The Tech job cuts – a phase or a permanence?

The FT had a short piece on Tech companies laying off staff (LINK) with 34,000 cut since the start of the year and the the announcements keep rolling in as to more reductions in the sector – Snap stated it would cut 10% from its workforce when it announced its results, eBay is reducing 9% and Alphabet and Amazon have both announced cuts even though results were better than expected. I thought it might be useful to highlight why – from an analyst perspective – Tech companies are doing this (and the answer is not as straightforward as you think). So some thoughts:

1. Firstly, to state the obvious, there is not often one single cause of why companies make cuts. That probably explains a lot about some of the confusion around there are so many corporates making reductions in the space. Yes, in some cases, the challenges to the businesses should be obvious but the Q4 earnings results season was generally positive for the major Tech companies. It might therefore be seen as confusing as to why there is a need for more cuts.

2. One thing I do not see the recent moves as reversing out the hiring sprees of the pandemic era. Virtually what companies wanted to do there would have been done in 2023, when over 260,000 jobs were cut according to layoffs.io There was already enough evidence by the end of the first half of 2022 that the pandemic trends were not translating into permanent shifts (with a few exceptions) and so companies would have been planning their cuts accordingly then with a view to implementing them in 2023 (there is an interesting question for management consultants to perhaps answer here regarding persuading clients to take actions based on the supposed permanence of the shifts but we will park that for now).

3. So why are companies making the job cuts now? First up, there is a desire to protect margins and / or a desire to prepare for a weaker outlook. EBay might be considered an example here, as they cited weaker consumer spending (which is interesting given the consumer spending data seems to be holding up well) and competition in the space. If you think your top-line performance will not be great, and you want to protect margins, then you reduce your workforce.

4. Yet that reduction also comes with a cost. As the Agencies found out in 2021 and the first part of 2022, if you make a lot of people redundant quickly and business bounces back, you find yourself in a scramble to cover your clients (the airlines industry is another classic example). Given the experience of many corporates in the pandemic of a yo-yo effect when it comes to demand, there is a reluctance to fire staff you may need to rehire quickly.

5. Hence, in some cases, job cuts are quite a useful indicator of what companies are thinking about their longer-term future, even if not all are so vocal about their long-term challenges and prefer to claim short-term / macro pressures for their problems (you don’t hear Meta talking about these in the same way it did eighteen months ago now its results are a lot better). Snap is an example here. They are clearly facing structural issues and a 10% reduction is sending a signal about how they see the future.

6. Spotify would be another example of this but they are slightly different, partly because they have been arguably more candid but also because the drivers of their rationale for cuts is slightly different. In their case, the business is growing both its subscription base and revenues quite nicely. The problem for Spotify is that it gives away, on a revenue proportional basis i.e. a variable cost model, most of its revenues to the music labels and artists (c. 65% according to the latest numbers but the general rule of thumb is 70% – podcasts probably reflect the difference). If you want to grow your margins, you need to reduce your fixed costs (labour and property) to do so.

7. There is also the matter of the share price and sending a message to investors about your discipline. This is what I think is at least part of the rationale for the cuts at the likes of Alphabet, Amazon and Microsoft. Given their results, there is a not a need to cut, and two years ago they would have been unlikely to implement such cuts. But making them now sends a signal that you will remain focused. That pleases investors. You only have to look at what happened to Meta’s share in 2023 which than doubled in 2023 off the back of its “Year of Efficiency”.

8. That message is particularly needed when analysts and investors are starting to prepare for a world when your revenue growth slows down and you become more of a “normal” company (note this is different to points 5 – which is really a case of structural challenges – and 6, which is more about the need to reduce fixed costs due to your business model). I would put Alphabet in this category – there is a (probably correct) view that the revenue growth in its core Search business is trending down to a level of mid-single digit growth. What Alphabet seems to be doing now is preparing for this future now.

9. Alphabet’s example shows another point. Namely that the rationale for cuts is not only driven by one rationale but can encompass several and / or change over time. This is the case with Meta which is a perfect example. Its job cuts plan was initially driven by a need to please the share markets as analysts and investors became increasingly critical by boosting margins. Yet, having started its job cuts, it soon came to realise that much of its work needed far fewer resources than thought previously. The cuts therefore gained a momentum of their own. Meta ended the year with a workforce 22% lower than what it started it at (and some cuts had already come in 2H 2022). The feedback I have received from managements in the sector is of this.

10. What about AI which seems to be increasingly cited as a cause of job cuts? I think this is companies getting ahead of the curve in part even though the final destination is somewhat clouded (I think companies have some clue because AI is not an entirely new concept and they have been automating / rationalising for years). However, I also think AI is a move being used by companies to somewhat redress the balance of power between employees and managements – after several years of the focus being on the employee, the pendulum seems to be swinging the other way.

11. Finally, what does all this suggest about moving forwards? None of the above points suggest that there will be a reversal of these patterns. Moreover, many of these companies are aware of being caught out by the rapid rise in US interest rates in 2022 which impacted their share prices so there will be a focus on vigilance (and especially given signs the dollar is strengthening again which will impact their foreign revenues). It feels like there is more pain to come.

As usual, this is not investment advice.