First Cut is The Deepest

Richard Kramer: Welcome to Bubble Trouble, conversations between independent analyst, Richard Kramer, that's me, and the economist and author, Will Page, that's the other guy. And that's what we do...

Will Page: [laughs]

Richard Kramer: ... lay out some inconvenient truths about how financial markets really work. Now, our new strap line is, if there's a bubble that bursts, we pricked it first. And this week's episode will cut like a knife, pun intended, in that we're gonna try to make sense of the headlines about headcount reductions and cost-cutting strategies across tech companies large and small. The First Cut Is The Deepest was the song from Cat Stevens, then copied famously by Rod Stewart and Sheryl Crow, but there's a lot more than one verse to that song, and we can expect lots more about cuts to come in the markets. More in a moment.

Will Page: So we're gonna go back to our foundational series of Bubble Trouble Podcast where I assume no prior knowledge on a complex topic in finance, which for me is called method acting, and then I grill someone who does know a lot about complex topics and financial markets, that's Richard Kramer, so our audience can make sense of it all. This one is for our audience not for ourselves, and I wanna get straight into this headline frenzy about hiring freezes, headcount reductions, and cost-cutting we're seeing in tech companies, which in many cases have never had to do this dance before. So let's dive in on that point, Richard. When we talk about first cut's the deepest, full credit to Cat Stevens in North London or there, but would it be fair to say that the Googles, the Amazons, the Meta Facebooks of this world haven't had to cut before? Is this the first time that we've seen net reduction in headcount in these tech companies?

Richard Kramer: Well, to answer your question directly, Will, indeed this is the first RIF, or as they say in the business, reduction in force that many of these companies have ever undertaken. Now, certainly there have been areas they de-emphasized in the past, there have been areas they shut down, and there have been areas they've had headlong growth, but what we've seen since the end of last year is that nearly every tech company has fired around five or 6% of the staff. And if you do the math, that's around one and 20 at the organization. And typically they're split up into teams that might be 10 or 15 people, so it might be that your team escapes unscathed, or it might be that your team gets de-emphasized.

But when you step back even further, you realize that most of them have huge increases of 30, 40, 50% of staff numbers since the end of 2020 when the war of talent, or war for talent, began. Now, there was a massive acceleration in that war for talent because of what I would call the WFA trend. Not WFH, but WFA, which is work from anywhere.

Will Page: A new acronym.

Richard Kramer: All of a sudden there was no head office to recruit you into, and you could get exceptional people to consider roles from anywhere in the world that they wanted to work from home.

Will Page: Great. Now, I think what we should do to kind of give the foundational stepping stones for this podcast is just look back over the past year or so and put into some sort of chronological order what these layoffs have looked like. And I'm interested in layoffs which have got at least four figures, maybe five, and I think the first one to cut them like a knife was Shopify. If we go back to July, they shed 1000 people. It's a big correction there in their stock price. Then in August, we saw Peloton shed 780, and Snap 1,280. Moving forward to November, and then we saw that knife cut that bit deeper. We saw November, we saw Twitter delete 3,037 tweets, Meta shed 11,000 friends, Namson offloaded 10,000, and then doubled that again in January.

And then we come forward to January of this year, we're seeing some big numbers. We're seeing Microsoft offload 10,000, Alphabet offloading probably 12,000 on top of that. So we've had this trickle, this drip feed of headcount reductions across tech, and these are just some of many, but these are big numbers. How should we put these layoffs into context? Uh, uh, for Bubble Trouble audiences, we always want to put absolute and relative terms around this. Are these absolutely big numbers? Are these relatively speaking big numbers? Give us some context.

Richard Kramer: Well, I wanna do that in three separate areas. The first one is pointed out brilliantly by my friend Scott Galloway, who knows that-

Will Page: A friend of the show.

Richard Kramer: ... friend of the show who notes that the 12,000 people that Google laid off in its RIF at the beginning of this year contrasts to the 68,000 people it's been hiring since the pandemic.

