The demand for continuous innovation is a driving force behind the spectrum of businesses that make up the technology sector. This focus on innovation has taken on added importance in recent months, as uncertain macroeconomic conditions have forced companies to adapt in order to sustain and grow their businesses. Software firms and semiconductor companies in particular have worked quickly to adapt to these challenges.
Software Businesses Turn Toward Efficiency
A high-interest-rate environment has had a marked impact on software companies, leading to what some leaders in the technology industry have dubbed the “year of efficiency.”1 In recent years, with interest rates hovering near record lows and capital readily available, many software companies were eager to capitalize on the demand for digitization from businesses in all industries and sectors, spending significantly on sales, marketing, and research and development in order to capture the market as quickly as possible. However, as rising interest rates and volatile markets made capital less easily accessible, companies are now focusing their investments on how they can become more efficient in an effort to achieve positive cash flow.
But even as they try to reduce operational costs, software companies face undiminished demand in the market for digitization, which can create a challenging balancing act. “The question for a lot of software firms is, how do you balance cutting costs while still investing in your business to find the appropriate tradeoff between efficiency and capitalizing on growth trends in digitization,” said Matthew Embacher, head of the technology sector for PNC Bank.
Technological Advances and Geopolitical Tensions Drive Semiconductor Industry Dynamics
Semiconductors are experiencing a similar growth in demand, although recent economic turbulence has led to challenges. The COVID-19 pandemic saw a surge in the purchase of devices that use semiconductors, such as laptops, tablets, and other electronics, as schools and businesses transitioned to remote operations. Demand subsequently began to wane, leading to a decrease in semiconductor production. However, an uplift appears to be on the horizon, in part because businesses are increasingly looking to implement artificial intelligence (AI) into their operations. Training large language models to enable AI processes requires a significant investment in hardware that depends on semiconductors, which is putting pressure on semiconductor developers to accelerate production. The automotive industry is facing a similar tailwind, as what were once optional features, such as infotainment systems, rear-view cameras, and driver-assist systems, have become standard in new automobile production in recent years, thus adding to the need for increased semiconductor supply.
Geopolitical tensions are also creating the impetus to increase semiconductor production. Friction between Taiwan, which produces over 60% of the world’s semiconductors2, and China has led to concerns about the ongoing viability of the supply chain. Many U.S. semiconductor companies do not have their own manufacturing facilities, or “fabs,” and currently send designs to Taiwan for production. To mitigate potential risk of supply disruption, some companies are exploring onshoring, nearshoring, or “friendshoring” (manufacturing and sourcing from countries that are geopolitical allies) their operations. But this process has proven to be intensive in terms of both time and cost for some companies that have embarked on building their own fabs within the U.S., as they encounter challenges with construction and labor supply, as well as managing costs to ensure they remain competitive with those of current manufacturing suppliers.
A Different Perspective for Mergers and Acquisitions
The changing landscape for technology companies extends to the mergers and acquisitions (M&A) market, where activity has slowed in recent years compared to the high volume of M&A activity that was once a hallmark of the technology industry. “We are still seeing a good amount of M&A activity in the technology space, but the dollar amounts of the deals are generally smaller compared to past transactions,” said Embacher. “Businesses are looking for transactions that allow them to add some capability around the fringes of their operations.” Embacher noted that some prospective buyers have a more selective filter than in the past. “A lot of buyers now are seeking out businesses that have positive cash flow, which is a big change from prior years, when technology companies were attractive based on their strong growth or potential growth, more so than on cash flow.”
Finding a Path Forward
In order to keep pace with a market that continues to demand innovation, technology companies must evolve alongside the innovations they enable. But it can be difficult to balance the pressures of the marketplace with constraints imposed by a challenging economic backdrop. To do so, according to Embacher, businesses should lean on trusted financial advisors with deep industry experience. “The current landscape in the technology industry is vastly different than it was even a couple of years ago, which makes it hard for companies to have confidence when making big decisions about the direction of their operations,” Embacher said. “That’s where turning to advisors who have an ear to the ground in the industry can provide proactive insights and solutions in response to trends and pressures can provide a real advantage.”
Ready to Help
PNC’s Technology Finance and Advisory Solutions group delivers a comprehensive range of financing options and advisory solutions to fit the wide-ranging needs of technology firms. For more information, reach out to your Relationship Manager or contact us.
Sources
1. What CEOs Are Saying: 2023 ‘Is the Year of Efficiency’ - WSJ
2. Taiwan chip industry emerges as battlefront in U.S.-China showdown (reuters.com)
