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The world is sinking into recession. Who in the IT sector will suffer the most?

The looming economic downturn has affected not only the approach of IT companies to recruitment, but also the level of salaries. Sergey Belyaev, Managing Director of the Investment Department of UFG Wealth Management, analyzes whether the tech giants are ready to reduce personnel costs amid stagnant and falling profits.

The world is facing social and economic problems. Last month alone, global rating agencies revised their forecasts for GDP for the world's major economies, adjusting the growth by more than a third compared to prior estimates. Inflation in the U.S. continues to rise, with consumer prices rising by 9.1% in June, marking a record high since 1981. In Europe the cost of energy is increasing: in Germany the increase amounted to 38%. Against this background, one should expect a decrease in the real disposable income of the population. It is only logical, that people switch from consumption mode, often at the expense of credit money, to savings mode, which will spell trouble for the economy and, particularly, for the technology sector.

The technology sector consists of many segments, each with its own laws and business principles. If we remove from the equation the companies that are at the stage of venture capital investment (that is, those that live off investors' money), the sector can be roughly divided into three categories: hardware, software, and gig economy. Ideally, many large technology companies want to become vertically integrated, i.e., to create both hardware and sell software for it. One such company is Apple, which, while producing hardware, is also actively selling digital services in the form of iCloud and other subscription models.

Let us look at each segment separately.

Which IT companies are willing to cut payroll costs

Hardware companies are ready to slow down hiring, but are unlikely to make massive cuts

Hardware companies are heavily tied to their global manufacturing facilities. This part of the cost is inflexible because the production cost of, for example, the iPhone consists of components that have a market price. All Apple can do is reduce or increase orders. Thus, in case real product demand decreases, hardware companies will be backed into a corner. According to Bloomberg, in 2023 Apple plans to slow the rate of hiring in some divisions to cope with the economic downturn. The biggest problem for hardware companies is extensive development without significant technological breakthroughs. The issue of cost reduction in this case falls on contractors and component manufacturers. Until there is a technological breakthrough that creates either a new market (as was the case with the iPod) or a sought-after device such as the iPhone, we are unlikely to see a tectonic shift in demand.

Companies continue to actively pursue "non-obvious" solutions, but the next round of development is not yet in sight, and that is unlikely to change if costs decrease over the next two years.

Software companies can easily cut staff because they outsource

Software companies depend on how much profit their product generates. For example, for Google, advertising revenue remains the main source of profit. Consequently, the corporation can be quite flexible in its personnel policy. It is a normal practice among software development companies to outsource a significant part of their tasks. It makes sense, because it allows to avoid social payments, recruitment of staff and their inclusion in the employee incentive program. However, low workforce quality (people are usually hired in India and Eastern Europe) and high staff turnover are the price to pay.

A separate example of a software company is Amazon, whose business consists partly of online retail. Last year, the total number of Amazon employees in the U.S. alone grew by 18% to 1.1 million, while 1.6 million people work for the company worldwide. Only 105 thousand of them are IT professionals, while the rest are warehouses employees, delivery services, etc. This flexible structure has allowed Amazon to increase its total headcount by 24% over 2021, but it is easy to cut back if business slows down. Such an approach certainly raises concerns on the part of the government. Therefore, not all companies disclose how many contractors and subcontractors work for them. The dot-com crisis of the early 2000s taught the survivors how to handle costs properly.

Gig economy companies will be hit the hardest: each employee brings them a percentage of their order

The gig-economy is a new approach to hiring, where a company does not hire people as full-time employees, but as independent contractors and freelancers. Such "relationships" are especially in demand in the IT industry. For the last ten years, the technology sector has experienced a constant staff shortage. Existing companies, such as Uber and Lyft, have grown rapidly. At the same time, many new companies have emerged in a variety of segments, such as the food delivery services DoorDash and Grubhub. According to statistics from the freelance platform Upwork, more than 50 million people in the U.S. (which is 16% of the country’s population) earn income from the gig economy, and for a third of them it is their main revenue source. If demand for cabs, grocery deliveries and other excesses falls in the face of declining real income, the number of orders will fall. And that means the couriers and drivers will no longer be able to count on their usual pay. According to Uber's latest public statements, the company has 209,000 active drivers in California alone. Unfortunately, this supplemental, and for some, primary earnings will be greatly reduced, and since gig economy companies get a percentage of each order, their profitability will be greatly reduced and they will probably be unprofitable for several more years. It will be the companies that focus on outside contractors - deliverymen, drivers, artisans, and others - that will be hardest hit. Even if their headcount declines are not significant, the impact could be severe.

Will the sector survive the recession?

The Big Techs will be experiencing “tough times” in different ways. Large IT companies such as Facebook* (a resource banned in Russia - RBC), Apple and Google have sufficient margin of safety. At the end of 2021 these three giants had over $200 billion in cash on their balance sheets and they generated $199 billion a year, so technically they could replace all that cash in just one year. Amazon and Netflix, by contrast, were showing close to zero cash position on their balance sheets and negative free cash flow. This was partly due to the pandemic, and also their extensive growth, which the companies could wind down if there is no demand. Thus, the giants of the IT sector will largely survive the one- to two-year crisis. Many of them will even become stronger through acquisitions of other companies.

Potential staff reductions will hamper employee demand in relation to companies and will bring to senses those who believe that salaries in the IT sector should constantly grow. At the same time, the demand for top professionals will not decrease.

As for the rest of the sector outside of FAANG (the top five global technology leaders - Facebook*, Amazon, Apple, Netflix, and Google), the downsizing situation there will directly depend on the individual business’s viability and financial security. It is possible that a large share of startups will not survive the difficult 12-18 months and will be gobbled up by Big Tech.

Companies operating in the gig economy paradigm will have the hardest time. The gig economy is supported by value-added services and services that people will abandon in order to save money. Thus, the most serious blow will be dealt to people who work in this sphere, although they are often not formally employed by the companies.

RBC

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