Briefing | Techsodus

Silicon Valley is changing, and its lead over other tech hubs narrowing

Great success has brought high costs and structural change

|SAN FRANCISCO

THE garage in which Hewlett-Packard was started in 1939 is now a private museum—a modest monument to the cut-price creativity and bare-knuckle entrepreneurship that made Silicon Valley famous. Drive south from Palo Alto through 20 minutes of inevitable traffic to Sunnyvale and you will find a landmark of a different kind. Nothing of technological note has taken place there. But in February this small two-bedroom house, which boasts just the sort of garage a startup would once have felt at home in, sold for $2m, 40% more than its asking price, within two days of listing—a new record for the area. That translates into a price of $25,386 per square metre ($2,358 per square foot).

When Ajay Royan of Mithril Capital, an investment fund, asks rhetorically “How are you supposed to have a startup in a garage if the garage costs millions of dollars?”, he is barely exaggerating the problem. The immense success of its tech industry means that the San Francisco Bay Area in which Silicon Valley sits has the highest cost of living in America. A median-priced home costs $940,000, four-and-a-half times the American average. The Department of Housing and Urban Development considers a family earning less than $120,000 in San Francisco “low income”.

As a result, a region that has long drawn people in is beginning to cast them out. More Americans are leaving the Valley than moving to it. In 2017 several counties in the area saw their largest combined domestic outward migrations in around a decade (see chart 1). In a recent survey by the Bay Area Council, a think-tank, 46% of Bay Area residents said they planned to leave in “the next few years”, up from 34% in 2016.

This is not just a case of people of more modest means being pushed out by carpet-bagging techies. At this year’s “FOO camp”, a freewheeling annual gathering of hackers and others, a session called “Should I/you leave the Bay Area?” saw a strong turnout. Participants shared their gripes about the high cost of living, bad traffic and a “toxic” culture obsessed with money.

“We’re seeing a lot of the talent moving or saying they won’t come here,” says Dan Rosensweig, who runs Chegg, an education-tech company in Santa Clara. “It’s hard to imagine doing another startup in Silicon Valley. I don’t think I would,” says Jeremy Stoppelman, the boss of Yelp, a review site. “I will probably never scale another company in the Bay Area,” says one of the founders of a public internet company. He says that for his next venture he will keep a small team in the Bay Area but will hire most of the software developers and executives in other cities, where the cost of talent and the risk of them being poached are both lower.

Silicon Valley is still a place where new ideas can flourish, fortunes can be made and products that change millions of lives will get dreamed up and brought to market. But thanks to its past success it is no longer the ferment it once was, and it is unlikely it will ever again dominate the technology world in quite the way it has over the past decades. The cost of living and operating a firm will drive more people away. The dominance of the companies that have generated its current wealth will change the paths to success for those who stay. And unfavourable governmental policies will further harm the Valley’s dynamism.

A whole generation

On top of all that, Silicon Valley’s own products and services make it ever easier to start out elsewhere, or everywhere, and be connected to Silicon Valley’s culture through messaging, video-conferencing and collaborating online. By changing the way companies work, this technology is making it ever more feasible to have a presence in the Valley while keeping most or almost all of your employees elsewhere. No other tech hub in this more spread-out world will grow as powerful as Silicon Valley has been. But its lead over a growing pack of competitors will narrow.

With its strong networks of experts, stellar universities, culture of risk-taking, deep-pocketed investors and history of helping startups grow into giants, Silicon Valley—now taken, for the purposes of discussions like this, to include San Francisco proper—has over decades become the tech hub that all others measure themselves against. The centre of semiconductor innovation from the 1960s on—hence the name—in the 1990s it made big bets on the internet, which by the 2000s it dominated. Since then its firms have created the operating systems on which more than 95% of the world’s smartphones run.

From 2010 to this year venture capitalists invested $168bn in firms in the Bay Area, a third of the total they invested in America. No other area comes close (see chart 2). In the second quarter of 2018 the Valley was home to three of the world’s five most valuable companies: Apple, Alphabet (Google’s parent) and Facebook, valued between them at almost $2.5 trillion. Apple and Alphabet, true natives, were born in garages in Los Altos and Menlo Park, respectively. Facebook moved into somewhat plusher digs while still an infant. It hosts 57 unicorns—private startups valued at more than $1bn—including household names like Airbnb and Uber.

