When the music stops¶

The Patrician has observed that economic cycles in Ankh-Morpork follow predictable patterns. There are periods when money flows freely, when speculative ventures find eager funding, and when everyone is convinced that this time the prosperity will continue indefinitely because the circumstances are different from previous cycles. These periods are inevitably followed by the moment when someone notices that the circumstances are not actually different, that the ventures are not actually profitable, and that the money has stopped flowing. This moment is always surprising to everyone involved despite being entirely predictable to anyone who has seen previous cycles.

The technology industry is currently in a phase characterised by abundant venture capital, minimal concern about profitability, and widespread belief that AI will generate returns sufficient to justify current valuations. This phase has lasted long enough that many participants have never experienced different conditions and genuinely believe that current arrangements are permanent rather than temporary. History suggests otherwise, and The Patrician has learned to trust history over enthusiasm when they conflict.

The question is not whether the music stops but when it stops and how abruptly. Gradual deceleration allows participants to adjust strategies, reduce burn rates, and position for survival. Sudden stops create chaos as companies simultaneously discover they cannot raise additional funding, cannot achieve profitability quickly enough, and cannot exit at valuations that justified previous investments. The outcome depends partly on external factors like interest rates and economic conditions but mostly on whether participants recognise early enough that conditions are changing and adjust accordingly.

The Patrician notes that the people most confident that the music will continue indefinitely are typically the people who would be most embarrassed by the music stopping, which creates incentive structures that discourage realistic assessment of when conditions might change. This makes predicting the timing difficult but makes predicting the eventual stop itself quite straightforward.

When interest rates matter again¶

The technology industry has operated for over a decade in conditions where interest rates were effectively zero, which meant that capital was cheap and investors were willing to accept minimal returns because alternatives provided even less. This created environment where growth was valued over profitability and where companies could operate indefinitely at a loss as long as they demonstrated increasing revenue or user engagement.

Interest rates that are no longer zero change this calculation fundamentally. When safe investments provide reasonable returns, investors require higher returns from risky technology investments to justify the additional risk. Companies that were acceptable investments when alternatives yielded nothing become unattractive when alternatives yield five percent or more. The shift is not about technology companies becoming worse but about the opportunity cost of capital increasing.

The venture capital model depends on occasionally extraordinary returns compensating for frequent losses. When a small fraction of investments return 100x or more, the overall portfolio can be profitable even when most investments fail. This model requires exit opportunities at valuations that justify the return multiples. When public markets are unwilling to pay extreme multiples for unprofitable growth companies, the exits that generate venture returns become scarce.

The down rounds where companies raise funding at lower valuations than previous rounds become common when capital becomes selective. Companies that raised at billion-euro valuations during peak enthusiasm discover that current investors value them at hundreds of millions, which dilutes existing shareholders dramatically and demoralises everyone involved. The companies survive but the early investors and employees holding equity see their paper wealth evaporate.

The startup failures accelerate when companies cannot raise additional funding and cannot reach profitability with existing capital. The failures are often quiet, with companies acquired for disappointing prices, shut down with minimal announcement, or limping along with declining teams and ambitions. The failure rate was always high but becomes more visible when funding conditions tighten.

The pivot to profitability where previously growth-focused companies suddenly prioritise reducing burn rate and reaching positive cash flow creates awkward situations where companies that were hiring aggressively begin laying off staff, that were spending liberally on customer acquisition suddenly become frugal, and that were dismissive of profitability suddenly discover it’s essential for survival. The pivots are rational but reveal that the previous growth strategies assumed unlimited funding availability that no longer exists.

The Patrician observes that interest rates near zero were historically anomalous conditions that many participants mistook for permanent normal, and that the return to rates that reflect actual time value of money creates adjustments that are painful but ultimately healthy for directing capital toward ventures that can actually generate returns rather than just burning through funding.

When venture capital dries up¶

Venture capital availability is cyclical and the current cycle of abundant capital will eventually turn to scarcity, either because returns disappoint and investors withdraw capital or because economic conditions make alternative investments more attractive. The transition from abundance to scarcity changes company strategies dramatically.

The immediate effect is that fundraising becomes difficult for all but the most attractive companies. The companies with strong metrics, credible paths to profitability, and proven teams can still raise funding, though at lower valuations and with more scrutiny than previously. The companies with weaker fundamentals discover that investors who were previously responsive become unreachable and that pitch meetings that would have led to term sheets now lead to polite disinterest.

The valuation resets where companies that raised at high valuations during abundant capital conditions must accept lower valuations in scarce conditions create situations where founders and early employees lose equity value while new investors demand terms that protect them from further decreases. The down rounds are demoralising and often include provisions giving new investors preferences that subordinate existing shareholders.