Will Page: [laughs]

Richard Kramer: And Meta added about 42,000 people and let 11,000 go. Microsoft added over 77,000 people and let 10,000 go. Even Salesforce, which is certainly under a lot of pressure from a theme we touched on in a previous podcast, activist investors, they're piling in there, they've let go of 8,000, but have added, both through hiring and through acquiring other companies, about 31,000 people. So the first point that we wanna make is that while you hear about these big number headcount cuts, there were many more people hired and what you're doing oftentimes is swapping out older, more expensive staff for younger staff with credentials that might fit what the companies next big projects are a little bit better.

A second thing that's really important to understand is that these companies are constantly refreshing their workforces. I remember back a- a decade or so ago when I was spending a lot of time looking at the Indian IT outsourcing companies, they would tell you that 20% staff attrition is normal. One out of five people would move or job hop every year.

Will Page: Mm-hmm.

Richard Kramer: And in the US, 6% that most companies are targeting in terms of headcount reduction might be less than the natural attrition they see in their workforce.

Will Page: That's interesting.

Richard Kramer: People [inaudible 00:05:59] hire, they wanna move, they get fed up, they get a better offer. For example, the new CEO of Pinterest is someone who left a role as a senior vice president at Google running a much larger business, but it's clear that he wasn't gonna get the chance to be CEO at a big company like Google where there are probably many people waiting in the wings and a succession plan. So the second point I'd make is that this headcount cut to our reduction is just some- an accelerant of the natural moving around that happens all the time at these companies.

And then a third thing that I think is important a- when you're asking about putting these layoffs into context, again, you have had a tremendous boom period in terms of the shift towards tech jobs, especially coming out of the pandemic, because all of a sudden we were all naturally relying on all these tech tools. Now, one of the companies that had to make big layoffs because we've all settled into a pattern of using their products regularly or trying to use them less is Zoom where they fired, I think, about 15% of their workforce because, guess what?

Will Page: [laughs]

Richard Kramer: The growth that happened in leaps and bounds for them in the last two or three years has now settled into a much more normal pattern.

Will Page: That's inspired two thoughts. That's a very, very helpful description there that- not just for me but for our audience gets their head around the headlines, but the first thing is not all headcount is the same because, to your point, if I just stopped hiring, I could reduce the headcount on my phone through natural churn. And what you're saying is I'm just gonna bring that headcount reduction forward, as opposed to let natural churn do the job itself. Then secondly, again to reiterate, not all headcount is the same because [laughs] I think Amazon fired their recruiting force and that was about 10,000 people. So I'm firing the people whose job is to recruit labor. So if I'm not gonna hire anymore, then I don't need to- that headcount involved in hiring. Fair comment?

Richard Kramer: Yeah, and I think a company like Amazon with a million and a half workers-

Will Page: [laughs]

Richard Kramer: ... it's very difficult to know whether-

Will Page: That's the workforce of Scotland.

Richard Kramer: It- it's very difficult to know whether they are reducing people who work in warehouses or people who have an Amazon.com e-mail address and work in high paid data science jobs, for example.

Will Page: Mm-hmm.

Richard Kramer: And you also realize that part of the natural attrition that you see is because many people working inside these tech companies have jobs which they wake up in the morning and try to automate what they did yesterday. They try to replace with technology the work that they were doing the day before, so there is a sort of natural rolling obsolescence inside these companies and equally structurally the way many of them are attached to projects. And when the project comes to an end, you need to either find a new project within the company or it's assumed that you'll move on and do the same thing somewhere else.

Will Page: Right. [laughs] So it just made me think about that expression tech is eating tech. Maybe one of the perverse outcomes of the pandemic is that we've now had technological advancements which means tech can destroy its own headcount even faster as well. Now, we were toying with the idea of a name for this podcast, and we leaned on Cat Stevens' song First Cause Is The Deepest because you're saying it's not the first cut. You're saying there could be a second and a third on its way. Talk me through this idea you have about why first cut is not the last.

Richard Kramer: So in my close to 30 years of being a tech analyst, I have seen many companies go through what is affectionately called restructurings. The typical pattern of these is usually involving three or four stages. Now, the first stage is a very simple, very easy one, you cut the flight of fancy projects; the providing Internet service in emerging markets with balloons or gliders-

Will Page: [laughs]

Richard Kramer: ... the strange robots that are supposed to follow you around your home and ask you questions or listen to what you're saying. All of these crazy projects that get funded, especially in very heady times when everybody wants to believe the best and interest rates are zero, so money is free, you may as well try your hand at things, all of those flight of fancy projects are the first ones to go on the chopping block to say, "Look, we've poured a lot of money into this, it's clear it might take years to come to fruition or never work, let's just end it now. Let's cut- cut our losses and move on." That's the first phase, and I think that got done already before these headcount cuts you're talking about come through.

