of people are frozen in place, so you can't rely on M&A to bail you out," he said. "You better rely on your own proactive action. You should seek M&A, but not count on it."

There is some reason for confidence. So far, when it comes to employment, American business has yet to fall off the cliff, said Stephen Mader, vice chairman and managing director of recruiting giant Korn/Ferry International in Boston. But the health of jobs across the country depends greatly on the ability of the federal government to restore confidence in the short-term credit market, he said.

"All you're hearing today in boardrooms across the country is we just don't know. And when you just don't know, you act cautiously," Mader said. If the situation doesn't improve, he expects businesses to "aggressively" cut payrolls heading into the new year to adjust to the new credit conditions.

The start-ups
Gina Bianchini and Marc Andreessen, the chief executive and chairman of the social networking company Ning, have reason to say "I told you so." Earlier this year, Andreessen (the Netscape co-founder who knows a thing or two about tech booms and busts) predicted the industry could be headed for a "nuclear winter" and needed to prepare for it. Ning landed an additional $60 million in venture funding to wait out whatever bad news should come down the pipe.

Gina Bianchini
Credit: SXSW
"Do I think a
nuclear winter is
going to happen
in the market?
Yes. Do I think
that has a
negative impact
on us today? No."
-Gina Bianchini

Andreessen was jeered by many as a hyperbolic killjoy at the Web 2.0 party. (It didn't help that he repeated the comments on stage at the Web 2.0 Expo in San Francisco.) Few should be jeering now. "We're great. That's why we actually went and raised the money that we raised. We are well positioned, and I would say well stocked for the coming months," said Bianchini. "Do I think that (a nuclear winter) is going to happen generally in the market? Yes. Do I think that has a negative impact on us today? No."

Conway likely would say raising that money was a fine idea. "Any company that doesn't have one year of cash burn in the bank could be in trouble," he said.

Other start-up execs, such as Corey Bridges, the co-founder of virtual worlds platform developer Multiverse Network, says the best thing to do is plan conservatively for 2009 and watch your cash--because anyone who has to go to the venture capitalists for money will find the terms have dramatically swung in favor of the money men. Bridges said he could see conditions worsening for the last few months.

"There have been a number of leading economic indicators, for some months, that things were going to get rough," he said. "We do a lot of work with big media companies, and sotto voce, the big media companies have been saying that the 'Big Three' car companies are cutting back on their advertising on TV, and that's going to affect them."

Jonathan Kaplan, CEO of Pure Digital, which makes the Flip Video Camcorder, said his company is approaching the current economic climate with a "cautious but optimistic" business plan, especially in light of the upcoming holidays. He does say it helps that his most popular product is a less expensive alternative compared to the competition.

But the retail outlook this holiday isn't great. "There's no doubt in my mind this will be bad for everyone. It's a consumer-centric decline, and consumer spending is going to change considerably," said Kaplan. "I think Christmas will be hit very hard, and it will be a difficult one for many retail partners and consumers."

Can big companies steer clear of trouble?
SAP's problems are well known by now. But what about other big tech companies? Microsoft executives have so far tried to alleviate panic about the downturn, while at the same time battening down expenses. And though their stocks have been pummeled, there's no indication (yet) of trouble from many of tech's bellwethers, ranging from Hewlett-Packard to Google.

Marc Benioff
"This is an
unprecedented time
in the economy...
Most of the experts
I see talking about
this are at a loss
to make a
-Marc Benioff

Marc Benioff, CEO of on-demand software company Salesforce.com, would say watching your dollars is a wise idea. In an e-mail exchange, he quickly pointed out that Salesforce finished the second quarter with $823 million in cash--enough to weather the worst of downturns. But even the oft-loquacious Benioff is stopping short of predicting how bad conditions will get for tech.

"This is an uncertain and unprecedented time in the economy," wrote Benioff. "I am not an expert, and most of the experts I see talking about this are at a loss to make a meaningful prediction. So we are focusing on what we good at: making customers succeed."

Clean tech's funding challenge
In the clean-tech arena, investors and entrepreneurs expect the most pain to be felt with firms on the cusp of commercialization, where large amounts of money are needed to build a biofuels or solar manufacturing plant, for example. Many of these expansion projects are typically financed in part with debt. But with the credit crisis, those deals are far more likely to be funded through private equity or project finance, investors said.

"The debt market is in the ER (emergency room) in a terrible way," said Jon Bonanno, president of renewable energy developer Principle Power. "Us, as power plant builders, in the next 24 months, we are doing all equity (financing). If there's a will, there's a way, even in the worst market."

Valuations of clean-tech start-ups trying to raise capital will likely shrink as part of the overall economic downturn. But the level of activity in green tech--an area flush with venture capital--appears to be holding steady, for now at least.

"We're still seeing a lot of companies looking for financing. The deal flow still seems to be active," said John Cote, a vice president at General Electric's financial services arm. "But you have to expect that it's going to slow down."

Some investors speculated that there could be a wave of mergers and acquisitions, as start-ups struggle to find sources for funding.

"Our assumption is that we will probably exit (from start-up investments) through sale to strategic investors," said Steve Goldby from early-stage venture capital firm Venrock. "There is no IPO whatsoever."

Asking the futurist for answers
Again, so who's right? We turned to Silicon Valley technology forecaster Paul Saffo for some answers. In the short term, the economic downturn will make it harder for tech companies to attract private equity and venture financing, as well as the lines of credit that are often needed to pay the bills, Saffo said.It's too early to tell how bad the financial panic will be and how long it will last, but the economic meltdown signals a shift to a new type of economic model in which tech companies are well positioned to thrive, he said. It just may take some time to get there.

"The chaos might blow some roofs off in Silicon Valley," Saffo said, "but in the long run the winds are blowing in the favor of the technology sector."

CNET's Rafe Needleman, Martin LaMonica, Stephen Shankland, Erica Ogg, Elinor Mills, Caroline McCarthy, Daniel Terdiman, Marguerite Reardon, and Tom Krazit all contributed reporting to this article.

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