At a number of points in the past it has looked as though the Valley’s ascent was over. In the early 1980s its semiconductor-memory-makers lost out to Japanese competitors; in 2000 the dotcom bubble burst. But the Valley has always kept climbing, and there are plenty who believe that, unequalled in its wealth and its claim on the world’s attention, it can go on doing so. Things may currently be unhelpfully overheated; some think a recession might clear out some badly run companies and lower costs for the fitter survivors. But the long-term outlook is cheery. “Florence was in its position for more than 200 years,” says Mike Volpi of Index Ventures, which invests in startups. “Silicon Valley still has many years to go.”

Others, though, think things have really changed. AnnaLee Saxenian, dean of the School of Information at the University of California, Berkeley, says she has spent her whole career “defending the Valley’s vitality whenever people have said it’s over”. Now, she thinks there has been an important cultural shift.

In “Regional Advantage”, a seminal study published in 1994, Ms Saxenian compared Silicon Valley’s culture to that of the rival tech cluster around Boston, Massachusetts, known as Route 128. The Valley started to outstrip its competitor in the late 1980s, she argued, because Route 128 was dominated by large, hierarchical companies that were inward-looking and secretive. They valued corporate loyalty and strongly discouraged employees from leaving for a competitor or starting their own venture. In the Valley, in contrast, information was shared much more freely both within companies and between them. Leaving to start something of your own was not frowned upon. Indeed it was encouraged; established firms helped support or spin off younger ones.

“Regional Advantage” has become a classic study of what works and goes wrong for innovation ecosystems, but it may need a new afterword. Ms Saxenian says that the tech titans have developed an increasingly “autarkic” culture that goes against the way that the Valley used to work, “shutting off the flow of talent.” “The problems of Boston,” she says, “are reappearing here”.

There have always been big companies in the Valley. Today’s are bigger—but they are also able to use their size differently. A giant internet company can move into new areas a lot faster than a big incumbent semiconductor company could in the days when the Valley’s original cultural norms were set. The big firms can seize on novelty almost as quickly as startups do—and with a lot more oomph.

That has made it harder for young startups to prosper and grow into big companies themselves. They are imitated, stamped out or acquired while they are still young. Some talk of a “kill zone” around the big companies, where it is impossible for startups to operate. Innovation continues, but without the near-nutty breadth of approaches that used to be one of the area’s strengths.

A new explanation

The giants have other chilling effects. It used to be that working for an incumbent firm was safe but not lucrative, unless you were a top executive. Those who made real money had sweated it out as early employees at startups that made it big. Now profitable business models, piles of cash and soaring share prices mean giants can afford to pay employees handsomely. “The payoff of a higher-risk startup is not so different from what you would get over the same number of years at Google or Facebook earning top dollar,” explains Yelp’s Mr Stoppelman.

In 2017 Alphabet, Apple and Facebook issued $16.2bn in stock-based compensation. Even those in middle-management positions are paid handsomely; the median compensation is $240,000 at Facebook and around $200,000 at Alphabet.

Where Ms Saxenian sees the ghost of Route 128, Tim O’Reilly, a publisher and Valley-watcher of long standing sees a flickering echo of Hollywood, with successful entrepreneurs acting the part of high-maintenance movie stars. Those with graduate degrees in artificial intelligence can fetch $5m-10m a year. People complain that such pampering has eroded tech’s work ethic, with employees focusing on free lunches and other perks. In the Financial Times earlier this year Michael Moritz, chairman of the venture-capital firm Sequoia, suggested that American techies could learn from the hard-driving culture of Chinese entrepreneurs.

Others draw a comparison with Wall Street, seeing greed taking on ever greater importance. This has been amplified not just by the Bay Area’s high costs but also by the amount of capital flooding in. For example, SoftBank, a Japanese conglomerate, has raised a $100bn technology fund, which is more than the entire American venture-capital industry invested last year. And like both Hollywood and Wall Street, the Valley has its share of toxic masculinity and entrenched sexism. A mere 2% of venture-capital funding went to female founders’ startups last year.

Companies like Airbnb and Uber, which have raised lots of cash, can compete in this monied-up world. Young startups increasingly cannot. Launching a startup rarely makes actuarial sense, since the odds of success are so slim. But when office space, homes and top talent were within the reach of young, unproven companies there was a constant spate of dreamers willing to try it. At today’s prices, the spate has slowed. Claire Haidar of WNDYR, a productivity startup that relocated to America from Ireland in 2017, reckons it costs at least four times as much to base a startup in the Bay Area as it would in most other cities in America.

Many Silicon Valley startups are currently as much as 15% behind their hiring goals for the year, says Mr Volpi. This hurts their prospects of survival. Things don’t necessarily get easier as growth kicks in. According to CBRE, a real-estate firm, it costs $62.4m a year to run a 500-person startup with 7,000 square metres of office in San Francisco, more than anywhere else in America or Canada (see chart 3). That is 47% and 49% more than it costs to run a startup in Portland and Atlanta, respectively, and more than double what it costs in Vancouver and Toronto.

