Business is, at its core, a give-and-take process. The more you invest, and the more you're willing to part with, the more you'll reap in rewards in kind.
Sandy Lerner discusses the biggest challenges facing founders and the country as a whole, from excessive CEO pay to an unrestrained venture capital industry.
Google discloses *another* Microsoft Windows vulnerability before a patch is ready
— As with the previous controversial disclosure, Google gave Microsoft 90 days to fix the flaw. Microsoft requested that Google wait until a security patch …
An overview of the ideas, methods, and institutions that permit human society to manage risks and foster enterprise. Description of practices today and analysis of prospects for the future. Introduction to risk management and behavioral finance principles to understand the functioning of securities, insurance, and banking industries.
The stock market is at an all-time high. Tech startups with no revenue are raising billion-dollar valuations. Engineers are demanding Tesla sports cars.
The stock market is at an all-time high. Tech startups with no revenue have billion-dollar valuations. And engineers are demanding Tesla sports cars just to show up at work.
Here's the evidence that we're in a new tech bubble, heading for a crash, just like the dot com bust of 1999.
Interest rates are effectively at 0%.
Fred / Think Progress
Before we get into specific evidence that the tech sector is inflated, it's worth restating the macro-economic context: Interest rates are basically at zero and have been for some time. When borrowers are paying close to zero interest on loans, that makes money cheap to get. This chart shows the Fed's target rate for interest since 1970.
People with money generally have a choice: save it in interest-paying, risk-free bank accounts or invest it in riskier assets that may pay more money over time. When interest is at zero, virtually any other kind of investment is likely to pay more because the risk-free alternative is so lousy. So investment asset bubbles get created. Stocks tend to go up.
The stock market is at a peak, which is exactly what you'd expect in a zero-interest environment.
Yahoo Finance / Jim Edwards
We've had five years of solid growth in stocks. People who have invested in stocks in the last five years now feel very, very rich. What could possibly go wrong?
The market moves up and down, in cycles, as this chart of the S&P 500 stocks shows.
We're due for a downturn.
(BlackRock CEO Laurence D. Fink, whose company manages $4.1 trillion in assets, agrees that the Federal Reserve is creating “bubble-like markets.”)
In the tech sector specifically, there has been a recent run-up in deal prices.
Thomson Reuters / PricewaterhouseCoopers
This chart was published by PriceWaterhouseCoopers, which tracks merger and acquisition activity in the tech sector.
It notes that "software deal volume tripled that of the second quarter."
The driving force?
High stock prices and corporate giants who are rich with cash and need to invest it, PwC says.
It's not just tech asset prices that are high. Salaries are high, too.
While unemployment generally may be high, in the tech sector it is very low.
REUTERS/Edgar Su
Tech companies, led by Mark Zuckerberg at Facebook, are lobbying Congress to relax immigration rules so they can hire more foreign talent because they believe domestic talent has gotten too scarce and too expensive. It's driving up wages bills like crazy. Matt Allen, a tech recruiter at Vertical Move, told me recently:
We're experiencing first hand greater insanity than the dot-com days when Interwoven Software was pulling out BMW Z3's for engineers who joined. Instead, we're seeing sign-on bonuses for individuals five-years out of school in the $60,000 range. Candidates queuing-up six, eight or more offers and haggling over a few thousand-dollar differences among the offers. Engineers accepting offers and then fifteen minutes before they're supposed to start on a Monday, emailing (not calling) to explain they found something better elsewhere.
That suggests that wages in tech are in a bubble.
Want an example?
Twitter svp/technology Chris Fry got a $10 million pay packet. He only joined the company last year.
Twitter
Twitter's Chris Fry comes with a high price.
Fry is paid more in annual compensation that Jack Dorsey, the chairman of Twitter's board and the founder of the company.
That's how much the price of wages has risen in the tech world. Fry is not a one-off event. Facebook's vp/engineering, Mike Schroepfer, got $24.4 million in 2011, Reuters noted:
One start-up offered a coveted engineer a year's lease on a Tesla sedan, which costs in the neighborhood of $1,000 a month, said venture capitalist Venky Ganesan. He declined to identify the company, which his firm has invested in.
It's not just wages that are expensive. Company valuations are rising too.
Supercell, the game company, just raised $1.5 billion in new funding at a valuation of $3 billion. Supercell has real revenue — $178 million in Q1 alone. But you've got to question the logic of the people doing the deal: Investor Masayoshi Son, the founder of Softbank, believes he has a "300-year vision" of the future.
Even the CEO of Supercell thought he was joking when he first heard about it.
Companies with broken business models are highly valued.
