WORLDVIEW: Billion-dollar tech unicorns may sink the economy

By Felicity Duncan.Here's how tech venture capital works these days. A group of private investors finds a sexy startup – perhaps a workplace messaging app that integrates with Uber and Instagram and has cool offices in the San Francisco Bay area – and gives them some money..The startup then begins to pursue one thing with single-minded determination: scale. The only metric that matters is user growth. Getting people signed up and connected to the network is widely seen as the main goal in the platform economy. All else – profitability, free cash flow, cost management – is irrelevant..___STEADY_PAYWALL___.Backed by a good VC firm, the startup can burn through cash as fast as it likes if it is still growing users. It can usually, on the strength of its VC stamp of approval, even get a decent chunk of bank funding to help finance user growth (or the VC firm will borrow to invest – either way, its debt-funded)..The faster users grow, the hotter the startup gets. Subsequent VC and private equity investors bid up the valuation of the company with each enthusiastic cash infusion. Ultimately, in an ideal world, the startup transforms into a unicorn – a privately-owned company worth over a billion dollars..To achieve this feat, the company must become a virtual monopoly in whatever corner of the platform economy it has chosen to inhabit, because when network is all that matters, only the biggest survive..Amidst much fanfare, this monopolistic unicorn will list on a stock exchange and the VC crowd will cash out and look for the next big thing..On paper, this all sounds great – especially for the VC crowd. But there are a few things missing in all this magical thinking..One missing element is actual profits..The current tech investment climate focuses on scale above earnings. Thus, you have a company like Uber coming to market valued at $100 billion despite never having turned a real profit (it once reported a quarterly profit, but that was only because it sold a business)..There's a logical reason for this emphasis on scale over substance. VC investors looked at the big winners in today's world – Google, Amazon, and Facebook – and noticed that these companies all focused on growing their users first. Once they had built a huge network of dedicated users, they found ways to profit from them, but scale came first..Therefore, reasoned VC investors, if we want to bring the next Google to market, we need to find a company with the potential for world domination and finance it until world domination is achieved..There are a couple of downsides to this. The first is that profits do have to show up at some point. At the very least, there needs to be a plan for profitability. Right now, a fairly scary number of unprofitable, heavily indebted companies are listing on US markets at huge earnings multiples. You know not all of them are going to be gems. When investors get tired of trading on optimism, a repeat of the dot com bubble burst is entirely possible..The second issue is that there's a risk that capital is not being efficiently allocated. Although many market fundamentalists believe in the infallibility of markets, the objective history of the world shows that people routinely pour capital into nonsense, from South Seas explorations to tulips to bitcoin to pets.com. To the extent that investments in thirty interchangeable workplace messaging apps (all hoping to be no. 1) crowd out investment in other things, we're making ourselves poorer long term..The final issue is that monopolies aren't actually good things. Even when they don't raise prices, they do destroy innovation. Monopolistic companies swallow and kill nascent competitors. They manipulate laws to help them and hurt potential new entrants. And they abuse their market positions in a hundred small and large ways. Our current economic strategy of using huge amounts of debt to finance future monopolies seems like a bad bet for creating sustainable growth..There's no doubt that the current crop of tech giants – Google, Amazon, Apple – have made our lives better in many ways while delivering great value to shareholders. But the path to get here was not a smooth one. The boom and bust cycle, especially in tech, is both well-known and familiar. There's as much chance that one of today's sexy unicorns will be the next boo.com as there is that it will be the next amazon.com.