It is still possible for a Valley startup to grow large. Slack, which launched its workplace-messaging app in 2013, claims a private-market valuation of $7.1bn. However, its boss, Stewart Butterfield, is an experienced entrepreneur who had already had a well-known hit (Flickr, which was sold to Yahoo in 2005). Fewer first-time entrepreneurs are breaking through.

The corralling of talent in big companies is not just bad for startups. It is bad for future technological diversity. Talented people can still launch wild new projects from inside the giants—but probably not as new, or as wild, as they would in a startup culture where the pool of other innovators with whom to team up would be larger and more diverse. The problem which dogged Route 128 has come to the Valley in a big way. “People join the big firms, and especially Apple, and they fall off the face of the earth. It’s a genuine problem for the ecosystem,” says John Lilly, a venture capitalist with Greylock.

Route 128 did not just lose out because of culture. It also lost out because it was pursuing a technology, the minicomputer, from which the market was turning away. With smartphones ubiquitous and social networking more than a decade old, people in tech are increasingly worried about what is next. Even if the Silicon Valley giants can spot it, they may not be best placed to capitalise on it; flexible as the giants are, they cannot do everything. If the new new thing takes off elsewhere, Silicon Valley’s advantages will be lessened.

Take the continued spread of cloud computing, an increasingly lucrative business for both Amazon and Microsoft. If either could make its cloud-computing platform as dominant as Windows was in the PC era, it could cause yet more activity to move closer to Seattle, where both firms reside and which is already a buzzing tech hub much cheaper to live and work in than the Valley. Other technologies which could conceivably pull power away from the Valley might include blockchains (see Technology Quarterly) or quantum computing. Blockchains are by their nature decentralised; quantum computing could reorient the tech world toward China.

It is entirely possible that the next disruptor will be none of these things. But it is all but certain that something will supersede devices with the Valley’s namesake semiconductor at their heart as the key to success in tech, and that that will matter.

Having giants around can provide benefits as well as kill zones; in looking after their own interests through political lobbying and the like they often look after their neighbours’, too. But the biggest political problem for American tech firms, in the Bay Area and elsewhere, is one that has proved beyond even the best-paid lobbyists. A lot of Americans are worried about immigration, and President Donald Trump is determined to act on their behalf.

More than half of the top American tech companies were founded by immigrants or the children of immigrants. Despite lobbying from the tech giants, the Trump administration has brought in rules that severely restrict the number of foreigners who can receive work visas. Some tech firms have experienced delays of up to 18 months for foreign hires whom they might otherwise have been able to bring over swiftly. Students who come to America for degrees increasingly end up going home afterwards, willingly or not. “If you ask me ten years from now why Silicon Valley failed, it will be because we screwed up immigration,” predicts Randy Komisar of Kleiner Perkins, a venture-capital firm.

Nor have the tech giants as yet managed to improve things by using their muscle with local officials to ease some of Silicon Valley’s specific problems. Instead of building more affordable housing in a timely manner, which the Bay Area desperately needs, San Franciscan politicians are in the midst of discussing legislating the abolition of corporate cafeterias in order to force techies to eat lunch out. Big new infrastructure projects to ease congestion and make it easier to get to work from further away are nowhere to be seen. Instead there are private luxury buses to the tech campuses—which became, a few years ago, the centre of the first big popular protests against the new elite.

People in motion

Faced with high costs and the chilling effect of the neighbourhood giants, entrepreneurs who would once have planned to build their businesses entirely in the Valley are increasingly pursuing three other courses: launching their startups somewhere else; moving their headquarters somewhere else once they reach a certain size; or keeping their headquarters in the Valley but scaling their operations elsewhere—“Off Silicon Valleying”, as some call it. Mark Pincus, the founder of Zynga, a games developer, predicts companies “will have to think about multiple locations much earlier in their trajectory.”

Take Indinero, which sells accounting software. Jessica Mah, the startup’s 28-year-old boss, was born and raised in New York City. She started her first company in middle school and moved to the University of California, Berkeley, to study computer science. After graduating she went to Y Combinator, the prominent boot camp for startups in Mountain View. In 2009 she started Indinero in San Francisco. What could be more Silicon Valley?

But by 2014 Ms Mah had realised that “there was no way for me to build a profitable business in the Bay Area. I had to expand elsewhere.” She asked her employees to relocate, both to other American cities and to the Philippines. Today the firm employs 200 people, but only around 30 of them are in the Bay Area. Portland is its official headquarters. Ms Mah’s life is a ceaseless round of virtual meetings and real travel, but she reckons that building her startup in more affordable cities has enabled her to save millions of dollars.