Will Page: Got it.

Richard Kramer: The second phase is usually involving, and indeed I would call it the second and third phase, usually involves measuring productivity in your workforce. You've got 10s of thousands of salespeople, figure out which of them are exceeding their quota or not meeting it. You've got 10s of thousands of engineers, figure out which of them are completing their projects on time or have very high software quality deliverable scores, and which of them miss their ship dates again and again or have a lot of errors and bugs. And you can go through the whole organization and find spaces where in that second and even third phase, you roll through and constantly measure people's productivity.

You heard that Mark Zuckerberg, CEO of Meta, said, "We need to take people who are managers, and they all have to become what they call individual contributors. IE, if you're not doing something that directly generates a product or revenue, then we don't want you around, you don't have a job telling other people what to do," so it's equally a good time to take a hatchet to all those bureaucratic layers that tend to build up in large companies that move fast and try to hire in big teams quickly. And really, there's a last phase which will come on to talk about later, which is really when the wolfe gets to the door.

Will Page: [laughs]

Richard Kramer: But, you know, time and again, you see senior management to middle management saying, "Right, I realize this is not gonna be as easy an environment for me to operate, maybe it's time for me to do something different." The head of YouTube just left Google after 25 years, and said, "You know what, it's time for the next chapter in my life," as opposed to grinding out a recovery and ad revenue in a tough market.

Will Page: Well, [inaudible 00:12:21] one word or abbreviate, I think is two words that you didn't mention in that very eloquent answer is offsites. [inaudible 00:12:27] when do you cut offsites? I remember [laughs] we were sharing a hot desk with- in a coworking space with this company which had offsites, and the waste that happens in company offsites, that's gonna make your blood boil.

Richard Kramer: Ugh. So already, I think you've seen m- multiple tech companies mention that there will be no more boondoggle offsite, internal meetings, and I think that is just a prudent cost measure. There's other ways to do team building exercises than to take the whole company to Mauritius or Malaga or wherever you'd go for a long week of seminars and, uh, and boozing.

Will Page: [laughs] I remember at Spotify we flew I think 480 people to Cuba.

Richard Kramer: Ugh.

Will Page: To Cu- imagine flying the Japanese office to Cuba. That was, like, three days of flying for a two-day offsite and back again, and we all got sick 'cause you couldn't drink the water.

Richard Kramer: Those were the- those were the days, Will.

Will Page: Grand stuff. All right, so I think the best way to close out part one here after our three cuts is the deepest, which is what's the sign for our audience here, what's the sign we- that cut is the last?

Richard Kramer: Right.

Will Page: When do you think you can spell out that- that cut you heard about in the headlines in the Daily Telegraph and the Financial Times last week, that's it, no more cutting anymore, we've- we've cut it to the bone and there's nothing left to shave off?

Richard Kramer: So there's a brand new four letter swear word in the market that begins with C and ends with T, Will. And before your filthy little mind takes the wrong turn-

Will Page: [laughs]

Richard Kramer: ... it's cost, right?

Will Page: [laughs]

Richard Kramer: And there's been a huge change in tone from investors, from VC backers of small private companies saying, "Please take a hard look and look again at your cost structure." The cash flows are the new king, people realize you can't eat from adjusted earnings, and they're not a real proxy for cash flows. So every company right now is examining its cost with forensic detail and trying to understand when it is they got down to the level where this is the bare minimum we can spend to run the company. Now, I would not suggest that companies are going to pull the trick that Elon Musk seems to be trying at Twitter where he says to his landlords, "We're not paying rent on our offices," 'cause that usually doesn't end well."

