June 13, 2022 · 8 min read
The U.S. economy was on a tear for the past decade, barring a few hiccups along the way. Even COVID-19 and a global shutdown couldn't stop it, with the S&P500 doubling in value from its March 2020 lows in less than 2 years.
Following trillions of dollars in money printing, in the form of quantitative easing, forgiven PPP loans, and other stimulus programs, the US entered the fastest bull market in history. Private equity and venture capital, too, benefitted tremendously, touching all-time highs in investments and exits.
In turn, startup funding shattered records. However, the unprecedented stimulus, restricted demand, supply chain constrictions, and more have created persistent 40-year-high inflation. The Fed is stepping in with interest rate hikes to temper inflation. But, this could lead to an economic downturn, and startups need to act now.
Here's what you need to know about the current state of the economy, how a recession could impact your startup, and what to do about it.
A recession is defined as two consecutive quarters of shrinking GDP. This can be caused by many factors, such as high interest rates, falling consumer confidence, or weakening demand. A recession can have a ripple effect on the startup ecosystem, as businesses and investors may pull back on their spending, including investments in young companies.
In the first quarter of this year, the US GDP fell at a 1.4% pace, well below analyst expectations of a 1% gain. If the second quarter also sees a contraction, this would officially mark the beginning of a new recession.
There are several key indicators that a recession may be on the horizon. Large banks like the World Bank and Deutsche Bank have predicted recessions, while JPMorgan CEO Jamie Dimon sees an “economic hurricane” on the horizon.
The Deutsche Bank predicts a recession "worse than expected" for several reasons. First off, DB believes that a "soft landing," in which The Fed can successfully implement rate hikes without derailing the economy, is highly unlikely. Since inflation proved to be more persisent than expected, the Fed may have to raise rates aggressively, which could lead to a recession.
Several other factors play a role, including a reverse in globalization, increasing price pressure, an extremely tight labor market, sellers passing costs onto consumers, and an anticipation that the Fed will fail to curb inflation.
Even the prospect of a recession has already dramatically impacted many investors, startups, employees, and more.
Many investors have pulled back on their risk taking, becoming more conservative with their bets. This shift is being seen across the board - from VC firms to angels to corporate venture arms.
We're also seeing startups lay off loyal employees as they brace for an economic downturn. The resulting delays in product and service enhancements, less visibility through sales and marketing, reduced morale, and loss of institutional knowledge could do significant damage to startups in the long run.
All this is because the actual advent of a recession - should it happen - would have far-reaching implications that would touch every aspect of the startup ecosystem. For instance, reduced consumer spending would have a domino effect, causing businesses of all sizes to cut back on their own spending. This would include areas such as R&D, new product development, and marketing. Startups are particularly vulnerable during an economic downturn, as they tend to have less reserves and are more reliant on external funding.
Even without a recession, rate hikes make it more expensive to borrow money. This makes it harder for startups to raise capital and can lead to reduced valuations. In addition, many startups have variable-rate loans, meaning that an increase in rates would lead to higher interest payments, putting even more pressure on their finances. Simultaneously high inflation not only eats into profits, but also causes customers to cut back on spending.
In times of economic uncertainty, it's tempting for startups to reduce their overhead costs by laying off employees. However, this is often a short-sighted and counterproductive strategy.
There are several reasons why layoffs are generally a bad idea for startups. First, it can be difficult to predict which employees will be most critical to the company's long-term success. When startups lay off employees, they run the risk of losing key talent that may be essential to the company's future growth.
Tesla's recent move to do away with work-from-home has been viewed as a veiled layoff by some, and it may very well turn out to be a mistake.
Second, layoffs can damage a startup's culture and reputation. Startups are often lauded for their collaborative and innovative cultures - both of which can be eroded by layoffs. As employees see their colleagues being let go, they may become less trusting and more resentful of management. This can lead to a toxic workplace environment that inhibits creativity and productivity.
Further, layoffs send a message to customers and investors that the company is struggling. This can damage a startup's reputation and make it harder to attract future investment.
Finally, if the startup ever aims to become successful, it will need to hire again - and good talent may be hesitant to join a company that has laid off employees in the past. Not only that, but the costs of recruiting, onboarding, training, and lost productivity can be significant.
In short, layoffs may seem like a quick fix for a struggling startup, but they often do more harm than good in the long run.
For one, they should focus on conserving cash. This may mean reducing or eliminating non-essential expenses, such as high executive salaries, fancy office space, travel, and so on.
Further, they should consider alternative ways to reduce costs, such as renegotiating leases, discussing delayed payments to suppliers, using B2B buy-now-pay-later platforms, and more.
On the other side of the coin, looking for revenue opportunities is also critical. This may include expanding into new markets, finding new customer segments, or launching new products or services. Even maintaining the same number of customers can be a challenge during a recession, so it's important to be proactive about marketing and sales.
Cross-selling and up-selling existing customers can also be a great way to generate additional revenue.
At the same time, startups should communicate openly and transparently with their employees about the challenges they're facing and what measures they're taking to overcome them. This will help to build trust and maintain morale during tough times.