The extension rounds where existing investors provide additional capital to companies they’ve already invested in become the primary source of funding. The investors are protecting previous investments rather than making new bets, which means they provide capital reluctantly and with stringent terms. The companies receiving extension rounds are the fortunate ones because at least they have investors willing to continue supporting them.

The acquihires where companies are acquired primarily for their teams rather than their technology or business become common. The acquisitions provide some return to investors and soft landings for employees but represent failures to achieve the ambitious goals that justified original investments. The acquired teams are absorbed into acquiring companies and their products are usually shut down.

The shutdowns where companies run out of capital and cannot raise more simply cease operations. The orderly shutdowns return remaining capital to investors and ensure employees land at other companies. The disorderly shutdowns leave unpaid vendors, confused customers, and employees discovering that their equity is worthless. Both outcomes are common when venture capital becomes scarce.

The survivor bias becomes pronounced where the companies that succeed are presented as validation of their strategies while the companies that failed are quietly forgotten. The survival often depends as much on fortunate timing of fundraising and conservative financial management as on product quality or business model strength. The successful companies look prescient in retrospect while the failures look obviously flawed despite being indistinguishable at the start.

The Patrician observes that abundant venture capital creates illusion that all reasonable ventures deserve funding while scarce venture capital reveals that funding was never about deserving but about supply relative to demand, and that many ventures fundable during abundance cannot attract capital during scarcity regardless of merit.

When the AI hype cycle completes¶

The current AI enthusiasm will eventually complete its hype cycle, transitioning from the peak of inflated expectations through the trough of disillusionment toward the plateau of productivity. This transition is inevitable for all technology hype cycles and the timing is uncertain but the pattern is reliable.

The first sign is when impressive demos stop translating to business value. The technology continues working but organisations discover that deploying it in production is harder than pilots suggested, that integration with existing systems is expensive, that reliability is insufficient for critical applications, or that the value generated doesn’t justify the costs. The demos were never fraudulent but they weren’t representative of production deployment difficulty either.

The business model failures where companies discover that AI capabilities are impressive but difficult to monetise create disappointment among investors who expected that impressive technology would naturally translate to profitable business. The inference costs that exceed revenue per user, the willingness-to-pay that’s lower than delivery costs, and the competitive dynamics that make differentiation difficult all contribute to business models that work on paper but not in practice.

The competition from open source models that approach proprietary model capabilities undermines business models based on offering AI capabilities as service. If comparable capabilities are available freely through open source, the companies charging for proprietary access must justify their premium through superior quality, better integration, or additional services. Some succeed at this differentiation but many discover that their advantages are insufficient to justify their prices.

The infrastructure overcapacity where data centres built for projected AI demand find utilisation lower than forecast creates financial pressure on cloud providers and companies that invested heavily in AI infrastructure. The infrastructure must generate returns to justify the capital invested, and when demand disappoints the providers must choose between lowering prices to increase utilisation or accepting lower returns and potentially writing down investments.

The talent market correction where AI specialists who commanded seven-figure compensation packages discover that demand has moderated and compensation expectations must adjust creates disappointment and occasionally bitterness among people who expected current conditions to persist. The correction happens through reduced hiring, flatter compensation growth, and layoffs at companies that over-hired during peak enthusiasm.

The realistic assessment where organisations conclude that AI is useful for specific applications but not transformative for most of their operations creates moderated expectations about deployment. The AI budgets shrink from inflated levels to amounts justified by demonstrated value rather than projected potential. This is healthy long-term but disappointing short-term for vendors who projected continued growth.

The Patrician observes that hype cycles are called cycles because they’re repetitive patterns rather than permanent conditions, that the technology often becomes more useful after the hype subsides because expectations become realistic and applications focus on genuine value rather than speculation, and that surviving the transition from hype to reality requires financial resilience and realistic assessment of actual value provided.

What survival looks like¶

The companies and individuals that survive the transition when conditions change are those that prepared for possibility of change rather than assuming continuation of current conditions indefinitely. Survival requires financial conservatism, operational efficiency, and realistic assessment of actual value creation.

The financial conservatism means maintaining longer runways than seem necessary, refusing to spend based on projected future funding, and treating current funding as potentially the last funding available. Companies that operated frugally during abundant capital conditions are positioned to survive when capital becomes scarce because they can extend their runway through modest adjustments rather than requiring dramatic restructuring.

The focus on unit economics where each customer or transaction is profitable rather than contributing to growth at a loss becomes essential when growth for its own sake is no longer fundable. Companies must demonstrate that their core business generates profit at unit level even if they’re currently operating at a loss due to fixed costs or growth investments. Without profitable unit economics, path to overall profitability doesn’t exist.