Will Page: [laughs]

Richard Kramer: There's usually an eviction notice somewhere at the end of that process, but certainly the last cut is when you come near to the last pages of chapter 10, and you're about to churn the page to chapter 11, where you file for bankruptcy. So the companies that know that they don't have to cut their costs anymore are ones that can either see a recovery in their business already happening from a lower cost base, or they've simply had the wolf at the door and no way to hold them back.

Will Page: Fantastic. Well, you've taken us through the first, second, and third cut in the deepest. Let's park it up for part one. And p- part two, I wanna get into how these cuts are working with stock buybacks. How can companies hack their workforce yet buy up their own stock? But for the now, First Cut Is The Deepest and we'll be back for the second and third in the second-half of this show.

Welcome back to Bubble Trouble. And this episode, we're dedicating it to the famous Cat Stevens of North London with the song First Cut Is The Deepest, where we've been learning about the second cuts and the third cuts which are coming down the pipeline to tech companies any day now. And to get back into the conversation, I wanted to ask the doer, pessimistic, Scottish economist question, which is there's gotta be a cost to all this cost-cutting. Cost-cutting doesn't just hang off trees and you know just press F key on your keyboard and it happens, there's gotta be a cost of firing all these people. So talk to me about the nature of the layoffs, how they happen, the cost of making them happen, and the ramifications when they do happen.

Richard Kramer: Sure. So The first thing you can see is that the numbers of staff are what gets all the headlines, but what you've got to realize when we dig into the profit and loss statements of these companies is that the headcount alone is only part of the cost you reduce. Because remember for all of those staff, you've got benefits, you've got the desk space and the office space, the HR coverage, the healthcare plan, the food in the cafeteria, the travel to the sales conferences-

Will Page: Mm-hmm.

Richard Kramer: ... these seats bought for software that they use from Salesforce or Zoom or Microsoft or many others. So there are a whole range of overheads that tend to leave on a lagged basis because you might have an annual software contract with a company for a certain number of seats, and as you reduce headcount, you reduce the amount after your contract expires on your new deal how much you pay, and so that's why companies both take upfront charges for severance because they have to pay out staff that get paid several months of salary depending on how long they've been in service with the company, and maybe a lump sum payment or some other options will vest, but also they don't see the benefits of turning over the new contracts for external services until those contracts expire and then it get renegotiated with lower headcount numbers attached to them.

So that's why you're not going to see an instant reduction in costs for all these companies that fire people. Those costs tend to be more durable and need to come out overtime.

Will Page: So you're making me think I should switch lanes from private sector to public sector. Back when I was young, free, single, alcoholic, and a civil servant, I remember understanding the cost benefit analysis in government where redundancy costs were treated as a transaction fee and not part of a cost benefit analysis. So you could fire lots of people, but it didn't affect the cost of a proposition, which is quite surreal. It made firing a very easy thing to do, not that the government did much of it. Now, I wanna switch lanes again and just pick up on a developing story, And you've talked quite a lot about how these large tech companies sit on, pardon my French, shitloads of cash.

Richard Kramer: Mm-hmm.

Will Page: And when the stock prices are down, you've got the ability to buy up your own stock. And in a thin market, that can create momentum trading and that can lead a rally and that can get stock back up to where it used to be. Now, Facebook's shed a lot of people. I know a lot of people who have lost their jobs at Facebook and are quite bitter about it. How should they feel when Mark Zuckerberg then after sacking a bunch of workers, chooses to spend millions and gazillions of dollars on buying up his own stock to get the stock back- back up? How- how- can you square that circle for me?

Richard Kramer: Well, look, I think for all of the employees that are going to be affected by these reductions in force, again, they are a fraction of the people that got hired in the past couple of years, and I think they're all big enough boys and girls to realize that this is the way the labor market works. Now, there's another very important dynamic at play, which is everyone else who remains at the company is still typically incentivized on either stock options or restricted stock units, which is a kicker or a bonus or additional pay, however you want to look at it, but it only works when the stock price is going up.

So while these companies are still cash rich and they can easily handle with the cash that they have on their balance sheets the cost of severance, they also, for all of the remaining staff, need to show a positive trend or u- upward momentum in the stock price because many people at these big companies are sitting on options which are so far underwater there's no prospect of the stock price, in the near term, getting back to the level where they would want to exercise those options. There's no point exercising an option for a stock at 100 bucks when the stock price today is only 50. You'd be paying an extra $50 to own the stock at $50, so the managements are really forced to take action to shore up the stock prices beyond the sort of red meat announcement that investors wanna see that they're taking a close look at their cost so that they can deliver more profit to the bottom line in future periods.

