Turns out all the people asking: "Why does company X have so many employees?" weren't completely wrong.
1. There are companies that are run inefficiently, especially ones that grew spectacularly quickly during the pandemic due largely to FOMO concerns from execs.
2. Large companies have a huge number of responsibilities and needs for staff that are rarely grasped by the "It's just a website! I could build this in a weekend!" crowd.
The question that I have is: why are all these big corporations doing synchronized layoffs? Is it about having more people than needed or is it pure greed and expectations that they can easily get away with it because "everyone is doing it"?
Tech company growth rates were high during the pandemic so they hired to fuel that growth. Now that growth rates are lower, they have to re-balance their cost structure to match their new forecasted growth. This is happening at every company currently doing layoffs. In Twilio's case, they went from almost 70% year over year growth during the pandemic to currently about 20-30% year over year growth. The same evaporating growth rates is true across the tech industry - Meta is actually seeing revenue decline year over year, Google has seen growth shrink to just 1%. Even more telling are operating margins which are evaporating very quickly as growth stalls - Google's operating margins are down 17% year over year.
No one has a crystal ball, so companies hire during high growth periods to capitalize on growth, and lay off during low growth periods to re-balance their cost structure towards profit. This is true of many industries - you see the same effects play out in the boom and bust cycle of industries like O&G - which are currently hiring and not too long ago were laying off as well. People want to frame lay offs as de facto failure, but really it is just companies responding to market conditions - no different then companies hiring when growth is high.
I predicted there would be mass layoffs in tech right like this last year, and more specifically predicted 6 months ago that we'd be seeing basically what we're seeing as far as layoffs.
With rising rates investors are asking companies to show a clear path towards profitability. Most of these companies are losing more money each quarter and industry wide this has to stop.
For the larger profitable companies it's likely because they realize a huge amount of their revenue is coming from these companies that don't make money.
While I'll be the first to criticize companies for working to remove power from workers, what we're seeing is simply investors waking up to the economic reality that growth without profits is not sustainable.
What do you predict is the resolution to this dillema?
"the United States Federal Reserve raised the Federal Funds Rate from 0.25% to 4.75% in the past 6-18 months, therefore, these companies are reacting to that and having to cut back on costs"
where it falls apart in my mind is (and I might be missing something)
why is that having such a massive impact so quickly on these companies to the point where, the cost to service NEW debt (not existing) rises?
i thought a lot of these companies had so much cash due to high tech margins that, they didn't really finance growth through cheap debt?
The rise in interest rates from 0.25% to 4.75% is meant to slow economic growth, therefore companies need to adjust to a period of slower growth. The higher interest rates work primarily through the real estate market, slowing construction, but this means less consumers, and therefore less income for companies.
Keep in mind, the banks raised rates rapidly as soon as they knew the Fed was going to raise rates. The Fed took many months to get to 4.75% but the banks jumped ahead and raised rates almost instantly.
In 2020 many CEOs needed to plan for hypergrowth, in 2023 many CEOs need to plan for a possible recession.
The money I spend becomes income for a company, and when that company pays you a salary, and you buy something from my company, then they money you spend becomes my salary. Everything goes around in a circle. Therefore, it doesn't matter how much debt a company has, but it does matter how much debt other people have. If other people suddenly need to pay more interest on their debts, then they have less money to spend whatever it is that your company is selling (unless you work at a bank).
I think it's more direct than that. Rich people weren't getting any return on their money from fixed income instruments so instead they gave it to funds that invested in tech startups that then used it to hire people. Now interest rates are higher, rich people don't need to do that any more.
This should not be surprising at all! The entire tech rally was fueled by a huge amount of leverage. That leverage was very cheap in the last 10 years, because there was a lot of money sloshing around and the interest rates were zero (sometimes even negative), which meant that the bar on portfolio returns was very low.
I'm going to simplify a lot: let's say you have a portfolio that returns 10% p.a., if the risk free rate (ie bond returns) are 0, then you can say that your portfolio gives people 10% in excess of what they could get by holding safe assets. But now rates are 5% (for the sake of simplicity), that same portfolio only gives you 5% excess returns. On any single given year that's not a huge difference, but if you compound this over 10 years, that's the difference of having earned 60% vs. 160%. Huge difference!
