Harvesting the Secrets of Silicon Valley

Why has Silicon Valley been so successful? "It is ironic, in light of traditional theories of industrial location, that a relatively high-cost location like Silicon Valley was the more attractive location for both startups and the business units of technology companies headquartered elsewhere," writes Annalee Saxenian in her book, Regional Advantage.

One secret to the region's success is its tolerance of failure. "Failure was viewed as an opportunity for learning." An executive recruiter told her, "Everybody knows that some of the best presidents in the Valley are people that have stumbled." George Gilder sums up the point: "Unless failure is possible, no learning is possible.... If you don't tolerate failure, you can't permit success. The successful people have a lot more failures than the failures do."

Another secret is the region's dense network of relationships and its continuous adaptation to new economic conditions. "The region's networks of personal relationships and culture of open exchange facilitated this process of adjustment and learning." Nothing is static. Bill Joy, co-founder of Sun Microsystems, says that "High technology obeys the iron law of revolution: the more you change, the more you have to change...you have to be willing to accept the fact that in this game the rules keep changing." You can't move ahead by sitting still.

Yet another secret is the region's emphasis on collaboration, even among competitors. For example, the venture capital fund Kleiner Perkins Caufield and Byers "imitated Japanese corporate models and created a zaibatsu fund that allowed them to remain intimately involved with the older firms in their portfolio and to promote cross-investment by member firms. The idea was to create a network that would strengthen each individual venture as well as the collective."

Case Study: The Sand Hill Road Network

Sand Hill Road in Menlo Park, California, is now home to more than 40 venture capital firms. "You can be in Tokyo and if you tell the Japanese you work on Sand Hill Road, they'll know exactly where you are," says Reid Dennis, a founding partner of Institutional Venture Partners. Why did they cluster there? The address offered a central location midway between the airports in San Francisco and San Jose and a few miles from the center of Stanford University and its Stanford Research Park, but so did other locations, like University Avenue and Page Mill Road in Palo Alto, which also offered more to do (like restaurants and movie theaters) than the sylvan setting on the hill.

The fact is, Sand Hill Road would not have happened without the vision of a developer who saw the chance to put people together in a single location that offered the potential for collegial dealmaking, proximity to support services, a handy restaurant where people could discuss deals under relaxed conditions, and the unintended side-effect of creating a kind of brand image. Steve Spurlock of Benchmark Capital agrees with the last point: "The address implied you were with a crowd of investors people consider worth talking to."

Tearing Down the Walls

The cluster was the brainchild of Thomas Ford, who built the first group of offices at 3000 Sand Hill Road in 1969, and "created an environment of tearing down all the walls of doing business," according to William Del Biaggio III, founder of Sand Hill Capital. Neal Douglas, former partner with New Enterprise Associates and later founder of AT&T Ventures put it succinctly: "I don't think there is any more to it than crossing people's paths and having opportunities to talk about things."

The clustered location encouraged collegiality. As recently as the 1980s, venture capital funds were small and had to work together to invest in promising startups. A large number of small funds had many eyes to scan potential startups. Once a good prospect was identified, they would pool their small funds together to provide enough cash to accelerate the growth of the company. Four to six firms were often required to complete a deal. Many syndications were consummated over lunch at The Sun Deck, a restaurant in the center of the complex--and the only restaurant within two miles.

Proximity and Connections

George Pavlov of the Mayfield Fund believes that proximity made it easy for all the people involved in a deal to interact easily. "Lawyers, bankers, investment bankers--Goldman Sachs, Merrill Lynch, Silicon Valley Bank, to name a few--all have offices here [on Sand Hill Road] as well."

Out of this collegiality sprang companies like Sun Microsystems, Apple Computer, and Cisco Systems. An entrepreneur might pitch to one firm and later that day have commitments for funding from several firms, although the funding dance usually takes much longer.

Sand Hill Road is tightly woven into Silicon Valley's dense network of relationships. Even a couple of college dropouts with a good idea can plug into that network. The Two Steves, Jobs and Wozniak, are probably the most famous example. Apple Computer's first significant investment (beyond the proceeds from the sale of Jobs' VW van and Wozniak's programmable calculator) was a $250,000 loan guarantee from a marketing guy named Mike Markkula. Markkula had retired at age 33 with a very small but comfortable fortune after the Intel IPO. Markkula was not a venture capitalist. He had never heard of Steve Jobs and Steve Jobs had never heard of him.

