The announcement marked the end of an era. It also marked down the value of Facebook by more than $200 billion. For the first time in its history, the social media company announced not a slowdown in user growth but a decline. Daily active users fell from 1.93 billion to 1.929 billion in the last three months of 2021.
It was a small drop but big enough to knock 25 percent off the value of the company.
The reason for the gap between the size of the fall in user numbers and the sharp descent of the share price has everything to do with expectations. Tech companies are expected to grow fast. Their business and funding models depend on rapid expansion to steal market share that network effects make difficult to steal away. The high valuations that companies with no revenue can demand during funding rounds assumes that they’ll acquire customers rapidly enough to make those valuations worthwhile. First, land lots of customers then when they have nowhere to go, charge them money. Or sell their data.
Facebook’s announcement that it was done with customer growth blew the froth off the balance sheet. Shareholders had to stop hoping that Facebook would one day have enough viewers to sell to enough advertisers to justify a valuation of over a trillion dollars. The $86 billion of annual revenue the company makes is about as good as it’s going to get.
It’s not just Facebook whose stocks are in trouble though. Spotify stock is down about 50 percent over the last twelve months, while Twitter is below $40 per share after topping $70 last April. The Nasdaq as a whole is in about the same place at the end of March 2022 as it was at the end of March 2021. Fortune’s list of the fastest-growing 100 companies, now contains just two technology companies.
So what’s going on? Are the days of technology’s fast growth over, and what do the new valuations mean for entrepreneurs?
When the Launch Runs out of Runway
One of the reasons for the slowdown in the growth of technology companies is that eventually you run out of room to grow. Facebook’s userbase of almost 1.3 billion people means that nearly one person in six in the world uses the company’s product every day.
Facebook, or Meta, doesn’t have a monopoly on air or fresh water. It serves content to people with Internet connections, and while its algorithms might be excellent at choosing the content that each user finds interesting, there is a limit to how many more customers it can attract. For Facebook to grow further, it’s going to have to hope that NASA finds life on Mars soon.
Smaller companies such as Twitter and Spotify aren’t in exactly the same position but they face a similar problem. Once the companies become household names, everyone who’s heard of them will have decided whether or not they want to use them. The growth potential shrinks, and with it the possibility of closing that gap between the expected earnings and actual earnings. Without radical innovation, which might drive away as many dedicated customers as it attracts, those companies soon become saturated.
Which is where we are now. Social media’s biggest innovation in the last few years has been the rise of TikTok, a Chinese-owned video platform used almost exclusively by teenagers. Everyone else is already using the platform they want and nothing innovative in social media has come along to pull people away.
Where recent technological innovation has taken place, regulation slows growth. The development of fintech demands close scrutiny from financial regulators and is vulnerable to competition from central banks. Medtech has now created a whole new category of vaccine and may be on the verge of personalized medicine adapted to each individual’s DNA, but that field too is heavily regulated and remains high risk. Far more medical breakthroughs lead nowhere (or to blood test machines that don’t actually work) than to new drugs or effective cure-alls. Clean energy remains expensive and the kind of space travel innovation developed by companies like SpaceX requires vast amounts of investment, decades of research, and depend on orders from only a handful of customers.
All of which is to say that one reason for slower growth among tech companies is that established companies are largely saturated and the most radical technological innovation is currently taking place in areas that can only grow slowly.
Covid Accelerated Growth
The end—or at least the decline—of Covid may also have something to do with the slowing of growth. As the pandemic forced lifestyle changes around the world, turning bedrooms into offices, phones into storefronts, and sales assistants into couriers, tech companies that could make online work and play easier prospered. Zoom saw revenue growth of 55 percent in the last fiscal year.
Those days are over. Roku is streaming less. Etsy’s stores are shipping fewer custom facemasks. Moviegoers are actually going to movies instead of Netflixing and chilling. And as the economy cranks up again, misaligned supply chains are still hindering hardware developers from putting chips on boards.
Covid might have been bad for the economy as a whole but it was good for some technology companies. As people drop their masks and head back to restaurants and hotels, technology will play a smaller role in the old-new economy than it did in the brief Covid years.
The result of that slower growth is greater tightfistedness among investors. Funds are still looking for opportunities, and they’re still handing out money but decisions from VCs appear to be coming slower and the numbers offered are smaller. The war in Ukraine, with all of the financial instability the conflict has brought, has slowed decision-making down even further. Crunchbase noticed that in the first days of the war new funding rounds were announced at a rate of just 39 per weekday compared to 80 before the war began. The value of investments are lower too.
“If you are a special company, you are still getting the valuation you want,” Mark Sherman, managing director at Telstra Ventures told Crunchbase. “But I would say the more ‘meat and potato’ companies are probably down 20 percent in January-February in relation to November-December—some more, some less.”
Companies that are growing at rates of at least 300 percent a year are raising funds easily, Crunchbase explains, but for others, late funding rounds are a particular problem although the lack of capital is also now being felt in earlier series.
So for entrepreneurs looking for cash injections to fuel their sprint to rapid growth, these may be difficult times. What can they do to plug the gap between current revenues and the capital they need to increase their income in the future?
Do More with Less
One option is simply to make do with less. In Digital Africa: Investing in Africa’s Most Untapped Source, venture capitalist Jesper Drescher explains how start-ups in sub-Saharan Africa make up for limited funding by rushing towards profitability instead of focusing on growth. If they can’t prove that their business model works before their seed funding runs out, their business model doesn’t work.
So instead of looking to buy customer share, aim to recruit paying customers from the beginning.
That’s a strategy that can work as long as competitors are following the same approach. The challenge will come if one company offering a similar service is able to access funds. They’ll then be able to subsidize customers in the way that Uber continues to do, buying market share and pushing less well-funded rivals out of the market.
One advantage of a tighter funding market then is that if capital is hard for everyone to find, entrepreneurs without connections to VCs can more easily compete with larger and better connected rivals.
Entrepreneurs can also look for alternative sources of funding. Instead of preparing Powerpoints and pitching in meeting rooms, they can crowdfund, giving themselves just enough to get a product out of the door and discover whether there’s demand for what they want to offer.
There are well-known downsides to crowdfunding, of course. Success is as dependent on careful campaigning as VC rounds are to planning and presenting. The funding only enables the production of a single product; it doesn’t pay for research or for scaling. And it doesn’t suit every kind of product. Sites like Kickstarter tend to focus on creative consumer goods and hardware rather than on software or commercial products.
It’s a solution for some entrepreneurs but it won’t do for everyone.
Other options include convertible notes, which Crunchbase says have become increasingly popular. These supply funding from VC firms now in return for a discount in future rounds.
Or entrepreneurs can wait. Funding might be slow at the moment but capital is available and investors will always want to put their money somewhere. The investment market might be slow now but like the market as a whole, funding tends to be cyclical. If your business can hold on until investors become more generous—or more daring—again, patience might be the best option.
For now at least, a rapid, capital-fueled sprint toward the kind of dominance that Facebook has been able to enjoy will be harder than ever. But slower growth at a sustainable pace could well be a surer path—and one that won’t knock 25 percent of the value of your company.