January 27, 2023

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Is Big Tech Flabby? | financial times

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Good morning Earnings season starts in earnest today, with major companies from Johnson & Johnson to Union Pacific reporting. We don’t expect many big surprises, apart from perhaps some cautious projections. The real pain in terms of growth and margins, if it comes to that, will be in the second half. Let us know your expectations: robert.armstrong@ft.com and ethan.wu@ft.com.

Big Tech, downsizing and activists

Elliott Management, the activist investor, has invested in Salesforce and plans to “work constructively with Salesforce to realize value befitting a company of its size.” Salesforce isn’t alone among big-cap technologies. Activists have also been banging on the doors of Meta and Alphabet in recent months.

It would be surprising if this trend did not continue. Activists like companies with (1) strong underlying profitability, (2) structural issues that dilute, obscure, or misdirect those underlying profits, and (3) weak bargaining power.

Point one and three are easy. Big Tech became big because of high profitability, or at least high growth, which suggests the possibility of high profitability. Meanwhile, the absolute defeat in big tech stocks has created vulnerability to investor demands. Point two is trickier, but many big tech companies have spent a lot of money over the past few years to sustain growth. Activists can tell them to stop, which should give profits a boost. That’s exactly what investors have been asking of Meta and Alphabet. I’d be surprised if that wasn’t also Elliott’s baseline on Salesforce.

(By the way, activists in Big Tech haven’t always focused on cost; in previous cycles, calls have ranged from “buy back lots of stock” to “fire Steve Ballmer.”)

It’s not too surprising, then, that Google, Meta, Amazon, Microsoft, and Salesforce have all announced job cuts. The companies’ statements about the cuts all say the same thing: Demand has been high during the coronavirus pandemic, we hired a lot of people, but now things have slowed down. The story makes sense overall, but the unanimity of the message and the near simultaneity with which it was delivered makes me suspicious that it’s (how shall I put it nicely?) obscuring a more complex situation.

There are many big questions to answer. Are the activists right that big tech is letting go when it comes to capital allocation? Does this apply to some companies more than others? Are the companies correct that the extra weight is a pandemic phenomenon – or are the problems more fundamental?

Here is a table with some basic data:

One observation that needs to be made here is that these companies are diverse. First off, Microsoft, Meta, and Alphabet are much, much more profitable, both per employee and in return on assets, than Amazon and Salesforce. Amazon is simply a company with a lot of assets and human capital. Salesforce still has the low earnings of a growth-stage tech company, at least when earnings are calculated on a GAAP basis (return on investment above is calculated by dividing after-tax income by total assets).

This point has implications for activists. An activist taking on Meta might say, “Just retire your Metaverse investments and focus on your great core business.” At Salesforce, Elliott might have something to say about acquisition strategy, but it’s the core business itself that requires change.

Will reversing the excesses of the pandemic, particularly on hiring, be enough to keep investors happy? Here is a chart of company headcounts over the past decade (2022 figure is from the latest available quarter):

This chart shows that the pace of hiring has not increased as much during the pandemic. Microsoft accelerated hiring a little and Alphabet a little, but the trend has been steady for the other three since at least 2017. So the job cut announcements are best seen as a sign that the cost to troubled investors is being taken seriously. In and of themselves, these are minor tactical adjustments at best.

A job cut of 10,000 jobs is big — and huge for each of those 10,000 people — but consider that these companies have been hiring that many or more workers every year for years. This is not necessarily a meaningful change in normal business operations.

You may have noticed that Amazon is not included in the table. That’s because the chart looks like this when included:

Is Big Tech Flabby?  |  financial times

Again, Amazon is a whole different beast. It’s hiring as it vertically integrates distribution and diversifies its business at a different scale than the rest of Big Tech. That really belongs in another discussion.

How do we assess whether the rest of big tech’s decades of hiring frenzy has rendered companies inefficient? It’s not that easy from the outside. Revenue per employee is stable to increased (except again at Amazon):

Line chart of revenue/employee showing who is limp?

Looking at operating expenses as a percentage of revenue, the story is more mixed: Multi-year improvements at Microsoft and Google, while Meta and Amazon have slipped. Again, the fundamental point is that the trends are long established. This is not about the pandemic.

There is still work to be done here, but there is one important conclusion we can already come to. The pandemic has done little to change these companies; They don’t look much different than a few years ago. It also seems unlikely to me that they’ve seen very significant changes in demand recently as the slowdown is only now showing in the data.

So what has changed that activists are circling and companies are announcing austerity measures? The stock prices, of course. The rumble we’re seeing at Big Tech now has nothing to do with any decision the major companies have made over the past five years and relatively little to do with the companies’ recent financial performance (with the exception of Meta, which is in a real crisis). In terms of content, the only thing that happened was that the sell-off changed the balance of power between the companies and their investors.

You’ll note that one of the big tech groups hasn’t announced any layoffs and hasn’t attracted any attention from activists since the sell-off began: Apple. This is no coincidence. Its shares are down just 20 percent.

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