Jason / Goldberg / Facebook
Fab CEO Jason Goldberg
Fab.com, the design retailer, recently raised $165 million in new investment this year, for a total of $336 million in all venture funding. It did so despite laying off 440 employees after deciding that the flash sales model — in which customers are asked to suddenly purchase a daily deal — doesn't work. It was Fab's second business model "pivot" — the company started life as a gay community site.
We're not saying Fab is going out of business. We're saying that Fab's backers have been fabulously generous.
Companies without meaningful revenue are highly valued.
Natasha Foote / Pinterest
Pinterest just raised $225 million in new investment funding, a stake that values the company at $3.8 billion. That valuation is fictional, of course. It's based on the notion that the company could be sold or go public at that price. That price is 10 times what investors have actually plowed into the company.
To be clear, Pinterest is showing every sign of turning into a great company. It has already solidified a role for itself as a key referrer of online retail and e-commerce traffic.
But still, this is a company that currently is rumored to make only between $9 million and $45 million in revenue.
Companies with no revenue at all are highly valued.
Snapchat / Apple iTunes
Snapchat is rumored to be raising a new round of funding that values the company at $3.6 billion on paper.
This company has zero revenues.
Zero.
And it's not easy to see how it might make money: It's defining product deletes itself after just a few seconds.
The last time we saw companies with no revenue receiving high valuations from investors was right before the 1999/2000 dot com crash.
Yahoo is again paying top dollar for companies with no meaningful revenue, just like it did in 1999.
Wikimedia, CC
Tumblr's David Karp and Yahoo's Marissa Mayer
Yahoo recently paid $1.1 billion to acquire Tumblr, the social blog network. Tumblr's revenues are so small Yahoo isn't required to mention them in its financial statements — they just don't move the needle.
Again, to be clear, Tumblr is actually an excellent product with 50 million users. But for Yahoo to make money on this deal Tumblr will have to generate profits after sales of greater than $1.1 billion.
My sources tell me that with the right adtech, Tumblr could generate several hundred million in ad sales revenue over the years. But they don't believe Yahoo will ever get its money back on the deal.
This is significant because Yahoo does not have a good track record when it comes to buying in a bubble. In 1999, right before the last tech crash, it bought Broadcast.com for $5.9 billion in stock and GeoCities for $3.57 billion. Neither business had meaningful revenue and both have since been shuttered.
Companies are making dumb decisions: This startup chose beef jerky over a 401 (k) plan.
waitscm | Flickr
The New Yorker recently wrote:
Hunter Walk, an entrepreneur who recently co-founded an early-phase venture firm called Homebrew, told me about a startup where he’d previously worked. The company had needed to figure out whether to spend its limited budget on beef jerky to keep around the office or 401k plans for the staff. “We put it to a vote: ‘Do you want a 401k or jerky?’ ” he explained. “The vote was unanimously for jerky. The thought was that well-fed developers could create value better than the stock market.”
Correction: Walk now tells me that the beef jerky incident happened in 2001. The New Yorker presents the anecdote as if it were current. Nonetheless, there are plenty of companies making dumb decisions. For instance ...
Companies are making dumb decisions (part 2): There are more Facebook ad agencies than regular ad agencies.
Facebook has about 300 so-called Preferred Marketing Developers. They all do one of just four things: Place ads on Facebook, manage Facebook pages for companies, provide social media analytics, and create marketing apps for Facebook. They are basically ad agencies, in the sense that advertising clients hire them to promote their brands via Facebook.
But there are more Facebook PMDs than there are major ad agencies in the U.S., even though the non-Facebook ad business is many times the size of Facebook. Not all of these companies will survive, and a few have recently realized that there is not enough money to support them all. Even Facebook has moved to cull the herd.
Serious investors are beginning to suspect a tech bubble has formed, and that a crash is coming.
UBS
Art Cashin
Art Cashin, the the director of floor operations for UBS Financial Services, has been around the block. He recently worried that he he was seeing things that reminded him of 1999:
"I do worry a little bit that we're beginning to hear things that are reminiscent of the 1999-2000 period—the number of hits, the number of eyeballs," said Cashin, ...
"I think if we hold to the old tried-and-true—how many dollars are coming in—then we might be better served," Cashin said. " But people are extrapolating, in some way, in a manner similar to the way they did in 1999-2000."
"For an old fogy like me," the trend of extrapolating future earnings based on users and viewers "gets the warning flags flying," Cashin said.
Andreessen Horowitz is pulling up the ladder.
Flickr / coltera
Andreessen Horowitz is is the sine qua non of Silicon Valley investor groups. It had stakes in Facebook, Twitter, Pinterest, Groupon and Zynga. Now it is saying it will no longer invest in early stage consumer-oriented startups.
