The Wide-Ranging Effects of Cloud Computing and the Sharing Economy on Corporate Reorganizations
The ever-increasing efficiencies offered by the Cloud and the sharing economy will continue to cause massive disruptions across a variety of industries, leading to significant strategic, operational and financial distress at companies operating within those areas.
It is particularly important to note that the companies and industries affected by these advances will in no way be limited to businesses that compete directly with tech companies, but rather, that the effects of these efficiencies will be felt across the entire value chain of most industries, including both B2B and B2C organizations.
It is imperative to their long-term survival, that companies understand the dynamics of these shifts, and plan accordingly. Likewise, it is imperative that a company — especially one in distress, or contemplating pre-emptive measures to avoid distress — retain a restructuring advisor who understands these dynamics, the magnitude and direction of these trends, and the first, second and third order effects these developments may have on the company over the next several years in order to align the capital structure accordingly.
I believe the biggest mistake a company can make is to not properly anticipate the effects of these shifts on its business, or to simply look at these shifts via a “static” lens (i.e. focusing on shifts have already occurred) verses a “dynamic” lens that evaluates how the ongoing shifts will evolve in the future.
The Definitions of Cloud Computing and the Sharing Economy
Cloud Computing is generally defined as the delivery of on-demand computing services (including software, data processing, database management, storage, servers, and analytics) over the Internet. Companies offering these services are known as cloud providers, and typically charge based on usage, similar to utilities such as electricity or water.
Because these providers deliver services on an as-needed basis, they dramatically lower the cost of these services, eliminate capital outlays, remove the need for dedicated IT teams, ensure 24/7 reliability, and provide cutting edge performance in terms of speed, upgrades and everything else needed by a user.
Similarly, the Sharing Economy is loosely defined as a business model where individuals rent assets owned by someone else on a very short-term basis, either directly (like AirBnB, which allows owners to monetize their homes when not in use by them), or on a service basis (such as Uber or Lyft, which allow owners to monetize their vehicle as a personal taxi service based on their own availability).
Although sharing models have existed throughout history, the pervasiveness mobile devices has made it significantly easier for owners and those seeking to use these assets to find each other. This has led to the creation of a new class of services known as “Peer-to-Peer” (P2P) to complement (and compete with) the existing B2B and B2C models.
As a result, though dramatically different in form, cloud computing and the sharing economy have one thing in common: by dramatically increasing the utilization rates for hardware, they decrease the demand for that hardware.
The Nature of Efficiency and the Threat of Creative Destruction
Creative destruction, a term coined by legendary Austrian economist Joseph Schumpeter in 1942, describes the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” The net effect is that this process rewards innovations and punishes less efficient ways of deploying resources. The process can be a death sentence for some companies, though the overall trend for society is progress, growth and higher standards of living.
Some historical examples of creative destruction include personal computers decimating typewriters, automobiles decimating the horse and carriage, CDs decimating sales of vinyl music, and then being decimated themselves by MP3 and digital music players.
Perhaps the most notable example of creative destruction would be how e-commerce — Amazon in particular — is absolutely annihilating the traditional brick and mortar business, with major players disappearing completely, while other once dominant brands shutter thousands of stores through a Chapter 11 process, or pre-emptively to avoid that fate.
In a similar manner, improving technology and business methods are dramatically increasing the efficiency of businesses, resulting in increased productivity. Although, from the consumer perspective, this increase in efficiency and productivity is a positive trend, from a business perspective, improved efficiency it is both a blessing and a curse, since needing less of something is just another way to describe decreasing demand.
In particular, manufacturing companies will suffer because productivity growth tends to be on the order of 5% — 7%, while global demand grows at only 2% — 3%. As a result, services and recurring revenue models are displacing manufacturing. The net effect of these forces — dramatically improving efficiency, and the unstoppable march of creative destruction — will radically alter the business landscape over the next several years.
Industries Directly Impacted By This Evolution
Over the past decade, we have seen the dramatic effect e-commerce has had in terms of the obliteration of the brick and mortar retail industry. Not surprisingly, this trend will continue until a new equilibrium of supply and demand is reached, while second order effects — such as the viability of malls, commercial REITS, and other areas — will begin to manifest and accelerate as their customers (the retail outlets themselves) continue to disappear.
Replicating their own success with creative destruction in the retail industry, Amazon (through Amazon Web Services) has also become the leading provider of cloud services to hundreds of thousands of businesses around the world. Along the way, they (as well as other dominant cloud players such as Microsoft, Oracle, SalesForce and others, who now offer their software as a service) are laying waste to thousands of smaller hosting and storage companies, software providers, IT departments and a variety of other similar firms.
