US subprime crunch impact on high tech
There has been a good deal of literature on the recent subprime mortgage financial so-called crisis. I haven’t seen anything related to the impact of this downturn on the high tech industry. Let’s hence cross the chasm and write a brief note about it.
In short and broadly speaking, what the subprime lending crunch is all about:
Not-so-professional professional lenders like NovaStar & New Century Financial grant mortgages to low-revenue borrowers; interest rates pick up and so does the debt burden, from a low-revenue borrower view point; so, low-revenue borrowers can’t actually refinance the interests of their debt, which means they have to sell their property. But since a large number of low-revenue borrowers act the same way and the real estate market shows uncertainties, estate prices go down, which urges potential buyers to wait longer, and refrains borrowers to refinance their debt, and so on and so forth. At the end of the day, this year’s subprime credit crunch looks a lot alike what happened in Japan in 1993, although and fortunately at a much lower scale: mortage lenders limited partners (mainly financial institutions: banks or insurance companies) as for a due subprime lenders can’t refinance because their low-revenue borrowers are having a hard time making both ends meet. Henceforth, subprime lenders are stated insolvent and go bust, their assets being redistributed to their lenders, and the remaining to their accounts payable & shareholders. It goes without saying that the last ones to get their money back, namely the shareholders, usually don’t get it all back (this is A)… Meanwhile, financial institutions from all over the world have invested, on behalf of their in subprime securities, supposed to be zero-risk investments. However, it appears these zero-risk investments happen to be very risky (this is B). A + B = generalized lost of confidence in financial markets that central banks try to diminish by printing dollar bills aimed at making sure local financial institutions, which have invested their clients’ money at zero-risk rates, don’t fall; scapegoats nominated: debt / risk rating agencies like S&P, Fitch, Moodies (the usual suspects); increased volatility due to higher sensitiveness to macroeconomic perspectives.
Nothing so bad after all. Everybody knew there would be a downturn at some point. The point is that nobody knew how bad it would turn out to be, and when it would occur.
Impact of subprime crunch on the Software industry:
R&D budget cuts: this is typical everytime there’s a downturn: large corporations cut R&D budgets (which I find dumb since downturns are excellent times for innovation and fostering one’s competitive advantage through information systems; but well, I’m not in charge here). End result: software sales aimed at R&D departments (eg. Dassault Systèmes’ CATIA) are likely to suffer temporarily.
Online Advertising. Well, let’s not beat around the bush: what about Google? My call: any crisis can only be positive for Google; offline commercials are harder to track. Through online advertising, you get to gather scientific ROI metrics, and benefit from increased accountability, flexibility, reactivity. A crisis can only accelerate the shift from offline advertising to online ads. It would be a good time for Microsoft to launch its AdCenter platform. Advertisers are dying to be able to choose between Google (which has become pretty expensive being alone over years) and something else than Yahoo! Overture. By the way, Criteo is soon to release Criteo Ads worldwide (only available in Beta and in French as of today) as an alternative to Google.
US subprime crunch will necessarily benefit independent software vendor SideTrade, a net working capital killer SaaS company (reduced net working capital increases free cash flows and accelerates debt refinancing – which is always a smart move when interest rates go up).
- US subprime crunch will also benefit procurement management software (for cost control reasons obviously).
- The subprime crisis will have no impact on retail (people will still need to eat and buy consumable &/or perishable goods), storage investments, and security solutions.
- Telco-related software technologies potentially driving cost killing (like VoIP systems: remember Skype is software, not telco) will regain interest from corporate buyers and CIO since negotiations are likely to get tougher with mobile and land line fleet vendors.
- CRM and BI / Datamining shouldn’t suffer from the downturn since it is generally agreed that it costs more to acquire a new client than to keep existing customers.
Impact on subprime crunch on IT consulting:
Severe shortcuts are expected in IT consulting, especially in banking / insurance where uncertainties are likely to remain higher for a short period of time (a few months). Such redundancies will have a positive impact on the software industry where finding skilled developers has become nothing less than a nightmare. Last and not least, the subprime crunch is very likely to accelerate the ongoing IT & BPO offshoring trend.
Impact on Venture Capital:
On the one hand, venture capitalists may suffer from limited partners (financial institutions in general + wealthy individuals and families) appearing less eager to increase VC-managed funds. On the other hand, venture capitalists invest in private equity that isn’t correlated with either the fixed income market (high tech startups never raise debt).
So what, is that a draw? Not quite. My call is that the VC market will suffer if stockmarket indexes remain low. The reason I believe so is that IPO opportunities will result dampered for a mid-term time frame.
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Wow, a lot of information to digest.
I think that a housing-crisis is probably a most damaging problem to an economy of all. People and banks depend on using housing as collateral for loans. A natural consequence would be less consumer-loans and less loans for pre-VC / small start-ups as well.
It reminds me a little of the shift that happened in some European countries (e.g. Germany) in the 90s. Banks used to finance a large part of the purchase-price of housing, up to 85% in Germany in some cases. After this seized, it had a lot of consequences for the ability to buy housing of course, but also on the risk-mentality of the people, which often comes from ease that they can purchase credit.
