Yikes, I'm a few weeks later than usual and now slipping into February, so let's jump right into our ninth annual predictions post before it's too late to publish! A quick reminder that I do these for fun and fun alone. See my FAQ for my terms, disclosures, disclaimers, and the like.
Kellblog 2022 Predictions Review
Let's start with a review of last year's predictions which, as it turns out, were pretty good.
1. Covid transitions from pandemic to endemic. Hit. We can debate the semantics. Epidemiologists would surely differ. And the billionaires at Davos still don't treat it like a cold. But nevertheless, I think people now generally treat Covid as endemic.
2. Web3 hype peaks. Hit. I don't think I've ever nailed a prediction harder than this one. My new#boi weeps for its loss in financial, if not aesthetic, value.
3. Disruptors get disrupted. Hit. The point here was that just as we become our parents, that Salesforce becomes Oracle, Nvidia becomes Intel, and so on. This is more the ebb and flow of natural cycle than a specific prediction -- but given Salesforce's rather dismal year end, I'll give myself a hit.
4. VC continues to flow. Miss. Well, while VC funding was down dramatically in 2022 compared to 2021, but remember that 2021 funding was at all all-time high.
The more interesting point is that all this didn't slow VC fundraising, which hit a record high in 2022.
Going forward, while VCs clearly have dry powder, what's unclear is their willingness to invest it. High-quality companies will still be financed, if on less stratospheric terms. Those delivering average performance may find themselves with water, water everywhere, but not a drop to drink. Some believe that capital won't flow again until after an extinction-level event for startups in 2023/2024.
5. The metaverse remains meta. Hit. Big companies periodically catch self-boredom-itis and attempt to cure it with top-down pivots, dreamed up in corporate offsites with no regard for existing customers and no recollection of the organic, bottom-up processes that helped them become big in the first place. IBM Watson. Salesforce Chatter. Oracle Network Computer. Informatica Analytic Applications. BusinessObjects Sundance. Some companies treat these as publicity stunts, talking a big vision, but not really investing. Others get confused, believe their own marketing, and bet the ranch. Meta is in that situation: customers don't care, the market doesn't look attractive, and key employees are leaving. Yet on they plow. A+ commitment to a D+ strategy.
6. PLG momentum builds. Hit. I think PLG momentum built -- and peaked -- in 2022. Former Redpoint VC Tomasz Tunguz pointed out that product-led growth (PLG) firms are less profitable than sales-led growth firms, poking a hole in the "product sells itself" myth, and clouding dreams of liberation from costly S&M departments. (What drove people to the trial again, anyway?) PLG is a good strategy for certain categories, but VCs have a tendency, with all good intentions, to ram strategies down the throats of portfolio companies. As it turns out, PLG is like Nebraska: "honestly, it's not for everyone."
7. Year of the privacy vault. Partial. While it's hard to back this with data, I believe both Okta and Hashicorp are doing well with their secrets vaults, which continues to validate the vault design pattern. I remain excited about vaults as applied to privacy (for all the reasons I detailed last year) and my friends at Skyflow continued to make great progress with their privacy vault business and the evangelization of it. What if privacy had an API? Well, it should.
8. MSDS is the new MBA. Partial. I don't know how to easily measure this (irony not lost), so the scoring is entirely subjective. The in-hindsight obvious thing I hadn't seen coming was the integration of the two -- e.g., CMU's Tepper school offers both an MBA in Business Analytics and an MS in Business Analytics, as do many others. So the new MBA just might be an MBA in Business Analytics or an MSDS.
9. Get ready for social impact. Partial. I was right about the things that concern younger generations. I was wrong to the extent that those things now matter somewhat less as the downturn transfers power from employees to employers. Social change isn't just about what people believe, it's about their power to get it. This is not to stay the new agenda will be completely ignored, but simply that change will come more slowly because the balance of power has shifted.
10. The rise of causal inference. Hit. I continue to believe that causal inference will be to the 2020s what data science was to the 2010s. Read The Book of Why to learn more. Or take this causal data science course on Udemy.
Kellblog Predictions for 2023
With that warm up, here are my predictions for 2023.
1. The great pendulum of Silicon Valley swings back. If you look at Silicon Valley over long periods of time, you see a series of pendulums that swing over decades, all loosely coupled to a great pendulum. In 2022, that great (fka master) pendulum started to reverse its course and that will continue in 2023.
While Davos, Main Street, and Wall Street may differ on scale and scope, everyone agrees that the economy is turning. On Sand Hill Road, they're analyzing softening customer demand. The interesting part is how this will drive six sub-pendulums in 2023.
- The valuation pendulum: 10x is the new 20x, flat is the new up. That means a lot of companies need to double their size in order to earning their last-round valuation. Some have raised enough and/or spent sufficiently little that they can do so on existing cash. Others are not so fortunate. Runway extension is the watchword of the day.
- The structure pendulum: it's back. One way to maintain a flat headline valuation is to raise money with what's commonly called structure. Structure generally means financing terms, such as multiple liquidation preferences or participation (definitions here), that favor new investors over existing investors and the common stockholders in a liquidation. During boom times, structure falls out of favor. During slowdowns, structure, and the so-called dirty term sheets that propose it, come back. Caveat emptor. Think hard and model multiple scenarios before doing a structured round -- a dilutive downround or a clean company sale just might drive more long-term value.