The product focus where companies concentrate on specific use cases they can dominate rather than pursuing broad visions provides defensibility and clearer value proposition. The companies that tried to be everything to everyone discover they’re nothing to anyone when funding constrains their ability to build broadly. The focused companies that solve specific problems well have customers willing to pay and competitors less able to disrupt.

The operational efficiency through automation, streamlined processes, and careful resource allocation allows companies to achieve more with smaller teams. The efficiency becomes necessity when funding constrains hiring but also provides advantage through higher productivity and margins. Companies that developed efficiency during abundance have competitive advantage during scarcity.

The customer focus where companies prioritise retention and satisfaction over acquisition provides revenue stability and reduces dependence on continuous funding for growth. The high-growth strategies that emphasise acquisition over retention work when capital is available for continuous customer acquisition spending but fail when capital constrains marketing budgets. Strong retention provides organic growth and positive unit economics.

The realistic expectations where founders and investors acknowledge that venture-style returns may not materialise but that building sustainable businesses is worthwhile outcome even if not spectacularly lucrative makes navigating downturns psychologically manageable. The companies that accepted early that becoming sustainable was goal rather than just milestone on path to unicorn status are prepared for conditions where sustainability is achievement rather than baseline.

The Patrician observes that survival is often less about being best and more about being sustainable, that many mediocre but financially prudent companies outlast impressive but profligate competitors, and that the companies thriving after shakeouts are often not the ones that seemed most promising during boom times but rather the ones that prepared for possibility of conditions changing.

The Patrician’s assessment¶

Looking at the inevitable moment when current conditions end with appropriate attention to historical patterns and incentive structures, The Patrician concludes that the music will stop, that the stop will surprise people who should have been prepared, and that the aftermath will be survivable for prudent participants while being catastrophic for those who assumed abundance was permanent.

The interest rate normalisation is already occurring and its effects are visible in technology valuations, fundraising difficulty, and increasing emphasis on profitability. The full effects will take years to work through as companies with long runways gradually deplete capital and discover that raising additional funding at previous valuations is impossible. The adjustment is happening gradually which is preferable to sudden shock but is still painful for companies that must adapt.

The venture capital availability is already tightening and will likely tighten further as returns from recent vintages disappoint and as alternative investments become more attractive. The funding environment will remain challenging for years, which means companies must plan for scarcity rather than expecting abundance to return soon. The companies that adapted early to scarce capital conditions will survive while those waiting for conditions to improve will often fail first.

The AI hype cycle is in the inflated expectations phase and will eventually transition to disillusionment as deployments disappoint, business models fail to materialise, and competition increases. The transition will be gradual rather than sudden because AI capabilities are real even if overhyped, but the disillusionment will be substantial because expectations are unrealistic. The companies and applications that provide genuine value will survive while the speculative ventures will fail.

The overall pattern is that technology industry is transitioning from unusual abundance to more normal scarcity, that this transition creates difficulties for companies and investors who assumed abundance was permanent, and that the aftermath will leave industry with fewer but more sustainable companies focused on profitable businesses rather than speculative growth. This is healthy long-term but painful short-term.

The survivors will be companies that maintained financial discipline, focused on sustainable business models, and adapted early to changing conditions rather than waiting until crisis forced adaptation. The failures will be companies that spent based on projected fundraising rather than actual cash, that pursued growth without regard to unit economics, and that assumed current conditions would persist.

The individual survivors will be people who maintained skills valuable in multiple contexts, who saved during abundant compensation rather than spending based on expected future income, and who recognised that unusual conditions were temporary rather than permanent. The failures will be people who specialised narrowly in whatever was currently hyped, who spent based on peak compensation expectations, and who were surprised when conditions changed.

The Patrician’s advice is to assume that current conditions will change, to prepare financially and operationally for change, to focus on creating actual value rather than just capturing funding, and to remember that survival through downturns often matters more for long-term success than thriving during booms. The boom times allow risk-taking and ambitious bets, but the downturns separate sustainable ventures from speculative enthusiasm.

The music will stop because music always stops eventually. The participants will be surprised because participants are always surprised even though the pattern is predictable. The aftermath will create opportunities for prepared participants while creating difficulties for those who assumed the party would continue indefinitely. This is how economic cycles work and technology cycles are not exempt from economic reality despite periodic belief that they are.

The wise approach is dancing while the music plays but staying near the door and keeping your coat nearby, because when the music stops you want to exit smoothly rather than be caught in the rush of everyone simultaneously discovering that the party is over and nobody arranged transportation home. The Patrician has seen many parties end and the pattern is remarkably consistent. This party will end too, and those who prepared for that inevitability will fare better than those who convinced themselves the party was permanent.