I hope this does not happen in the US, but a lowering in entrepreneurial risk-taking may be an effect also… which, if it lasts, will also affect business angels, and eventually venture capitalists.
Can you explain how you foresee a shift to online advertising? I seem to remember hearing that general advertising-expenditure would probably fall, which would certainly have consequences on a lot of internet-sites’ business-models.
Vince, startups hardly get loans unless they have intellectual property and benefit from government grants to R&D industrialization efforts.
About online advertising and why I believe it’s not going to suffer any economic downturn: 1) the digital advertising market grows 20% per annum. 2) when you spend 1 euro in offline commercials, it’s EXTREMELY HARD to track your ROI, ie know how much revenues an investment of 1 euro will generate. 0? 0.5 euro? 2 euros? 5 euros? You never know. 3) Digital advertising, although it has become expensive because only one player offers a truly pervasive platform (namely, Google – and they should be given credit for their vision of this market), allows such performance trackings. When you spend 1 euro, you know exactly how much it generated in termes of clicks / visits / sales (depending on the pricing you chose).
In a downturn, managers get pressurized by the necessity to track all investments and show results. Traditional commercials barely represent a valid option in this respect. Online advertising is a much more accountable solution that will help managers say: “hey, I generate 2 euros in revenues everytime I spend 1 euro whilst you couldn’t even track that number last year. How can you not increase my bonus?”
Feel free to disagree Vince, sorry for not being crystal clear in my post. Hope visitors will bump on these 2 comments.
Well no, I don;t disagree with what you are saying. Nevertheless, banks play an important role in financing very early stage start-ups, before even business angels get involved.
A credit-crunch at the bank-level can have a direct effect, but also an indirect one, by making financial decision-making for private investors like business angels more difficult.
About online- vs. offline advertising, both are based on how well businesses are doing in the real world, and how much they have left for an advertising budget. Of course, it won’t be dead and I agree with your reasoning that businesses will aim at services that present the best and most measurable ROI, which includes online advertising on high-traffic sites. Again, low-traffic sites, i.e. start-ups, may suffer, and if the housing-crisis lasts, which is uncertain, I expect the total amount invested in online advertising to fall also.
It should be noted that there is a differentiated value for subprime or stated income loans in the commercial lending market. This loan type is not entirely bad despite the abuse of some in the residential lending arena. Oftentimes, individuals that want to start or acquire a small business, purchase a gas station, acquire a motel, open an auto repair shop or any of a myriad of sole proprietor establishements, and do not have the portfolio that would make them attractive to the big box leaders. Lending companies like Ocean Capital in Rhode Island offer subprime and stated income loans by using up close and personal evaluations of the borrower and the opportunity. We need companies like this to support new business opportunities.
Quite an interesting post Jeremy.
I have little time to go very deep in my comment, but just a few remarks:
- Let’s not forget there are two sides of the crisis: one is the slowdown and progressive downturn of the US housing market (as a whole, but of course this is particularly visible for the subprime borrowers) that has been going on for 15 months already; the other one is the liquidity crisis that arose from the realization that sofisticated risk-sharing financial instruments backed on subprime mortgages were indeed impossible to price.
- I therefore disagree with the fact that there could be no impact on retail. Even more, I do believe there WILL be, and I’m not the only one thinking so. Why? Just as in every single housing market downturn, households spend less when their house price falls (even more so in the US, where mortgage equity withdrawals are particularly used).
- But besides this, this “crisis” is in no way a cyclical economic downturn, as growth prospects throughout the world are strong (with the exception of the US of course, which should grow at about 2% in 2007, ie below potential: but there is absolutely no recession in view), corporate profits should remain also strong -including in banks.
- Therefore I see little impact on the software industry, except for those companies with strong and/or sole exposure to the US consumer goods markets -and that’s quite a few companies of course, but IMHO let’s not dramatize the situation more than it needs to be.
Vince> we disagree on something: I don’t think banks are of any help for poor entrepreneurs; 100% copy on the rest of your comment
Marianne> I love community marketing
ManuPD> I agree with everything, but hey, I needed to write a blogpost, right?
Folks : you’re too young to remember, but keep in mind the following fact. The last time Greenspan said “the American economy might slip into recession by year’s end”, the Internet Bubble exploded just a few months later.
The guy did it again last February. No wonder why this current tornado…
So, fasten your seat belts, it’s going to shake up quite a bit for the next couple of years.
The time for Greenspan and his peers to find another economy sector to put their money – ooops, sorry, to take your money – in.
Why are we too young to remember? Why “take your money”??? Marc, sorry to say so, but there are times I find it hard to understand your comments. Perhaps I’m growing old and my neural network deteriorates…
While Greenspan is/was the maestro of US financial markets, as an amateur economist, I’d like to remind you the quote that is usually attributed to the Nobel Prize-winning economist Paul Samuelson, “Economists have correctly predicted nine of the last five recessions”.
[...] yet no doubt we’ll see copies of aforementioned services in 2008. This of course depends on how the US economy and therefore VC funds will hold up. As we have seen before, changes are quick and some of the huge web properties might end up [...]