Ex-technology companies.
One of the most interesting questions I got after joining Calm in 2020 was whether Calm was a technology company. Most interestingly, this question wasn’t coming from friends or random strangers on the internet, it was coming from the engineers working there! In an attempt to answer those questions, I wrote up some notes, which summarize two perspectives on “being a technology company.”
The first perspective is Ben Thompson’s “Software has zero marginal costs.” You’re a technology company if adding your next user doesn’t create more costs to support that user. Yes, it’s not really zero, e.g. Stripe has some additional human overhead for managing fraud for each incremental user it adds, but it’s a sufficiently low coefficient that it’s effectively zero. This is the investor perspective, and matters predominantly to companies because it will change how their valuation is calculated, which in turn plays a significant role in investor, founder, and employee compensation.
If a company is a technology company in a “good” vertical, then the valuation might be 7-10x revenue. If it’s not a technology company, the valuation might be 2-5x revenue. The rationale behind this difference is that a technology company should be able to push its gross margin to 70+% as it matures, which will drive significantly higher cash flow, and most valuations are anchored in discounted future cash flow. This also means that if you’re perceived as a technology company one year, and then not perceived as a technology company a few years later, your company’s valuation plummets.
The second perspective on being a technology company is captured by Camille Fournier, “A company where engineering has a seat at the table for strategic discussions.” This is the employee perspective regarding how it feels to work within a company. If engineering has a meaningful influence in how the company makes decisions, then doing engineering work at that company will generally be a rewarding experience. If they don’t have much influence, then they’ll generally be treated as a cost center.
The recent trend that I want to apply these definitions to is that I see a number of companies losing their “technology company status.” These fallen technology companies are creating a new striation of company, whose employees and investors think of themselves as being in a technology company, but where the company itself is no longer able to effectively provide that experience to employees, or valuation to investors.
Companies are falling out of technology company status for a few reasons:
Their zero marginal costs were always aspirational constructs to attract investors. They can no longer find investors who believe in their dream, and they are not able to reach those zero marginal costs with their remaining cash reserves
They no longer believe they can change the business’ outcomes through R&D efforts, and as a result they shouldn’t include engineering as a major stakeholder in business decisions. I recently chatted with a data science leader who described their company reaching this state. They couldn’t show any business impact from the past two years of their product releases, so the finance team identified a surefire way for R&D to make a business impact: laying off much of the R&D team.
This is more extreme than the typical example of companies which have “overhired.” Those companies believe they have impactful R&D work to do, it’s simply that they have more capacity than high quality projects. These companies cannot identify non-maintenance R&D work that will make their business more valuable
The experience of working in this new striation of ex-technology company shares some of the ideas developed in Jean Yang’s Building Observability for 99% Developers: many of the latest ideas and trends are no longer appropriate or perhaps even affordable. However, compared to the 99% developer experience, this striation of ex-technology companies is in an even harder spot: they grew up, and established their R&D cost structures, believing they were technology companies. Now they have poor financial fundamentals and have downsized the R&D teams previously intended to build their way out of that predicament.
Organizations that spun up dedicated in-house build and deployment infrastructure have fixed engineering costs to maintain that infrastructure, and the math that convinced executives earlier–some sort of argument about the multiplicative effect on the impact of other engineers–doesn’t make as much sense anymore. But often you can’t just stop maintaining those investments, because that would require slowing down to decommission the existing systems, and ex-technology companies have little capacity for maintenance. Instead they’re focused on survival or roleplaying the motions of rapid product development despite actually spending the large majority of their time on maintenance.
This was the exact challenge we encountered after Digg’s layoffs: our architecture and processes had been designed for a team of ~50 engineers and now a team of ~10 had to operate it. Our service architecture of seven services made a great deal of sense for seven engineering teams, but was a lot less convenient for one engineering team with little redundancy in skillset.
If you’re trying to determine whether you’re in this ex-technology striation, the question I’d encourage you to ask yourself is whether R&D at your company can significantly change your company’s financial profile over the next three years. If the answer is yes, then I don’t think you’re a member. Even if you’re in a dark moment–and many people are in 2024–as long as you see a path for R&D to change your company’s financial fundamentals, stay hopeful.
On the other hand, if you simply don’t see a path to changing the underlying financials, then you probably have joined the new striation of ex-technology companies. This might be because your business never made sense as a technology company to begin with. Or it might be because your R&D operating structure is simply designed for a larger team than you’ll ever have again, and the work to solve that problem is uninvestable in your new circumstances.
The beautiful thing about our industry is that it’s a dynamic, living thing. We’re in a challenging pocket, but the good times are never too far around the corner either.