They're done.
Andreessen is interested more in later stage and business-to-business-oriented companies. Companies with actual prospects of real revenue, in other words.
This, arguably, is the kind of "flight to quality" you often see when asset prices and stocks start falling. What does Andreessen know that we don't?
One of the most legendary tech investors, Tim Draper, thinks we're at the end of the curve.
youtube/2millionminutes
Tim Draper
Timothy Draper is the founder of Draper Fisher Jurvetson, a venture capital outfit that has invested in dozens of tech startups. He's been around since the days when Hotmail was the big new thing. He recently told The New Yorker that he believed tech venture capital may have reached the top of its cycle:
“I’ll draw you the cycle,” he said, taking my notepad and pen. He scrawled a large zigzag across the page. “This is a weird shark’s tooth that I kind of came up with. We’ll call it the Emotional Market of Venture Capital, or the Draper Wave.” He labeled all the valleys of the zigzag with the approximate years of low markets and recessions: 1957, 1968, 1974, 1983, and on. The lower teeth he labeled alternately “PE,” for private equity, and “VC,” for venture capital. Draper’s theory is that venture booms always follow private-equity crashes. “After a recession, people lose their jobs, and start thinking, Well, I can do better than they did. Why don’t I start a company? So then they start companies, and interesting things start happening, and then there’s a boom.” Eventually, though, venture capitalists get “sloppy”—they assume that anything they touch will turn to gold—and the venture market crashes. Then private-equity people streamline the system, and the cycle starts again. Right now, Draper suggested, we’re on a venture-market upswing. He circled the last zigzag on his diagram: the line rose and then abruptly ended.
If David Tran were a more conventional CEO, he would be a fixture at conferences, a darling of magazine profiles, and a subject of case studies in the Harvard Business Review. Sriracha hot sauce, made by Huy Fong Foods, which Tran founded 33 years ago in Los Angeles, is one of the coolest brands in town. There are entire cookbookswritten to celebrate Sriracha’s versatility; memorabilia ranging from iPhone covers to t-shirts and all sorts of other swag; a documentary in the works to chronicle its rise; and innumerable imitators. Sriracha sales last year reached some 20 million bottles to the tune of $60 million dollars, percentage sales growth is in the double digits each year, and it does all this without spending a cent on advertising.
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Yet Tran shuns publicity, professes not to care about profits, hardly knows where his sauces are sold, and probably leaves millions of dollars on the table every year. His dream, Tran tells Quartz, “was never to become a billionaire.” It is “to make enough fresh chili sauce so that everyone who wants Huy Fong can have it. Nothing more.”
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Product before profit
Today hot sauce is an emerging global business. The industry, which is among the10 fastest growing in the US, now rakes in over $1 billion a year in global sales. But when Tran arrived in Los Angeles back in 1980, he was both jobless and hot-sauce-less. Having recently arrived from Vietnam, Tran found it near impossible to find a spicy additive worthy of his palate. The Southeast Asian community in Los Angeles, he soon realized, was suffering from the same hot sauce withdrawal.
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In a matter of months, he had arrived at his rendition of Sriracha, a version of the Thai sauce made with hybrid jalapeño peppers (red or sometimes orange in color), vinegar, sugar, salt, and garlic, and was delivering it to local markets throughout the city. Soon thereafter, he was packaging it into its now unmistakable clear bottles with the rooster logo and green caps.
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But the only hope he ever harbored was to provide Vietnamese immigrants with a hot sauce worthy of their pho soup. Growing a bona fide business wasn’t an afterthought—it wasn’t a thought at all. “I started the business with my eyes closed. There were no expectations at all,” he said.
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He still runs it in much the same way: with his eyes closed. He says he has not once hiked the wholesale price at which he sells Sriracha—a number he won’t share with anyone—no matter that inflation has more than tripled food prices since 1980. He can’t tell you where Sriracha is being sold, because all he knows is that Huy Fong has ten distributors, to whom he has handed off his hot sauce for over 10 years now. “We don’t have a detailed record on where it’s being sold,” Tran admits. Griffin Hammond, who is making the documentary about Sriracha, tells Quartz that as far as he knows, Sriracha is available in the US, Canada and Europe. “But it’s probably sold elsewhere, too,” he conceded. “At the very least, I know that on the bottle there is English, Chinese, Vietnamese, French and Spanish.”
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Tran also learned only recently that Sriracha has become a popular ingredient among sushi chefs, who have been using it to spice up spicy tuna rolls for years. “I didn’t know until one of my distributors told me,” Tran said. In fact, says Hammond, it’s “almost always the spicy ingredient in spicy tuna rolls these days. It probably makes up a pretty significant portion of their sales.”
