Before Twitter announced massive (~ 50%) layoffs after Elon Musk’s acquisition, financial services company Stripe announced a 14% layoff. Transport company Lyft followed with a 13% layoff, and on 9th November 2022, Meta, which owns Facebook, Instagram and WhatsApp, announced that it would cut 13% of its workforce. Earlier, Amazon announced that it would freeze hiring (often a prelude to “tougher decisions”).
Higher inflation and looming recessions are often blamed for these layoffs. However, the real reason for the layoff is often mistakes made earlier. There are some important lessons from these developments for entrepreneurs, small business owners and investors.
And this can be best seen from the CEO’s statements explaining the layoffs.
Mark Zuckerberg pointed to “massive long-term expectations for growth based on the firm’s rise in revenue during the pandemic.” He said, “Many people predicted this would be a permanent acceleration. I did too, so I made the decision to significantly increase our investments (spending)”. He also said, “the macroeconomic downturn and increased competition caused revenue to be much lower than expected”. Source: BBC.
Stripe CEO Patrick Collison said: “We were much too optimistic about the internet economy’s near-term growth in 2022 and 2023 and underestimated both the likelihood and impact of a broader slowdown. We grew operating costs too quickly. Buoyed by the success we see in some of our new product areas, we allowed coordination costs to grow and operational inefficiencies to seep in.” Source: Stripe.
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This can be seen as a form of hot hand fallacy. Looking at the recent performance and believing it will not drop in the future. Rookie mutual fund or stock investors know this mistake well. They see a stock or mutual fund offering huge returns in the last year and invest, assuming they would also get the same return only to see performance drop.
Many companies, big and small, make similar mistakes. First, they projected unrealistic growth often influenced by the recent past. Then they spend based on that projected growth (instead of the average growth and profit margins over the last few years). When the actual growth falls short, they are left with huge overheads and debt to service. Leading to budget cuts, frozen hiring and layoffs.
This is the problem with wanting to grow big too soon. While big tech companies have constraints and demands, at least entrepreneurs, start-ups and small businesses can learn from this and not make the same mistake – spend/borrow based on optimistic projections.
Paul Jarvis, web designer and co-founder of Fathom Analytics, explains why wanting to grow a business can be harmful in his book, Company of One, Why Staying Small Is the Next Big Thing for Business (link points to an audiobook). We strongly recommend this book for anyone running a business.
In this entrepreneur article, Mr Jarvis backs up his views with data:
Although contrary to most popular business advice, growth as a main goal or performance metric can actually be quite dangerous to the long-term operation of a business. In 2012, researchers from the Startup Genome Project looked at data from more than 3,200 high growth startups and found that more than 70 percent scaled prematurely through rapid growth and ended up failing — closing shop, selling off the business for cheap or having massive layoffs — because of it. The findings in this study where echoed in a similar study done by the Kauffman Foundation, where they found that 5 to 8 years after starting, more than two-thirds of high growth companies had to shut down due to the same reasons as the first study.
These lessons also apply to how we choose instruments. Most investors base their decision on the last year’s performance, not realising that asset classes and instruments (like businesses) go through cycles. Once they enter, the cycle reverses, leading to frustration. There is a lot of wisdom in the adage, slow and steady wins the race.
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