But when Jobs saw some advertisements for a then-little company called Intel that looked more like car ads than semiconductor ads, he called the company to find out who did them. Intel put him in touch with Regis McKenna, whose agency was handling both the PR and ads for Intel. McKenna was intrigued enough with Jobs' idea for a personal computer that he referred him to Don Valentine of Sequoia Venture Capital. Jobs was a college dropout living at home with his parents in a nondescript neighborhood of Mountain View. Valentine drove up to the garage in his Mercedes and was instantly on guard when he saw two kids in ratty jeans with a hand-made computer built into a wooden box. Even though Valentine chose not to invest in those scruffy "renegades from the human race," he put Steve Jobs in touch with Markkula. Markkula had always wanted a computer that could fit on his desktop, and demonstrated their little Apple I to the board of Intel, impressing Arthur Rock, the Patriarch of Venture Capital, who had provided seed funding for Intel, among other companies. Markkula also knew Hank Smith of Venrock, the Rockefeller family's venture capital arm back in New York, which decided to invest. By this time, even Don Valentine wanted in. And Regis McKenna became Apple's first advertising agency.

Building a Dense Network of Relationships

Without the dense network of relationships, it's doubtful that Apple Computer would have survived past the wooden box stage. This part of the network was established by people who had all been directly involved with one company, Intel. In a sense, they had all worked in one module of the network, and when they left, plugged into other modules, but kept their old links. Many of them had first worked together at a module called Shockley Semiconductor, which spawned another module called Fairchild Semiconductor, which spawned the module called Intel.

Spokane has a shortage of such modules, and they're often disconnected from each other. The existing modules are slowly being connected to form a larger network, but we will find success faster if we can jumpstart that network. The Phoenix Project is one way to create a large module quickly, by putting a whole bunch of little modules together in one big box. Successful companies will move out of the box and bring their connections with them, the way the founders of Shockley Semiconductor and Fairchild are linked to nearly every startup in Silicon Valley over the last 50 years. Even when startups fail, the founders bring their links with them to their next company.

Many Small Funds

Silicon Valley's venture capital funds were surprisingly small as recently as 1990. Thirty years ago in 1975, Institutional Venture Partners raised what was then considered an astoundingly large fund--its $19 million was half of all capital raised in the United States by private venture capital partnerships that year. No others had more than $10 million under management. Now firms often have billions of dollars under management. This excess of capital makes it ineffective for large funds to look at small deals (under $3 million, for example). Startups needing seed capital (up to $3 million, for example) often find it through angel groups and wealthy private investors.

In recent years, as the funds exploded in size and the network of dealmakers expanded into the thousands, some funds have found that a location on Sand Hill Road itself is not as important as it once was. (Although lack of available space and peak monthly rents topping $22 a square foot probably contributed to that conclusion.)

Promod Haque of Norwest Venture Partners complains of isolation on Sand Hill--there's just not much to do there. Norwest relocated to University Avenue in downtown Palo Alto, a few miles away across the Stanford campus, where monthly rents are down in the mid-teens. Jay Hoag, co-founder and general partner of Technology Crossover Ventures, also thinks University Avenue offers more vibrancy. Accel Partners and Oak Investment Partners are among the other firms that have found a home in downtown Palo Alto. But collegiality still seems important: few firms have located far down the valley in the sprawl of San Jose, where monthly rents are only $2 to $8 a square foot.

Steve Bird, general partner at Palo Alto-based Focus Ventures, sees the early clustering as a kind of brand-building. "It was a smaller, less well known industry then and Sand Hill lent a certain credibility." Bird told a reporter he "misses the industry's early collegial feel and bumping into colleagues on the way to work or home, but says that's not found at any address today."

The Phoenix Project is one way to replicate the collegial feel of early Sand Hill Road, promote brand awareness of Spokane as a startup capital, and incorporate the sense of vibrancy newer venture funds look for as they choose a business address. It's possible, and even practicable, for Spokane to emulate the Sand Hill Road of yore with a group of small funds, each scouting their own prospects, which collaborate on deals to build companies to the point that larger, outside funds, or even Spokane's own Northwest Venture Associates, would consider investing in them. The payoff could be large. Arthur Rock's $57,600 second-round investment in Apple became worth $21.8 million at the IPO less than three years later for a 387x return. Jobs had traded in his VW van for $256.4 million and Woz his calculator for $135 million.

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Case Study: Building Companies

The myth is that Silicon Valley entrepreneurs develop their business plans on a cocktail napkin while waiting for dinner, then go down to Sand Hill Road and find all the venture capitalists eager to invest in their great idea. More often the idea starts with a couple of people in a garage who get help from a lot of other people who think they have a great idea. This is how Apple and Hewlett-Packard grew. Or somebody comes up with the idea at work and their company encourages them to pursue it after business hours. This is how a programmer named Sandra Kurtzig built her company, ASK Computing. HP even donated time on the company's mainframes to develop the software, back in the days when computer time was an extremely valuable commodity. They knew her software would sell their computers, but they also wanted to help an employee make her own success.

