Low interest rates may be starting to generate the kind of irrational competition that should have tech bubble-watchers nervous.
Legendary Silicon valley venture capitalist Bill Gurley talked about this phenomenon in a Recode podcast recently. “In our industry we’re seeing that low interest rates are leading to overt competition that’s irrational,” he said. “Burn rates are areas we’ve never seen before. And steering those back towards profitability, if capital ever becomes scarce, is going to be a really difficult exercise.”
A great example of that “irrational” behaviour just appeared in real life:
Uber will give you a £30 credit if you order a Coke and they deliver it late
Uber is giving people in London hundreds of pounds of free food just to keep coming back to its UberEats meal delivery service. If your order is wrong or late, Uber will give you a credit of between £10 and £30 ($13 and $38) for a future meal. Even if all you have ordered was a can of Coke. Business Insider writer Rob Price found one customer who received £462.12 in meals this way. Rob himself gorged on £180 of free food.
Uber has a history of giving its product away free, in excess. We found one Uber driver who earned $90,000 from referring new drivers to the company en masse. And we found a passenger, Blake Jareds, who declared himself the “Uber King” after he earned $50,000 in credit from Uber for referring new passengers to the app.
Those “free” incentives add up. In the first half of this year, Uber lost $1.27 billion, according to Bloomberg.
Normally, the narrative around Silicon Valley tech startups goes like this: All companies initially lose money as they invest, promote their service, and gain market share. Later, when they have reached “scale,” the company can cut back on the spending and make profits.
But Gurley believes that may be easier said than done.
Money is getting thrown at businesses that would look ridiculous if interest rates were higher
Low interest rates make money cheap to borrow for investors. It also makes riskier returns seem more attractive than they should be: If interest is at 1%, then a 2% return on your investment suddenly looks like it is twice as good as the risk-free interest rate.
So money is getting thrown at businesses that would look ridiculous if interest rates at 5%, for instance. Here is what he told Recode’s Kara Swisher:
“And I was fortunate enough this summer to meet Warren Buffett — Chamath [Palihapitiya] was the one that made that happen. But we only had one question each, and I said, ‘You know, in our industry we’re seeing that low interest rates are leading to overt competition that’s irrational.’ And he says, ‘You bet it is.'”
“… There’s way fewer companies, whatever the number of unicorns is, but they’re being given piles of money. Hundreds of millions. And burn rates are areas we’ve never seen before. And steering those back towards profitability, if capital ever becomes scarce, is going to be a really difficult exercise.”
“… One of the things that Silicon Valley does when it gets risk-seeking, which it did in ’99 and now, is they invest in businesses with lower and lower gross margins. And that’s riskier. And a lot of times those involve consumer products. And then what they do is they start selling them heavily discounted. And there’s this old saying about selling dollars for 85 cents. But there’s a truism to it. You can create infinite revenue if you sell dollars for 85 cents. And if you give consumers more value than you charge them for, they will love you.”
This is the scary bit, for people who believe that this time is not different, and that economics moves in cycles: Interest rates are very low, allowing marginal businesses to survive. Uber is the biggest unicorn on the planet, valued at $68 billion. It is not profitable. It is driving cans of Coke around London and giving consumers £30 if their soda is late.
Tech startup pitches are starting to use the word ‘trillion’
At some point this comes to an end, just as it did for Pets.com, Kozmo, and Webvan. Those were the transport logistics unicorns of the 1999/2000 era, who went bust ferrying objects around town for prices lower than the cost of delivery. Here’s Gurley again, reminding everyone what this end looks like:
“I probably sit in on eight unicorn presentations [recently], and five of them use the world ‘trillion.’ Now I don’t think I had heard the word trillion in an investor presentation before that day.”
“But we had done something in the ecosystem to encourage this type of outlandish promotion — where you feel like you need to use words like trillion. And I think it’s dangerous when we act like we have the right to disrupt everything or eat every industry, but we’re not willing to play by the rules of profitability or GAAP accounting or being public.
“… People discount risk slowly. Like they forget about pain and they forget about layoffs and they forget about that this is supposed to be hard, you need to profitable. And the younger generation, they’re taught in very short time windows. So most of the entrepreneurs today weren’t around in ’99.”
“… If we play these bubbles out, if we just get extremely promotion-to-the-end-state, then you have the type of crash you had in ’01, which is complete wipeout. Like, 50 per cent of people get laid off. And it’d certainly be better if we can avoid that kind of thing.”