Pain In the Tech Industry Is Beginning to Hit the Rest of Us

Amazon.com’s

decision early this month to delay the next phase of its vaunted, $2.5 billion HQ2 construction project in suburban Virginia.

Facebook

-parent Meta Platforms’ recent announcement that it will slash another 10,000 jobs on top of the 11,000 it cut in November. A national crisis of confidence in the banking system sparked by the collapse of Silicon Valley Bank. These events show how systemic weakness in big areas of the tech economy—retail, advertising, startups and venture capital—are beginning to spread outward from the companies most affected by them.

As Meta CEO

Mark Zuckerberg

said Tuesday, “At this point, I think we should prepare ourselves for the possibility that this new economic reality will continue for many years.”

Mr. Zuckerberg cited higher interest rates, geopolitical instability and increased regulation as challenges. He didn’t mention the tech industry’s interconnectedness.

The collapse of Silicon Valley Bank is a perfect example of this phenomenon, in a three-act mini-play.

In the first act, we see how tech is especially sensitive to broader conditions. In the second, how trouble in one part of the industry can ripple through the rest of it. In the denouement, we witness the way this amped-up trouble spills back out into the wider world.

The unraveling of Silicon Valley Bank began when interest rates rose, the “free money” spigot shut off, and investment in startups crashed. The result was investors and companies drawing down their accounts at the bank. It is now apparent that the ruination of this 40-year-old institution was, in a sense, an inside job, initiated by the very startups and investors who had previously been so devoted to it.

When the crisis spread to other small and regional banks, the government stepped in and declared all SVB depositors would get all their money back. Still, that hasn’t completely calmed markets or investors. Witness Wednesday’s spasms in the market for the types of government securities long thought to be among the world’s safest assets.

The same tech industry-based economic engine that fueled the global economy on the way up—turning every invested dollar into what seemed like a buck and a half—is doing the opposite on the way down.

Tech’s outsize impact

It isn’t entirely bad news. The tech-heavy Nasdaq Composite Index has gained about 15% from its low point last year in October, and some stocks have done even better. Meta’s share price is up nearly 122%, though still miles below the all-time high it hit in 2021.

That said, part of investors’ enthusiasm flows from the same cost cutting and layoffs that aren’t great for the broader economy.

The information-technology industry directly accounts for more than 10% of the U.S. economy, and about 8% of all jobs, according to the Commerce Department of. The Information Technology & Innovation Foundation, a Washington-based think-tank backed by tech companies, claims that the industry accounts for nearly one in five jobs in the U.S., when you include roles that support tech.

Amazon’s second headquarters, initiated after a nationwide business beauty contest that epitomized tech’s widening economic clout, was touted as a boon to the Arlington, Va. economy. The full benefits may still come eventually, but residents will have to wait.

Meta is on course to cut nearly a quarter of the employees it had at the end of September, bringing it back to mid 2021 staffing levels. Many of those cuts are hitting employees in a workforce that has scattered across the country over the past several years—meaning the effects won’t be concentrated just in coastal hubs.

Francesco Barosi,

global head of the technology, media and telecommunications practice at consulting firm AlixPartners says that virtually all of the CEOs and CFOs he advises are considering layoffs. The two big reasons are the economy, and that when CEOs like Mr. Zuckerberg and Amazon’s

Andy Jassy

are eliminating swaths of their workforce, other leaders no longer need an excuse to do the same.

“You never let an opportunity for a good, thoughtful resizing be lost,” he says.

A potential meltdown

In his book “Normal Accidents: Living With High Risk Technologies,” Yale sociologist Charles Perrow unpacked how it was that something like the 1979 meltdown at Three Mile Island could happen, then the largest nuclear disaster in history. What he discovered was that any sufficiently complicated system with elements that are tightly coupled is especially prone to catastrophic failure. A lot can go wrong, and when something does, its happens quickly.

Dr. Perrow’s descriptions of the perils of complicated and relatively untested technologies could apply to America’s financial system in the lead-up to the 2007-2008 financial crisis, or today’s densely interconnected web of tech companies large and small. These companies aren’t just competitors, but for years have been constantly copying one another, hiring away each other’s talent, acquiring startups, and enabling one another’s business models, both directly and indirectly.

One obvious example of such an interdependency is the way that

Apple,

with a single change that allowed users to opt out of data-gathering, gutted revenue at Meta’s Facebook and Instagram—to the tune of more than $10 billion in 2022 alone, Meta has said.

Another example is the way tech companies depend on cloud services from Amazon,

Microsoft

and Google. As companies pull back their spending on cloud-based software, growth in revenue has slowed for both the companies that furnish cloud-based tools, like Salesforce, and the underlying cloud service providers, like Microsoft.

As other companies follow big tech companies’ lead in shrinking their workforces, they are also likely to shrink their spending on items like services and software. If a firm wants to cut $200 million in costs for payroll and benefits, says Mr. Barosi of AlixPartners, he advises them to cut just as much in spending on third-party services.

Remote work, layoffs, and the microchip slump

A related interdependency is the rise of remote work. It would be impossible without the mass adoption of countless cloud-based and remote-collaboration tools. There is some irony in the fact that Amazon is both the world’s largest provider of the cloud computing infrastructure that makes everything from Zoom to Slack possible, and that the remote work enabled by those tools is one reason Amazon paused work on its second headquarters. 

The rise of remote work has already had a devastating effect on small businesses in urban cores, like restaurants. These effects may be magnified as tech companies lay off more workers.

The same negative-feedback mechanisms are playing out in the microchip industry. The almost unprecedented drop in global demand for microchips of the past nine months seems mainly because people bought lots of devices during the pandemic and have not updated them since. But in the future, as tech companies and other corporations halt hiring or shed more workers, it follows that their spending on personal computing devices, and the cloud services they deliver, will also slow.

You can’t build a “cloud” without racks and racks of computers called servers, and the microchips they contain. Even with the generous subsidies in the $53 billion Chips Act, intended to re-establish American competitiveness in chip-making, the tech slowdown may mean delays in building out the domestic microchip manufacturing infrastructure Intel and others have promised.

Startups’ options narrow

Meanwhile, the pain for tech startups that led to the collapse of Silicon Valley Bank may be just beginning. Many startups are sustaining themselves on money they raised during the boom times for venture investing. They anticipate that raising more funds in the near future will be difficult, if not impossible. In the final quarter of 2022, fundraising by venture-capital firms hit a nine-year low, down 65% from the same time in 2021. 

Some companies are turning to “venture debt,” an alternative when they can’t raise another round of capital by selling more equity at a price they find palatable, says investor Adam Struck, founder of Struck Capital. 

One problem with this strategy: The institution most likely to offer startups venture debt, Silicon Valley Bank, just blew up. New leadership is trying to keep it running, and there is still a possibility it could be sold to a buyer and reconstituted in close to its original form. Late this past week, some of the country’s biggest banks deposited $30 billion to rescue

First Republic Bank,

another common source of venture debt, after its stock price collapsed.

“Having Silicon Valley Bank to provide venture debt so companies could keep moving forward was a huge part of the business of startups,” says Mr. Struck. “I have to hope the free market steps up, but I’m not sure who that is going to be.” Almost all of the startups he has invested in had accounts at Silicon Valley Bank, and he is not sure where any tech startup will go to get debt financing.

As with early nuclear power plants, when a complex and tightly-interconnected system, such as the tech industry isn’t as robust against failure as originally imagined, the crisis moves quickly and can spread far.

Write to Christopher Mims at christopher.mims@wsj.com

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