Will Page: It's a bitter pill to swallow, surely, though. [laughs] It's like, "I can't afford to keep you in my company anymore, but I can afford to buy my own stock." But equally, I guess what you're saying is it's better to have a shrunken workforce motivated by a rising stock price than have a bloated workforce demotivated by a sunken stock price.

Richard Kramer: Indeed. And also, for many of the companies that are doing this, they have the luxury of having raised a lot of capital when money was free and having come off, certainly in the tech sector, a couple of years where you had exceptional tailwinds to the business. We all shifted our lives towards tech for the last two or three years. We talked about the dog years and ecommerce in previous Bubble Trouble episodes-

Will Page: Mm-hmm. Mm-hmm.

Richard Kramer: ... the way you had sort of a seven years and one acceleration in that sector and many other areas of tech. I mean, we never imagined three years ago that we would be doing the majority of meetings or speaking engagements or whatever you would want to call it via Zoom or Teams or some other video conferencing medium. So again, these companies are flush with cash because they either raised it or generated it, and they are really under pressure to make sure that the stock price is seen as something worthwhile for their staff, and they aren't demotivated that a certain portion of the compensation is coming in effectively a worthless financial instrument.

Will Page: Dog years in tech. You remind me of a- [laughs] a founder met in Israel, a tech founder who talked about the average lifespan of a tech company was broadly in line with the average lifespan of a marriage, which is roughly seven and a half years I think, but I think-

Richard Kramer: S- seven year itch.

Will Page: So let's take the hypeness too of these headlines, and I wanna turn now to a former leader of this country, Margaret Thatcher. And when she looked at labor market reform, she always had this mantra, which is, "If you make it easier to fire, you'll make it easier to hire." And hop, skip, and jump across 15 years of political history here, she took on the unions, changed labor markets, and made Britain a flexible labor market, much like your homeland of America has a flexible labor market. I honestly believe, and I don't wanna go down my own rabbit hole here, but I honestly believe that is one of the successes of the British economy is it's really easy to fire, which makes it really easy to hire.

If you look at labor markets of Germany and France... And by the way, I think in this City of London we have, what, 300, 400,000 Parisians working here, there's very little net job creation. There's jobs created, but there's not nearly the net job creation you see in Britain. We have that here. So I'm thinking if it's now easy to fire, easy to hire, and there's some firing going on in tech, should we be really worried at all? Is this just capitalism working its way through the wash? You know, the labor market will correct itself.

Richard Kramer: So the easiest way to answer that is that in a super dynamic field like tech, you're always going to have labor market mobility. Right now, you have one of the world's largest companies, Apple, which has managed to develop its chips, with TSMC's help, at the lowest possible known geometry demand, three nanometer.

Will Page: [laughs]

Richard Kramer: But what's happened now is rivals like Google and Qualcomm, also with big chip programs, are going to Apple and poaching the engineers that have experience of how to work at that cutting edge field. So any of those areas in tech which are seen as cutting edge or where there are staff that have s- been seen to do an amazing job in bringing something to market, they will always be targeted by someone else looking to become a fast follower in that space. So I think there is a natural labor market mobility in tech that you may not see in other fields where there's a much smaller roster of competitors, or where the functions and the abilities of the management are less applicable across companies.

So it- will an aircraft engineer be poached to get a job working for an auto manufacturer? Maybe. But will someone who's a data scientist with a background in large language models and generative AI be sought after by all the big tech companies and the hundred or so startups in that field? Absolutely. So I think tech is more the exception that proves the rule to Thatcher's labor market mobility. There are always going to be companies seeking that top talent and willing to recruit it anywhere in the world.

Will Page: You're right, and I- an important point. When we put layoffs into context, this is not shaking up manufacturing and getting people back into services, this is a software developer lost his gig at one tech giant, he's going to find a new gig at a new one, or start up a company of themselves. One of the golden rules in tech I've always been taught is this easier to make money or make successful companies when the bubbles burst than when the bubble's bubbling. And now, we're such- looking at a landscape where the bubble is burst.