Another approach, which is often overlooked outside the Valley, is that a venture fund will actively create a company from scratch or from just the kernel of an idea. They bring not only money, but also expertise and a vast rolodex, putting together all the components that are likely to make the company thrive. Kleiner Perkins Caufield and Byers has used this approach, in part, on the way to becoming one of the world's most successful venture funds.

KPCB and Hands-On Investment

According to Fortune Magazine, Eugene Kleiner and Tom Perkins raised the first mega-fund, all of $8.5 million, in 1972. (In today's dollars that would be $33 million.) Five years later, Frank Caufield and Brook Byers joined the firm, which became known as KPCB. From that seed sprang companies that now employ over 300,000 people, have annual sales in excess of $100 billion and carry a public market value in excess of $160 billion. This is just one venture fund, but how they accomplished so much from such humble beginnings is worth exploring.

According to Kleiner, other venture capitalists at the time "were really risk-taking bankers," investing money but not much else. "Our feeling was that, sure companies need money, but they needed more than that--they needed help in getting started, in how to staff the company and plan the business, et cetera."

So Kleiner and Perkins started a venture fund that would work closely with the startups—to "create companies and grow them…. Some people have ideas and not a business, so some may use angel money to do some experiments and to write a good business plan, and then they go to a venture capitalist. At Kleiner Perkins we used to incubate some companies; there were people who had good ideas, but didn't have a business. We'd give them an office and we'd give them a salary and we told them to write a business plan. We would do this for three or four months or so, and this gave us a chance to observe people and to see whether we could work with them. Some succeeded and others left us in three months. In general the whole idea was very successful." [Italics added.]

Even the partners were encouraged to get into the act. Soon after 32-year-old Brook Byers had joined the firm, he wanted to invest in a startup that planned to make something called monoclonal antibodies. It was basically the first biotechnology firm. But Byers would have to take a leave of absence to start and run the company. He was afraid his career would be over if the company failed.

Byers asked Kleiner what he should do. At 54, Kleiner was "the benevolent, wise father figure. He was just a calm, wise person." Kleiner told him, "You should be taking these risks. What do you want to be? Do you want to be someone who invests with others your whole career or invest in something you initiated where you are the entrepreneur?"

Byers' risk paid off for everybody: Hybritech went public in 1981 and was bought by Lilly for $400 million in 1986.

So not only did KPCB help people with good ideas build their businesses, the firm also encouraged its own partners to become entrepreneurs. The success stories include Robert Swanson, who founded Genentech (2005 market cap: $98.81 billion), and James Treybig, who founded Tandem (acquired by Compaq for $3 billion, and now part of HP).

Tom Perkins attributes much of KPCB's success to the Silicon Valley environment. "A lot of things are in place here. You've got universities that are feeding out ideas more than anywhere else. You've got realtors who understand how it all works and are willing to speculate and gamble with small companies where they won't elsewhere. And then, most important, you've got the entrepreneurs," who are really aspirational role models. "The point is, there's almost nobody in Silicon Valley who doesn't know somebody else that's made a million dollars. At least!" Perkins, who grew up in Chicago, could be talking about Spokane when he says "there is almost nobody in Chicago who knows anybody that has ever come remotely close to making a million dollars. And that's all the difference. Out here, they know it can be done. In Chicago, it doesn't even occur to them."

Spinoff Benefits of an Entrepreneurial Culture

A common objection to efforts aimed at creating high-growth companies in the Spokane region is that the money would be better spent helping the poor. How does it help the poor, we are asked, even if these new companies do create millionaires and give jobs to college-educated people? Newly arriving engineers and managers are probably already relatively well-off. They'll just drive up housing prices when they move here from out of the area.

The surprising thing is that a rising tide truly can lift all boats, creating thousands of supporting jobs in manufacturing, prototyping, building maintenance, landscaping, and infrastructure construction and maintenance. Someone has to build new buildings and new roads and light-rail lines. Restaurants, theaters, banks, entertainment venues, dry cleaners, toy stores, sporting-goods stores, grocery stores, and shops of all kinds also grow and hire more employees. And all this forms a virtuous circle, with each new large-scale success creating numerous small-scale successes, benefiting local government activities as well. According to The Economist, "Silicon Valley's entrepreneurial activity creates huge extra demand for goods and services. Local municipalities have grown rich on the increasing amounts of property and sales taxes collected. So schools, community colleges, roads, parks and welfare services have all improved, redoubling the region's attraction."