Such a decision does not just cut costs. Hiring in other cities reduces the odds of talented employees being poached by the tech giants and other startups—especially engineers, who are in high demand. Indeed a startup in a place with cheaper housing and less crowded freeways (even on a comfortable corporate bus with Wi-Fi, a two-hour commute is a pain) can become the poacher. San Francisco has many charms, but it is not particularly salubrious. People regularly encountering used drug needles, human excrement and sidewalks full of homeless people when they arrive home late at night at their $4,000-a-month one-bedroom flat in San Francisco sometimes think they might just prefer it elsewhere.

This dispersion of startups embodies a deep irony. The technology industry, which has disrupted nearly all other sectors, is disrupting itself. The communications tools and virtual workplaces that Valley firms have pioneered let teams work productively across cities and time zones without ever meeting one another in person. The headquarters in Dallas to which Ms Haidar relocated WNDYR, the productivity startup, contains only four of its 33 employees. The far-flung crew communicates through Telegram, an instant-messaging app, talks with clients through Slack, uses Zoom for meetings and collaborates on goal-setting with software from Lucid and Google.

This does not mean that all places have become equal. Startups thrive on “network effects”: entrepreneurs, like internet users, tend to cluster where their peers are. Having a world-class university or two nearby can be very important for such hubs, especially if they actively encourage commercial activity, as Stanford has. It also helps to have an “anchor tenant” that validates the place and draws employees there; they can then leave to start their own companies or work elsewhere. This is one reason that Seattle, home to the two of the world’s biggest five companies not based in the Valley, is doing so well.

A strange vibration

Being a place where people want to live helps a lot, too. Putting together such a package does not in itself create a Silicon Valley simulacrum: history, culture and a lot of established venture capitalists are not easily replicated. But it does well enough. “There are probably a dozen cities that are just as promising [as San Francisco in which] to start a tech company today,” says Peter Thiel, a feisty venture capitalist who will soon move from San Francisco to Los Angeles, a city which has welcomed many Valley refugees before him. It has its own growing tech scene—one that gained more attention when the online-media company Snap chose to set up shop there.

Portland, Oregon; Austin, Texas; Vancouver (close to the United States, but easier for foreign immigrants to come and work in); London; Berlin: they all fit the bill, and then some. After considering 23 factors, such as employee compensation, retention, taxes, available funding, ease of access to other cities and the weather, the cities that Ms Haidar saw as runners up to first-choice Dallas were Phoenix, Arizona and Boulder, Colorado. The Kauffman Foundation, a think-tank, now ranks the Miami-Fort Lauderdale area as number one in America for startup activity. As each grows, each offers more opportunities for people who decide to move on from their current job. Internationally, Beijing and Shenzhen are hugely important. Admittedly, they mainly appeal to Chinese entrepreneurs who can speak the language and navigate the local business environment; but that is a big pool. And some foreigners are giving it a go, too.

“Silicon Valley will continue to be the strongest innovation ecosystem in the world, but on a relative basis it will become less important,” predicts Steve Case, the former boss of America Online. He now runs Revolution, a venture-capital firm based in Washington, DC, which is looking hard for investments outside the Bay Area. According to CB Insights, a research firm, in 2013 Silicon Valley-based investors put about half their money into startups outside the Bay Area; in the year to date, that share has risen to 62%. This has mirrored the geography of “unicorns”: in 2013 some 41% were based in Silicon Valley; today only 16% are, with 35% headquartered in China (see chart 4).

Even Silicon Valley’s most conventional venture capitalists are preparing for geographical diversification. One storied firm with headquarters on Sand Hill Road in Palo Alto was recently considering signing a new ten-year lease for a larger office space in nearby San Francisco. It decided not to. “A decade from now we’re going to be spending less time, not more time, in this area,” explains one of the partners.

Coming to Silicon Valley to network and fundraise will continue to provide advantages; nowhere else will match it for apprenticeship or pilgrimage. “There’s no place that’s replacing Silicon Valley,” says Mr Thiel. But it will be less critical to stay and set up shop here. “The Valley is going to become an idea instead of a place,” predicts Glenn Kelman, the boss of Redfin, a property company. “Wall Street went through a similar transformation,” he says, its name becoming shorthand for a whole industry. As tech firms set their sights on disrupting old-fashioned industries, like health care and logistics, they may find that it helps to be based in cities that claim deep expertise in these areas—and where garages housing startups are not just the stuff of museums and memory.

This article appeared in the Briefing section of the print edition under the headline "A victim of its own success"

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