- The growth vs. profit pendulum: balance is in, growth at all costs is out. Formerly backseat metrics like ARR/FTE, free cashflow (FCF) margin, R40 score, and gross dollar retention (GDR) come to the frontseat joining net dollar retention (NDR) and ARR growth. ARR growth still predicts enterprise value (EV) multiples well -- but particularly if FCF margins are better than 15%+. That means growth is great -- but only if you're profitable.
- The founder friendliness pendulum: the invisibility cloak loses some power. In the 2000s you'd routinely hear VCs whinging about "founder issues" at Buck's. But in 2009, with the founding of A16Z, came a new era of founder friendliness and along with it a founder invisibility cloak (or should I say invincibility cloak) whereby the presumption that the founder should run the company became nearly absolute. That pendulum will start to swing back in 2023.
- The employee friendliness pendulum. This is basic Michael Porter, but the new environment has reduced the bargaining power of employees. We'll discover that many of those perks and policies that were ostensibly rooted in culture and values were actually rooted in competition for labor. We're already hearing, "get back to the office" from Benioff et alia. Or unlimited PTO -- the ultimate perverse benefit -- from Microsoft. More companies will follow.
- The diligence pendulum: FOMO gives way to FOFU. In the past five years, I've never seen deals done faster in Silicon Valley, driven by a competitive market, growth investors with pre-conducted diligence, and a fear of missing out on investments. As the market cools, deals become less competitive, and stories like FTX emerge, things should return more to normal.
2. The barbarians at the gate are back. Valuations are down. Growth headwinds are up. S&M costs are high. Stock-based compensation (SBC) is increasingly controversial. That means activist investors will increasingly be swooping in to shake things up. And PE giants will increasingly be jumping in to clean things up. Anaplan and Zendesk were taken private in 2022. Salesforce is under pressure from two activist investors. Expect more of this activity to follow in 2023.
While it's not Henry Kravis at the gate this time, it's Robert Smith, Orlando Bravo, and Paul Singer. Management teams should prepare themselves for activist investors and adapt their financial profile to keep valuations high. While staggered boards and poison pills can stave off hostile takeovers, the best protection against an undesired take-private is a high stock price.
3. Retain is the new add. As companies prepare for a potential wave of churn, they put more emphasis on retention than ever before.
Why are companies afraid of churn in 2023?
- The downturn obviously puts cost pressure on customers. Must-have items can become nice-to-have overnight.
- SaaS sprawl. Per Statista, the average company uses over 100 SaaS apps and for many CFOs that's too many.
- SaaS rationalization. There's an entire emerging category of vendors (e.g., Vertice, Cledara, Vendr) who work to reduce SaaS spend. Their mission is to drive your churn.
- Consumption pricing. Consumption purists (without ratchets in their contracts) may well find themselves swimming naked as the tide goes out.
- Bankruptcy. Companies who sell to SMB may see increased amounts of uncontrollable churn as customers cease operations.
- Consolidation. Increased M&A can result in fewer, larger customers with larger discounts and lower costs per unit.
Companies increasingly have internalized the cost of churn. Namely that:
Cost to backfill churn = CAC ratio * churn ARR
That is, with a CAC ratio of 1.6, it costs $16M to backfill $10M in churn ARR.
While this bodes well for the customer success (CS) discipline, it does not automatically bode well for the customer success department. Those businss-oriented CS teams who thought customer advocacy meant generating customers who advocate for the company will continue to thrive.
But those checklist-oriented CS teams who thought customer advocacy meant internal advocacy on behalf of customers may well find themselves restructured. With new cost pressure, the idea of funding an internal K Street is unattractive compared to redeploying those resources to the underlying engines of customer success, such as product, services, and support.
There are, after all, two sides to being in the spotlight.
4. The Crux becomes strategy book of the year. Frequent readers will know that Good Strategy, Bad Strategy is my favorite book on corporate strategy. But my favorite part is how it eviscerates all the garbage that passes for strategy in corporate America.
In 2022, Rumelt published a second book, The Crux, which is more focused on how to build good strategy than on how to avoid bad strategy. I might have named the books Bad Strategy, Good Strategy and Good Strategy, Bad Strategy, respectively, but I suppose that would have been confusing.
I believe The Crux will become strategy book of the year in 2023 because:
- It takes a positive approach, more than a critical one. Readers generally prefer that, and I think it's the one thing that held back Good Strategy, Bad Strategy.
- It frames strategy around the plan to overcome a critical strategic challenge. I believe 2023 will provide many companies with clear strategic challenges that need overcoming -- and this book will help.
- He is logical, consistent, and practical in his thinking. Ruthlessly so. It's literally therapeutic to read Rumelt if you've spent enough years in the C-suite.
- Unlike business books that promise a magical answer (i.e., if you could just get <blank> right, then everything else will work), Rumelt offers a magical question: if you could just figure out the crux of your strategic challenge, then everything else can work.
The last point is not just verbal sleight of hand. Most business books preach a magical hammer (e.g., positioning, storybranding): learn to use this one tool and it will fix all of your problems. Rumelt does the opposite. He sets you on a search for the magical nail. Find that one problem -- that central knot or apparent paradox -- that, if overcome, will enable your success.
As he said in his first book, "a great deal of strategy work is trying to figure out what is going on. Not just deciding what to do, but the more fundamental problem of comprehending the situation." Learn how by reading The Crux.
5.
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