Now, let's bring it to a close with what we do best. I've got a pair of Rizla's, you've got some tobacco, we're gonna go smoking. But the first cut is not the deepest, you've clarified there is gonna be a second and maybe a third on its way. So with regards to those two and three, what about giving us one or two smoke signals so the audience can sorta get their head around the whole of this layoff business and understand what's really going on beneath the headlines that we're reading right now.

Richard Kramer: So the first smoke signal to keep an eye on is really the underlying health of the business. We hear about an Alphabet, the parent company of Google, firing 12,000 staff, but you realize that they had 190,000 of them.

Will Page: [laughs]

Richard Kramer: So they also had $80 billion of cash flow last year and $280 billion of sales, and they have $100 billion of cash on the balance sheet, so the wolf is hardly at the door. There's lots of ways in which a company like that can make itself more productive, tore efficient. There are lots of crazy projects that they might have been willing to fund when it felt like there was no cost of capital in the market, but now there's a 5% interest rate in perpetuity. They'll think h- a little harder about the business case of some of those projects. So like any top tier sports team, they're always looking to get better, and a lot of management will follow up watching those headlines and use the climate to make their own cuts because it's a convenient time to clean up the areas of everyone's organization that aren't as efficient as they could be.

But I think the smoke signal there is that managing with fewer staff doesn't necessarily make you a better business, nor does it necessarily harm your business immediately, it's how you manage through it, how you change some of these rather cosseted cultures that expect kombucha in the cafeteria, massages and a beach volleyball court outside the offices, but ultimately, it's the underlying health of the business. If the business is in good shape, they will always be looking for top talent, and a business that's well run will always be looking, just like top tier sports teams, to get rid of their weakest players and find better ones to- to fill the roles.

Will Page: The smoke signal number one is done. How about a second one? Take a second draw on that [inaudible 00:28:10] joint.

Richard Kramer: Well, look, the second one is that for all those headlines, this process is not only far from over, but never ending. There are going to be lots more quiet cuts. It's to some extent signaling that companies announce these big numbers, but they might be able to cut just as many people on the quiet by ending projects, shelving new business development areas, seeing natural attrition in the workforce, and so forth. No company is being forced to spend. And in a climate where economic growth is going to be limited, you can't squeeze blood from a stone. So if there's limited opportunities to chase, sometimes you allocate your capital to other things, whether it's headcount and hiring back those workers that you fired, or buybacks and reallocate your capital to your own stock because you need to keep the options afloat, or allocate your capital to acquiring companies to bring in competence and that you don't have the time to painstakingly build on your own.

So if there's a second smoke signal, it's look past the big headlines that say, "We've made a c- big change in the business," and focus more on the fact that every business is continually optimizing itself. If they're not, like a shark swimming through the water, they're going to slowly sink to the bottom of the ocean.

Will Page: This is a really helpful podcast. This episode of Bubble Trouble served its purpose. And closing out, I came out of this podcast less of a novice than I went in, and hopefully that applies to our audience as well. And you have made me think dynamically about headcount reduction.

Richard Kramer: Hm.

Will Page: Red Queen's race, that famous quote from Lewis Carroll's Alice in Wonderland, "You've gotta run as fast as you can just to stand still." Well, maybe you could run a little faster if you had less luggage on your back. Maybe that's the story here. And maybe to close out with a quick joke, which is an age-old joke about Google, which is, how many people work at Google? About half of them. Well, I've just worked out that if you reduce your headcount by 6%, 53.2% may work at Google. So you have your- your answer there.

This has been myself, will Page, and Richard Kramer, Bubble Trouble, making sense of the headcounts, and understanding that first cut is not the deepest, there's a second or third cut to come, and we'll be back next time with our own two people unless we've reduced our headcount of the show down to one. Thank you so much for listening. We'll see you again soon.

Richard Kramer: If you're new to Bubble Trouble, we hope you'll follow the show wherever you listen to podcasts. Bubble Trouble is produced by Eric Newsom, Jesse Baker, and Julia Annette at Magnificent Noise. You can learn more at bubbletroublepodcast.com. Will Page and I will see you next time.