So as you can see this relatively small (in absolute terms) change really compounds itself into a massive re-evaluation of investments. When rates are negative, you'd be happy to hold assets that merely do nothing - ie neither gain nor lose value - but once rates start to rise appreciably, the future value of those investments needs to be discounted and because we are dealing with compounding, the discounting itself can be pretty brutal. This is then further compounded by the expectation that money supply itself is shrinking, which makes the pool of available money smaller as well.
It's really a double whammy which will mostly affect highly leveraged and risky bets, as they become much much less palatable.
It was really perverse how many tech companies had no discernible avenue of ever becoming profitable, and yet had billion dollar valuations. People were looking desperate for parking capital anywhere they could.
I'd like to see a source/citation/proof for for that claim.
I find it hard to believe Apple, Microsoft, Google, or Meta have "huge leverage".
Except they aren't doing layoffs and everybody else who is profitable is
But the companies doing layoffs aren't tech startups (Microsoft, Amazon, etc.)
I get that Rich people were buying new assets, but I don't see how that is new funding for hiring. I thought it was more of an increase in asset prices for more risky assets. So the previous owner of the stock gets paid, but that doesn't result in hiring.
"Banks are intermediaries between the central bank (such as the Federal Reserve) and consumers and businesses. Banks borrow funds from the central bank at a certain rate and then lend those funds to their customers at a higher rate, earning a profit on the spread between the two rates."
> therefore companies need to adjust to a period of slower growth.
I think this is the missing piece for me. I didn't realize that since consumers will purchase less houses, the real estate sector will lag, and those who earn their living in it will have less discretionary spending to pump into the economy. From there (at scale), companies like Microsoft will grow less due to weakened consumer demand.
That and people who need to finance car purchases right now (new or used) would also be affected. If it costs them more to finance a car than it did 12 months ago, Microsoft/Amazon/Google/Facebook can expect to have weakened consumer demand.
So it isn't that Microsoft itself is directly impacted at a "we finance debt to pay our employees with the Federal Funds rate", but more that the Federal Reserve is trying to weaken consumer demand. Once that weakened demand reaches Microsoft, they need to adjust (lay off unprofitable teams/projects) to stay on their previously baked in growth projections that Wall Street expects to see/demands. Without this, Microsoft stock will go backwards because Wall Street wants to see perpetual continuous growth.
Right, but banks don't have to borrow money from the Fed. Banks also have the deposits from their customers, and so banks can make new loans based on those deposits. Last time I checked, this was roughly a 5 to 1 ratio (a bank with $1 million in deposits could make loans of $5 million) but that changes all the time, based on limits set by the Fed.
But in general, right, when the Fed raises rates, consumer demand will weaken, and then that spreads to the retail sector, and then that works backwards to the manufacturing sector and all the service sector activities that support businesses in general (accounting, legal, janitors, etc), eventually slowing all economic activity.
So it's not that the Fed rate affects Microsoft directly, because they don't really have any loans/processes where they need to get loans/debt at the Fed rate.
It's that they will be affected by lower consumer demand.
It's because a lot of tech companies have built their financial management on regularly refinancing and getting new cash through the debt market to keep things going, rather than minimizing the usage of debt markets for cash generation.
Companies still do have lots of cash but they need to manage that cash with the expectation that they won't be able to raise cash as easily in the near/mid future. Valuations are cut because there's better places to put money now to get yield so when you do raise, you'll need to sell an even bigger piece of the company to get the funds you need.
This is just speculation on my part but also perhaps instead of investing the money in the company it is better to just buy bonds for a better rate of return? Basically instead of buying workers time to get a rate of return. That worker has to 'beat' the interest rate which factors into MR=MC to make it worth the while of the company to keep them around. Wonder if there are any economic studies on that.
That is what I was trying to get an answer on. That is rooted on the premise that it needs to be a truthood/assumption that Microsoft's projects net them less than the risk free rate (which is 4.5%).