So the payoff is region-wide. But we don't build this economy by continuing to analyze what's wrong with our existing situation, or by sitting around waiting for people to show up with the perfect team and perfect business plan and a five-year record of profits. We need to follow the model of the people who have already done it. Kim Smith, CEO of New Schools Ventures, a spinoff of KPCB founded by Brook Byers and wunder-VC John Doerr, says her firm does provide hands-on assistance to the companies that already have an on-going business or arrive at their doorstep with a completed business plan and a strong team. But that's not enough. "We also incubate ventures when something needs to happen and hasn't evolved naturally. That means we have investments over the life cycles of organizations—i.e., some incubation, some early stage, some start-up, and some scale-up based on a strategic use of capital."

John Doerr, whom Cisco Systems CEO John Chambers calls "the best VC in the world," should have some idea of what works and what doesn't. His successes include Sun Microsystems, Compaq, Lotus, Intuit, Genentech, Millenium Pharmaceuticals, Netscape, Amazon.com, and Google. Maybe that's why nobody remembers the flops.

Floyd Kvamme, partner emeritus of KPCB, co-founder of National Semiconductor and former VP of Sales and Marketing of Apple Computer, confirms Doerr's perspective. "In a very real sense, my job is to help people's dreams flourish. I don't think you can be successful in the venture capital business if you say, 'You've got to be kidding, you're crazy, that's never going to happen, get real.' Those are expressions that just don't exist here in Silicon Valley. You have to be realistic about certain things (like running out of money), but it's important to say 'Terrific idea. How do we implement this?' You might come to the conclusion that the idea is not practical, but at least you're not pouring sand and water on a spark. Enthusiasm is a very, very big part of what makes Silicon Valley work. And in my life here in Silicon Valley, believing in the unbelievable has worked out pretty well."

MORE TO COME:

Case Study: University Avenue

Just a few decades ago, not much was happening in downtown Palo Alto. It was a place where the sidewalks rolled up at five o'clock and everyone went home. Stanford students found little reason to make the mile-long trek across the arboretum to town. Even the faculty who lived a few blocks away in Professorville rarely visited except to buy nails at the hardware store or foam at the famous House of Foam. There wasn't much else to do.

And because not much was happening, rents were relatively cheap. And because rents were cheap and Stanford was a 15-minute walk away, startups chose to locate there. And because startups chose to locate there, restaurants began to open. Things began to happen on University Avenue. St. Michael's Alley, a coffeehouse with a new gadget called an espresso machine, began wiring the electrical engineers and computer scientists who would create the Internet. Obscure performers like Joan Baez and the Grateful Dead began to draw crowds, who could browse through newspapers from around the world as they drank their high-powered coffee drinks. Moviegoers could watch old movies and foreign movies while lounging on beanbag chairs and old couches at the low-budget Festival Theater, one of a dozen downtown screens showing everything from mainstream to avant-garde films. The New Varsity Theater switched between midnight showings of the Rocky Horror Picture Show and a slate of entertainers who became famous on the local Windham Hill record label.

Would-be restaurateurs tried out their concepts in a funky place called Liddicoat's, which had been built in 1923 as a public meeting hall and community center. Behind the mission-style façade lay a deep and narrow food palace, filled with various vendors, including a tiny Japanese lady who learned French cuisine as the official chef of the American Embassy in Tokyo, exiles from Saddam Hussein barbecue and Japanese tempura fish. The most famous tenant of all was a 20-year-old named Debbie Fields. She opened Mrs. Fields Chocolate Chippery in 1977, which grew from one little store to a worldwide chain and frozen food empire.

University Bank, a new bank willing to take a chance on startups, built its headquarters a block away. Other banks became willing to take a chance on startups. Venture funds began opening offices on University Avenue. Empty storefronts vanished, replaced by more restaurants and shops. Formerly empty one-story buildings were replaced by fully leased two- and three-story buildings. A block away, seed fund Garage.com built its first offices in an old Victorian boarding house, and were joined by a dozen other venture funds nearby. Apartment buildings and condos began to rise nearby because people now wanted to live where nobody would ever want to live. Street musicians began to play. In what seemed to be a sudden change, the streets were full all day and late into the night. Restaurants were open after 9 p.m. even on weekdays, feeding hungry startup founders taking a break from the next Google or Yahoo. On a walk down the street, you could bump into a friend who could introduce you to a venture capitalist he was going to lunch with, who could bump into an engineering professor and a marketing expert on his way back to the office, who could find two brilliant students and three other people you need to start your company. With just a good idea and part of the startup team, you could literally put together a company in an afternoon. This didn't happen all the time, but the entire startup creation phase was vastly truncated because of proximity to the right people and the right tools.

That's what the Phoenix Project hopes to accomplish: To combine Sand Hill Road with University Avenue. To create a Silicon-Valley-in-a-box where everyone and everything that can help a business grow, including restaurants and shops and fun things for founders to do to blow off steam, including students and accountants and attorneys and funders and bankers, are all together, rubbing shoulders and making connections every day. That's what makes explosive growth possible.