Furthermore, this increased sharing of computing resources yields greater utilization rates, which may ultimately translate into less demand for hardware. This in turn would have a huge impact the entire value chain including chipmakers, contract manufacturing, value-added resellers and others. In fact, these dynamics can already be seen in major players such as Intel (which has become much less reliant on their x86 architecture, and more focused on the AI and autonomous vehicle space), and Cisco, which is executing a major shift in its business to focus less on hardware, and more on software and services.
These shifts will likely be accelerated as the major Internet companies and cloud providers begin to develop their own hardware — both systems and semiconductor chips — and further displace existing providers in those areas, leveraging their substantial purchasing power along the way. The net effect will be a convergence of Internet retail, cloud services and the sharing economy all coming together to reinforce each other in a positive feedback loop. Companies that are not part of that loop will inevitably need to adapt, or be subsumed in its wake.
Another major area to be affected will be the trillion-dollar automotive industry. The disruption in this area will be caused by the continued rise of ride sharing services led by Uber and Lyft, which dramatically reduce the need for automotive ownership (and the associated costs and headaches like down payments, registration, inspection, servicing, insurance and so forth). This decreased demand for automobiles can already be seen in the behavior of millennials, a high percentage of which have never even learned to drive.
This decreasing demand for cars will impact not only the auto companies, but puts the entire supply chain (parts, tires, axels, transmissions, seats, mirrors, metallurgy, windshields, airbags and so forth) at risk in a way that could be comparable to the massive shakeout in that industry some 10 to 15 years ago.
In addition to the automotive industry, another major area to be impacted by the sharing economy is the market for commercial office space, in which smaller companies avoid the high cost of office leases and administrative staff by leveraging companies like WeWork and others which provide office space on an “as-needed” basis, similar to the cloud computing model of pay-as-you-go.
When viewed in aggregate, it is clear that a massive disruption is underway. The exact repercussions of this disruption are difficult to predict, but sufficient to say they will present tremendous amounts of both pain and opportunity.
The Threat to Other Industries
At first glance, it may seem that these forces will affect only certain industries. However, once we dive deeper, it becomes clear that these dynamics will have a severe impact on a multitude of industries, and those companies not prepared — strategically, operationally, and from a capital structure perspective — risk being rendered distressed or obsolete as a result of legacy operations and cost structure.
One such example would be major car rental companies, such as Hertz Global Holdings (which, with $14 billion in debt, and a glut of used cars depressing the resale value of its fleet, does not have much margin for error). Although these companies were early examples of sharing, their models are currently being upended by the efficiencies of the Internet, including waning demand as people prefer the convenience of Uber/Lyft, pricing pressures due to online competition, hourly car rentals (such as ZIP), and other disruptions, effectively supplanting vehicles with technology.
Regardless of how everything plays out, it is clear that rental companies, like taxi services, will be hugely impacted by the sharing economy as the concept of TaaS (Transportation as a Service) begins to expand and eventually dominate that sector.
On the Cloud front, although major e-commerce players have decimated traditional retail, Cloud services themselves are now enabling a host of even newer companies to compete with both online and traditional retailers. One example would be Shopify, which allows anyone to be an online retailer, effectively disrupting traditional retail networks, distributors, B2B marketplaces and other sales and marketing channels.
At the end of the day, technology is the ultimate equalizer, and will continue to erode many of the competitive advantages once enjoyed by established companies. Although it would be impossible to detail every industry, line of business, or critical operation susceptible to these effects, it is sufficient to say that the effects are exceedingly pervasive, and often reside in non-obvious areas that may not be identified in the normal course of business.
Because of the wide-ranging disruptions cloud computing and the sharing economy are expected to have on such a broad variety of businesses, it is critically important that companies facing any form of distress — whether declining revenues or EBITDA margins, decreasing cash flow, reduced debt coverage, covenant violations, write-downs, impairments, or other issues — are fully prepared to evaluate any corporate reorganization in the context of these disruptive factors.
All too often, restructuring plans are premised on a static business environment, or based on slow and predictable changes. However, given the continuing accelerations of these disruptive forces, and in particular, the paradigm shifts they may trigger, it is imperative that companies understand the dynamics and impact of these shifts, and plan accordingly.
Only through this form of strategic reorganization — and a corresponding alignment of the capital structure — will the company have the flexibility to do what is needed, especially in an environment of increasing interest rates and a potential tightening of credit.