That seems low.
It's a valuation problem with how much FUTURE profits are valued vs CURRENT profits.
Losing money now to make money in the future isn't sexy anymore. So you have to fire people until you make money now.
For companies like FAANG - which are ridiculously profitable - it's still the same.
Future profits aren't worth as much. Current profits are worth more. Now it's sexy to fire people to make more money now, because that's valued higher than before.
I am familiar with this concept but I'm curious if you could teach me more on the specifics. I think what you are referring to is basically "cost of capital analysis".
If the companies weren't hiring/paying payroll with debt at 0.5%, why does the fact matter that debt would now hypothetically cost them 5% come into play? Are they up against the fact that their projects (after payroll and all expenses) need to return more than the risk free rate (4-5%)? Why would that matter? Are tech projects really that unprofitable? I figured most projects at tech companies are easily 20%+ in terms of margin.
> For companies like FAANG - which are ridiculously profitable - it's still the same.
Would you go as far as to say Microsoft laying off 10,000 and Amazing laying off 18,000 people had next to nothing to do with the federal funds rate then?
Just how much has it increased? If we use the 3-month Treasury bill rate as the risk-free return, it has gone from 0.05% to 4.64%. A dollar in five years used to be worth (1 / 1.0005^5) and now it is only worth (1 / 1.0464^5). That's a drop of 25%, definitely significant enough to make some speculative and longer-term investments no longer pencil out.
When the risk free rate was 0.25%, the net present value of estimated future cash returns was X
Now, the risk free rate (2 year) is 4.50%. A different of 4.25%, therefore the net present value of estimate future cash returns is whatever X was, but 4.25% worse
For a company like Microsoft, how does that translate to layoffs? If their project was profitable to the tune of 10% margins and the risk free rate makes it only 5%, why are they getting rid of the entire project?
Or, did they have projects that had 5% net margin, and now the projects are breakeven, so they get rid of them? That would mean the people who got laid off at Microsoft were almost unanimously working on projects that were only netting Microsoft 5% net margin? I thought tech had better margins than that?
The 5% needs to be weighed against the cost of capital, not just the absolute return from the company's perspective. A 5% return sounds fine but if the market is now pricing equities for a 7% return then a company is lighting money on fire by making that 5% investment (because they can return the cash to shareholders who can invest in other businesses at 7%).
Let's say it was hypothetically like this.
Microsoft
2019
Cost of capital: 0.25% (should be irrelevant because they had billions in cash on hand but let's assume they refuse to use it for whatever reason and instead went to banks to get loans to pay for employees working on projects)
They work on a project, it returns 20% gross. 20% - cost of capital = ROI of 19.75%
2022
Cost of capital: 4.50%
Project returns 20% gross still, but now the net ROI is 15.5%
Why would you lay off employees who could bring you 15.5% (average project profitability assumption?) in favor of instead parking your cash for the risk free rate of 4.5%?
2019 Cost of capital: 7%, gross return 10% for 3% excess return
2022 Cost of capital: 12%, gross return 10% for -2% excess return
In which case that project would get cut and layoffs would occur.
But now let's say that risk free rates are 5%, which means that your portfolio has to compete with a net positive value asset that is essentially free of risk and in the same 10 year horizon will make you 60%, so your excess profits are now "only" 100%, which is a significant reduction from the original value proposition.
Thus, for the same risk profile, investment firms have to become much more restrictive in what they put in their portfolio. An entire class of investments (e.g. companies who are not expected to ever make money but have hype) has become basically a negative value proposition.
How can Microsoft (big tech company) not have faith that their highly paid engineers + managers can't build amazing products efficiently (aka not costing too much) to the point where they can outcompete the risk free rate which is temporarily ~5% and headed back down to 2-3% within the next 2-3 years most likely?
This is part of why valuations in tech land have been cut so much. If you are the management of a public company, and you are trying to increase your stock price, the answer is to make the your cash flow profile look more like option 1 vs option 2 above. One (perhaps shortsighted) way of doing that is to cut cost via layoffs…