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Sushi chefs aren’t the only ones. Restaurant chain P.F. Chang, which has 204 branches in the US and worldwide, offers Sriracha-flavored dishes. Chef David Chang (no relation to P.F. Chang’s) has bottles of Sriracha on every countertop of his Momofuku Noodle Bar restaurant in New York. Bon Appétit magazine declared the sauce the ingredient of the year back in 2010, and Cook’s Illustrated called it the best-tasting hot sauce in 2012. Though it didn’t win, Sriracha was one of three new flavors chosen in Lays potato chips’ new flavor contest last year.
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Tran is, of course, flattered by all the fandom. He spends time every day reading through bucket-loads of emails, the bulk of which chronicle new and often unthinkable ways in which patrons use his chili sauce. One, he recalled, involved macaroni and cheese, a pairing Tran has never tried—he still almost exclusively eats it on his pho.
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Chili-driven growth
Demand is such that Huy Fong—which also makes Chili Garlic and Sambal Oelek, two significantly less popular hot sauces—recently purchased a new 650,000-square-foot (60,000 sq m) factory just to process and bottle its Sriracha. It’s quite the upgrade: the current facility produces 3,000 bottles every hour, 24 hours a day and six days a week, and the new one will have two-and-a-half times that capacity.
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But the company’s biggest obstacle to growth isn’t manufacturing space. It’s raw materials.
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Even the 100 million pounds of chilies that Huy Fong harvested last year wasn’t enough.Reuters/ Beawiharta Beawiharta
Most commercially distributed hot sauces are made with dried chilies to make it easier to harvest, process and bottle the product at scale. McIlhenny, the maker of Tabasco, for example, buys its chilies from producers around the globe. But Sriracha is—and always always has been—made with fresh chilies. It’s what separates it from the competition, says Tran.
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One of the few data points Tran will reveal about Huy Fong is that it processed some 100 million pounds (45 million kilograms) of fresh chilies last year over the course of its harvest season, which lasts only 10 weeks and provides for the entirety of the company’s yearlong Sriracha sales. ”We can only grow as quickly as our ability to harvest chilies grows,” Tran said.
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His unwillingness to compromise on quality means that the chilies for Sriracha need to be processed within a day of being picked. So Huy Fong’s Rosemead factory sits only an hour away from Underwood Family Farms, which has been the company’s only chili supplier for the past 20 years. Its new plant in Irwindale is only a few miles further away. Finding new land fit for further chili harvesting has proved difficult—the land needs not only to be vast, but also fit for the purpose. “I can’t buy land that’s being used to harvest oranges,” Tran explained. “It’s not right for chilies.”
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The other upshot of the high demand is that in 33 years, according to Tran, Huy Fong Foods has neither employed a single salesman nor spent a cent on advertising. Advertising would merely widen the gap between demand and supply even further. ”I don’t advertise, because I can’t advertise,” Tran explained.
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Huy Fong also doesn’t have a Twitter, Facebook or Google Plus account, and its website is bare-boned. As a result, patrons of Sriracha tend to know little if anything about the company whose product they consume by the gallon. “It’s all been word of mouth,” Hammond says. It takes little more than a glance at the bottle to learn that Sriracha is currently made in Rosemead, California, but “most people still think Sriracha comes from Asia.”
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Many people also have to dodge the growing pool of Huy Fong Sriracha copycats, which range from knockoffs with sharks instead of roosters on the bottle, to virtually indistinguishable mimicries. Tran’s lawyer, Rod Berman, an expert in intellectual-property rights, told Bloomberg he now writes four to five infringement complaints for the company every year.
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The reluctant mogul
Talking to Tran is a bit like pulling teeth. He only began granting interviews and extensive press access recently. His assistant and operations manager, Donna Lam, accompanies him on interview calls. His English is slow and calculated, and he often has to have more complicated questions and comments translated so he can properly answer—or slyly circumvent—them. Try to ply historical growth numbers from him, and you’ll hit a wall—he doesn’t share them. All he’s willing to concede is that sales have grown steadily and in the double-digit range since he started bottling Sriracha 33 years ago.
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Tran doesn’t want anyone to know how fast Huy Fong is growing for fear that more people will show up at his doorstep with business pitches he doesn’t care to hear and growth plans he couldn’t be less interested in. He says a number of investors have already approached with piles of cash and lofty promises, even full-on offers to buy the company on the spot. Tran has turned them all away. ”People who come here are never interested in the product, only in the profits,” he laments.
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