“It Is Now 2017 And We Did Not See Economic Disaster”

The publication Venture Beat published a column by co-founder and managing partner of the Fund Mucker Capital Erik Rannala. The investor told about why every year more and more companies valued over a billion dollars, getting the status of “unicorn”. According to him, this is due to the belated effect of the third industrial revolution. Edition vc.ru publishes an adapted translation of the material. According to the publication VentureBeat, in January 2016 in the world there were 229 “unicorns” — private companies whose score exceeds a billion dollars.

Edition of the Wall Street Journal recognizes the “unicorns” only 149 companies, while in 2014 their number has tripled. “The fans speculate about the end of the world to expand corporate “club of billionaires” there was only one explanation. In Silicon valley brewing another bubble that will soon burst,” writes co-founder and managing partner of Mucker Capital Erik Rannala.

In April 2016 the Fund Benchmark partner bill Harley has published in his blog entry, stating that the market, which is financed by “unicorns”, was “dangerous for all parties involved”. In may 2016, the correspondent of newspaper the Wall Street Journals Christopher MIMS suggested that “the beginning of the end could happen”, and in June the city of San Francisco has announced that work on a “rapid recovery”, which will help the city survive the inevitable downturn. “Then the whole it world is watching.

And nothing happened. Of course, some companies have made investments with a lower rating, some of the old “unicorns” kind of content-company Mode Media died, and the rate of emergence of new billionaires has slowed. But now it is 2017 and we have not seen a sharp decrease in assessments of start-UPS and subsequent economic disaster that many predicted,” writes Rannala. According to co-founder of venture Fund, the collapse will not happen either in 2017 or in the next year or a year later.

“Despite sky-high valuations, we are not in a bubble. Most of todays scores reflect the process of value creation — and at a level that we havent seen since the Second industrial revolution. And the sooner imbued with innovation, the higher the rating will rise” — says Rannala. By the end of the 20th century, the proliferation of computers and computing devices have not led to productivity growth.

The labor market researcher Robert Solow wrote in 1987. “You can see that the computer age has occurred everywhere but in the productivity statistics”. This phenomenon is called the “Solow Paradox”. “But looking back on the first and second industrial revolution, Stanford University Professor Paul David has argued that the slowdown in productivity growth after major technological change was not a paradox, and a sure indication that this revolution is already happening,” writes co-founder, Mucker Capital.

Industrial revolutions take place due to the emergence of innovations that launch the process of change. In the language of economists, they are called “General purpose technologies”. The first such technology was the conversion of steam power, the second is the use of electricity. These technologies are special because they allow innovation in many if not all sectors of the economy.

According to David, “General purpose technology” for the third industrial revolution are it, and this revolution continues. In the United States in the period from 1890 to 1913 in connection with the distribution of electricity first came the drop in performance. It was due to the slow rate of electrification of factories or other reasons. When electrification was completed, the next 15 years, until the great depression, the rate of production was growing incredibly fast.

A similar pattern is suitable for it. In 2005, researchers Jovanovic and Rousseau defined the year of the beginning of the spread of it. In 1971 Intel introduced the microprocessor, which became the nucleus for the first personal computers. Almost immediately the growth of productivity slowed down because the other company took the time to introduce computers.

The growth rate of production accelerated only in the mid 1990-ies. “Jovanovic and Rousseau predicted that if the spread of information technology will be the same as the distribution of electricity, the economy will experience the same growth rate of production as in the first half of the 20th century,” says managing partner of Mucker Capital. However, this has not happened yet.

After 2004 the rate of production fell again. “This suggests that in 2016 we cant enjoy the benefits of the it revolution,” says Rannala. As an example, from uses the McKinsey report 2015, which argues that the American economy uses the technology of only 18%. Outside Silicon valley, many organizations apply outdated equipment.

For the control of air transport used a computer system developed in the 1970-ies, and in the American nuclear program is still use computers running on floppy disks. According to Rannala, in parallel in the USA may occur by the fourth industrial revolution, associated with the proliferation of smartphones and artificial intelligence. He cites a special report edition of the Economist, which concludes that the decline in performance that emerged after 2004, “coincided with an apparent acceleration in the development of technology, as the web and smartphones spread everywhere, and robotics and AI quickly began to evolve”.

According to the Economist, the decline in the rate of productivity growth can also be associated with globalization as American companies have gained access to cheap labor abroad, and they no longer need to invest in technology that would reduce labor cost in the United States. “But because the cost of labor in China and other developing countries grows, we will again see an increase in the rate of productivity growth, and it will probably be incredibly fast, because the effect of the fourth industrial revolution will rely on (yet invaluable) the effect of the third industrial revolution. It will be something unprecedented,” — said Rannala.

As an example of the impact of such a revolution, he cites a modern company that best use the potential of existing technologies. “They benefit from the two main mechanisms by which their income grows is the network effect and effect data,” continues the managing partner of Mucker Capital. The network effect implies an increase in the value of the product grows its base of users (Uber and Facebook). The data effect is observed when the performance of the R&D Department increases with increasing the number of clients or user data (“Google Search”).

“In both cases, the performance and market share of such companies grow at the fastest pace. Therefore, the winners continue to win and leave their competitors from other areas behind,” writes Rannala. So in 2016 there is a gap between “unicorns” and all the rest.

“Companies that fully apply modern technologies have faced an unprecedented rate of productivity growth, unlike the rest of the economy. When that happens, the sky-high valuations unicorns will not seem something extraordinary,” — said Rannala. During the second industrial revolution was not the unicorn, however, was the stock market. Jovanovic and Rousseau noticed that the number of IPOs increased markedly in 1895, just five years later since the advent of electricity.

And throughout the period of adaptation “General purpose technologies” IPO attracted more money. “In other words, investors pumped money into new companies, created through the use of electricity,” writes Rannala. According to Jovanovic and Rousseau, the reaction to the dissemination of it was belated. Since 1977, the IPO increased the share on the securities market, however, until the second half of 1990-ies this rise was not, said the managing partner of Mucker Capital.

“Perhaps it was because the cost of distributing it was much higher than the spread of electricity, and we have yet to feel the effect”. Anyway, the high valuation of companies is not going anywhere, and there are a number of strong bases. Online distribution is the ability to scale profit. This means that as it companies grow larger, the boundaries of their profits rather increase than decrease.

While traditional companies, by contrast, the growth of face effect of diminishing returns. So, Im sure Rannala, shares of it companies should get higher scores than the shares of companies that fall under the effect of diminishing returns. “I agree with that not all investors, because in the books the increase in profits is still regarded as deviant, and the financial analysts still model the growth of income, based on diminishing returns. But this is another reason why the increase in the number of “unicorns” is not a sign of a bubble, evidence of the revolution”.

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