“Excessive automation at Tesla was a mistake. To be precise, my mistake. Humans are underrated,” Elon Musk wrote in a tweet last Friday. It was a stark admission from a CEO who has declared revolutionary robotic assembly as his decisive advantage over incumbent automakers. As recently as February, Musk claimed Tesla’s “parts conveyor system” in its Model 3 production facility was “probably the most sophisticated in the world.” In an interview with CBS last week, he admitted: “It wasn’t working, so we got rid of that whole thing.” It is an automation pitfall many saw coming. As Bernstein wrote in a report last month: “One tenet of lean production is ‘stabilize the process, and only then automate.’ If you automate first, you get automated errors. We believe Tesla may be learning this to its cost.”
From historically elevated P/E ratios and a rash of global scandals to escalating regulatory concern about tech giant monopolism, there has been constant evidence over the past year that tech’s market leadership may fade. Yet, time and again, tech companies and venture capitalists have renewed euphoria by selling the technologies of the future as imminent panaceas for the technology-driven problems of the present.
Long term, there is little doubting the disruptive potential of emerging technologies, whether robotics, machine learning, or blockchain. However, as Musk’s admission illuminates, the near-term promise of these technologies to generate real-world value has likely been oversold. Hand-in-hand with an E.U. and U.S. regulatory backlash, a seismic sentiment shift toward the technologies of the future could catalyze an equity downturn with contagion implications across the economy.
In WILTW April 5, 2018, we explored “Why the co-dependence between big tech and passive and algorithmic investing could cause far more pain than most anticipate.” Few times in history have markets been so dependent on the steady outperformance of so few companies. Escalating regulatory concern in the E.U. and U.S. presents a clear and present danger to tech’s market leadership, and in turn, the S&P 500. As a Bank of America report last week highlighted, technology (including e-commerce) is the least regulated industry sector in the U.S.:
Mark Zuckerberg was asked at his congressional testimony why tech tech giants should remain so lightly regulated. The Verge summed up his response:
Over the course of an accumulated 10 hours spread out over two days of hearings, Mark Zuckerberg dodged question after question by citing the power of artificial intelligence…Moderating hate speech? AI will fix it. Terrorist content and recruitment? AI again. Fake accounts? AI. Russian misinformation? AI. Racially discriminatory ads? AI. Security? AI…It’s not even entirely clear what Zuckerberg means by “AI” here…AI is not up to snuff when it comes to the nuances of human language, and that’s not even taking into consideration the edge cases where even humans disagree. In fact, AI might never be capable of dealing with certain categories of content, like fake news.
AI may be the most important enabling technology to emerge since the internet, but it is not a near-term, catch-all solution to Facebook’s gravest problems. In the moment, technologically-illiterate U.S. lawmakers appeared to take Zuckerberg’s AI-defense at face value. Post-testimony consultation with more-informed advisors should bring reality as they consider next steps. At the very least, the E.U.’s Margrethe Vestager won’t be as gullible as her U.S. counterparts.
As we argued in WILTW March 29, 2018, a regulatory crackdown on tech giants could cripple the most prominent unicorns in the private market. Uber appears particularly vulnerable. The company’s near- to medium-term future depends on two factors: continued global regulatory permissiveness and steady capital injections that allow it to subsidize rides and undercut competition. Both are under threat by the global regulatory backlash. Compounding the problem, Uber has oversold its autonomous vehicle progress—a reality exposed by tragedy last month when an Uber AV struck and killed a woman in Tempe, Arizona. If Uber’s backers lose faith in the company’s ability to compete for the future of autonomous ride sharing, the company’s VC funding stream could dry up.
Which brings us to another key vulnerability in the tech ecosystem. Global VC funding has skyrocketed over the past half-decade. As Mother Jones reported last week:
In 2004, total VC investment amounted to about $30 billion. Since then it’s grown at a rate of 13% per year. But most of that growth is in just the past four years: venture capital has exploded since 2013, increasing from $50 billion to $150 billion [annually].
Asia has been the main driver of this growth (see chart below). SoftBank’s Vision Fund has only escalated the competition. As The Wall Street Journal reported this week: “[SoftBank] is injecting billions of dollars into tech, in turn causing deep-pocketed global investors—and some U.S. venture firms—to arm up in response.” In 1Q18, 102 U.S. startups raised at least $50 million. The prior quarterly high was 91 deals in 3Q15.
Source: The Wall Street Journal
As the chart suggests, VC funding may follow a common economic dynamic: the “J curve effect”—sustained periods of slow growth, a dramatic spike as euphoria sets in, and then a rapid fall back to reality. The dot-com bubble’s J-curve crash was driven by a disconnect between enthusiasm about the internet and the timeline required for companies to seize economic value from it. We suspect a similar dynamic may be at play today.
It is doubtful any technology of the future provides clearer evidence of euphoria than blockchain. Irrational exuberance about cryptocurrencies last year caused a spike in funding for all things blockchain. Yet, global cryptocurrency interest only exposed the fact that the technology still requires fundamental innovation for it to be viable and in turn, valuable. Scalability is a central question. As Anju Patwardhan, managing director at CreditEase China, told TechNode last month:
If you look at the payment space, the global Visa/Mastercard networks can handle about 40,000 to 50,000 transactions per second. Ripple network can process 1,500 transactions per second. And blockchain can process about 1,000 transactions every eight minutes… That’s it. You need to get massive scalability before this technology can be used in payment solutions.
According to TechCrunch, “over the past 14 months, blockchain and related startups have raised nearly $1.3 billion in traditional venture capital rounds worldwide.” Initial coin offerings—startups crowdfunding by selling “tokens” to investors—have been an even bigger source of capital: nearly $4.5 billion was raised via ICOs over the past 14 months. The track record of ICO-funded companies is abysmal. We quote TechCrunch:
Bitcoin news site Bitcoin.com ran a survey that found that out of 902 companies that sought to raise an ICO, 142 failed before closing funding, and 276 failed after fundraising. It also found an additional 113 projects it classified as “semi-failed”.…The ultimate conclusion of that survey is stark: “59% of last year’s crowdsales are either confirmed failures or failures-in-the-making.”
For decades, disruption has been one of 13D’s key themes. It remains so. However, there are cycles in all life and as internet zealots discovered at the beginning of the new millennium, the downside can be just as painful as the upside was euphoric and exciting.