Just as a quick recap. I have argued in Computers and the Return on Capital that having cheaper information flows will in the long run drive the risk free rate of return to the time preference. I then examined how technology is likely reducing time preference for individuals through a variety of different mechanisms. In reply to that post Marc tweeted
And yet tech companies keep raising giant rounds of funding and spitting off huge gushers of cash :-).
That would suggest tech companies need more capital (increased time preference) and that they are producing large returns on capital. The second part of this is I have already addressed, writing that in the short run (some) tech companies will produce huge returns on capital.
Today though I want to dig into the first half of Marc’s reply and examine whether companies generally (and tech cos specifically) are needing more capital and how technology is impacting that in the long run. Here is the TL;DR I will conclude that overall technology acts to reduce time preference for companies as well but that in the short term (some) tech cos are raising larger sums due to potential winner-takes-most dynamics.
As a starting point it is useful to remind ourselves why companies need external capital at all. This was the favorite interview question of one of the first people I worked for after college. Most people answered something along the lines of buying equipment or paying expenses. But the answer he was looking for was more precise: paying for stuff before being paid by customers!
That’s important because one way technology reduces the need for external capital is through the pre-purchase of products by customers as happens on crowd funding sites like Kickstarter and Indiegogo. One way to look at this is that the company is effectively borrowing from its customers (ie getting capital in the form of loans rather than as equity). That, however, is only a semantic point. There is no separate opportunity here for a return on capital for someone who just wants to invest without buying the product.
Now obviously a bunch of companies that have done successfully avoided the need of capital initially through pre-purchase campaigns have gone on to raise lots of traditional equity capital, most notably Oculus VR. I will get back to that point later as it is part of the perceived winner-take-most dynamic. Before that I want to cover several other ways in which technology is reducing the need for capital for companies.
Companies, just like individuals, have less need for capital as technology is making (nearly) everything cheaper. I am typing this on a Macbook Air which gives me a ridiculous amount of compute power and memory by historic standards and yet costs less than $1,000. As I wrote previously, companies can also increasingly substitute technology for labor which as a result of this pressure is also becoming cheaper (at least at the unskilled end of things).
And, in another parallel to individuals, companies too are benefiting from assets becoming shareable and rentable by the minute or even second. Most startups today for instance don’t buy their own hardware. They rent it as they need it, which again reduces the amount of capital that they require. Companies that achieve profitability early on can then rent additional machines out of current income instead of having to raise debt or equity. Our portfolio company Science Exchange is helping to bring this model to lab equipment which demonstrates that this trend is not isolated to computer servers.
If these are the trends, then why are some companies, and in particular tech companies as per Marc’s tweet, raising literally billions of dollars in equity? For starters of course part of the answer is “because they can” meaning that investors are offering this money up even if companies could do without it. To dig a bit deeper though, there is a sense that more markets will have some level of winner-take-all characteristic where the leading company will be 10x, 100x or even more valuable than anyone else. And if that’s the case it would be a great source of time preference, meaning if you can buy your way into that position by spending ahead of revenues it will still be worth it.
I do believe that this argument has merit due to network effects. It is still worthwhile though to remind oneself that some formidable network effects businesses have been built on relatively little capital (eg. Google raised only $25 million of venture capital) and that networks too can be disrupted. That can happen for instance when there is a technological shift or if the network operator is trying to keep too much of the economics of the network for itself (or its investors).
In summary then, I believe that technology largely acts to reduce the time preference of companies, ie reduces their need to raise external capital. The exception to this appear to be winner-take-most dynamics which to the extent that they are real and sustained will lead companies to want to spend significantly ahead of revenues (and investors to want to provide that capital).