One of the biggest operating expenses for startups is cloud computing. An Andreessen Horowitz analysis, titled The Cost of Cloud, a Trillion Dollar Paradox, looks at the incredible costs of cloud infrastructure.
It's no wonder that businesses spend big on cloud services. The benefits are clear: agility, scalability, no need to invest in hardware, and pay as you go. Immediately available infrastructure drives efficiencies and reduces the barriers to entry for new businesses.
However, the cloud eventually puts pressure on company margins. As startups grow, their reliance on cloud services grows with them. At some point, the cost of cloud services can become a drag on the business.
The analysis finds that cloud costs are weighing down the market capitalizations of public software companies by a shocking $500 billion. This is because the market values these companies based on their growth potential, and high cloud costs limit that potential.
Hence, the paradox of the cloud: You're crazy not to use it, but once you do, it will eventually eat into your profits. This paradox is only worsening amidst rising cloud costs, including GCP doubling prices for some of its services. This is even driving businesses to the edge of bankruptcy. In one case, a mobile app startup faced a $72,000 bill after testing GCP.
To stay ahead of the curve, startups need to be proactive about reducing their cloud costs. This doesn't mean skimping on quality or features. Instead, it's about using the right tools and processes to optimize efficiency and control spending.
One problem with this logic is that it underestimates the true cost of managing your own data center. According to Stream Data Centers, the average cost of managing a data center ranges from $10 million to $25 million a year, including spending on hardware, software, disaster recovery, continuous power supplies, networking, ongoing maintenance, heating, air conditioning, property and sales tax, and labor costs.
Multi-billion-dollar companies like Dropbox have a different set of challenges, but they're still paying a hefty price tag for maintaining their own data centers. Not only that, but even the poster child of moving to on-premises data centers, Dropbox, relies on the cloud for some of its critical services. For example, Dropbox uses Amazon S3 in regions like the "UK, mainland Europe, Japan, and much of the non-American world."
The other issue with leaving the cloud is that doing so can hamper flexibility, the ability to innovate, and speed to market. In our fast-paced, constantly-changing world, businesses need to be able to move quickly. The cloud gives them that ability.
Simply put, startups that opt for on-premises solutions should be prepared for a laundry list of costs, a complex and time-consuming management process, and the fact that they'll probably have to eventually migrate systems to the cloud anyway. The cloud is still worth it,
The cloud offers startups a wide range of capabilities that simply aren't available with on-premises solutions. For example, cloud-based artificial intelligence and machine learning can help startups quickly and efficiently gain insights from large data sets. Additionally, the cloud's dynamic scalability can help startups quickly adapt to changing market conditions and customer needs.
The cloud also offers significant benefits in terms of customer satisfaction, with research finding a strong correlation between customer satisfaction and cloud use
There's no question that the cloud can be expensive. But for many organizations, the benefits outweigh the costs. Before making a decision to leave the cloud, make sure you understand all of the implications. It might not be the right choice for your business.
How to Cut Cloud Costs the Right Way
As prospects of a recession loom, cutting cloud costs has become a top priority for businesses across industries. In order to achieve meaningful cost savings, it's important to take a holistic approach that looks at all aspects of your cloud usage.
One framework that can be helpful in thinking about cost optimization is the AWS Well-Architected Framework. This framework provides guidance on how to build secure, high-performing, resilient, and efficient systems in the cloud.
Cost savings measures can be broadly classified into two categories: those that can be implemented by the cloud provider (e.g., rightsizing resources, identifying idle resources, and releasing unneeded storage capacity), and those that require the cooperation of the customer (e.g., creating a cross-functional FinOps team, conducting audits, and using AWS Cost Explorer). See this article for 21 cloud cost-saving measures.
While Reserved Instances can result in significant cloud cost savings, they require careful planning and management to be effective. Failure to do so can result in instances that are under-utilized and not providing the desired level of savings. In other words, RIs can easily become a sunk cost if not managed properly. Compounding this challenge is the difficulty in forecasting future capacity needs, which can change rapidly in today's dynamic business environment.
Thankfully, there is a solution that can help you navigate these challenges and optimize your Reserved Instance usage for maximum cost savings. Usage.AI is a cloud cost optimization tool that uses machine learning to identify cost-saving opportunities and automatically buys and sells EC2 reservations in real-time as your needs change. The tool takes the guesswork out of RI management, making it easy to achieve superior cost savings without sacrificing agility or performance.
To set-up Usage.AI, you'll simply make a limited-access IAM Role, with no changes to EC2 configuration, your workflow, or anything else. Security is top-of-mind as well, with Usage AI only requesting access to benign data, which gets encrypted both at rest and in transit.
One customer, FabFitFun, is saving $1 million a year on AWS costs after just a few minutes of set-up, and it’s common for companies to slash their EC2 spend by 50% or even more. Facing a recessionary environment, no business can afford to leave money on the table. Usage.AI can help you get more out of your cloud budget and keep your business running lean.