Why is Silicon Valley Underperforming? Part II: The Maturity of the High-Tech Industry


(T) Even after 10 years in business, successful and profitable start-ups cannot reach $100M in revenues. It is now a different game for Silicon Valley start-ups. Consider the tale of the following three start-ups: the first one is based in San Jose and design and manufacture wireless data network equipment for Verizon, Orange, NTT DoCoMo; the second start-up is based in Menlo Park and market a new encryption technology for data networks to DuPont, Goldman Sachs, and the US Army; the third one is based in San Francisco, south of market street, and improves the delivery of voice over the Internet and help Google, Cisco and IBM designing their own VoIP solutions.

The first start-up has break-even and generates around $30M in revenues a year, the second one still needs significant cash infusion for its operations and generates a few million dollars a year; the third one generates around $15M a year but has $15M in cash on its balance sheet.

All those three start-ups were started roughly 10 years ago during the exuberance days of Silicon Valley and survived the implosion of the Internet bubble in 2001. All those start-ups were funded by tier 1 and tier 2 Silicon Valley venture capital firms. Two of those three start-ups are profitable and one has even cash on its balance sheets. But none of those three start-ups is preparing itself for an IPO or had significant acquisition proposals but all of them have excellent intellectual property, products, and customer base.

Since 2001, capital markets have required companies to reach $100M for an IPO. OpenTable with $56M in revenues in 2008 does not comply with that requirement. And, I think that where is the fundamental root cause of the underperformance of Silicon Valley: even after 10 years in business, successful and profitable start-ups cannot reach $100M in revenues.

Leading tech companies cannot find any growth

The history of the computing industry can be summarized in five architecture phases: the Mainframe, the Mini-Computer, the PC and Client/Server, the Internet and today the Mobile Web. During each phase, the computing industry delivered more with less.

But we have now reached a point of no return where the leading technology infrastructure providers cannot find any more significant revenue growth.

For the first time in 2009, Microsoft laid off 5% of its workforce. Microsoft Q1 2009 was the first quarter in the company history where revenues decrease from the quarter a year ago.

Oracle has bought all major enterprise software companies (PeopleSoft, Siebel, Hyperion, BEA….) to the exception of Microsoft and even bought very recently a hardware company: Sun Microsystems only for its software: Java and Solaris!

While Cisco revenues are still mostly in switching and routing, Cisco’s strategy is opposite to Oracle’s. The company is trying to expand beyond its core networking market into Software (Cisco’s Application Networking), Web services (with its WebEx acquisition) or more recently into the blade server market (with its Unified Computing)  and so competing with Dell, HP, and IBM.  For the last few years, Cisco has bought more non-networking start-ups than networking ones and hired more executives outside the networking industry than inside the networking industry.

While Oracle and Cisco have been trying different strategies to fuel their growths, IBM is now mostly a service company, HP a printer company taking significant shares to its competitors because of a better execution under the leadership of Mark Hurd while Dell even with the return of Michael Dell as CEO is struggling with its own execution and limited by Intel and Microsoft’s growth.

Among large public companies, only Apple and Google are the engines of innovation and growth.

The new markets: Social Networks, the Mobile Web, Web Services and Cloud Computing

Since the 2001 tech bubble, the major areas of innovation and growth for start-ups have been Social Networks, the Mobile Web, Web Services and Cloud Computing.

Social networks are ubiquitous and a growing and nearly profitable industry: Facebook revenues were $265M in 2008 while LinkedIn revenues were in the $100M.

With the combination of the new 3G/4G cellular networks and WiFi/802.11n networks, creative mobile hardware and operating systems with the iPhone, the BlackBerry and the Android and many new Mobile applications, the Mobile Web is certainly the last wave in computing and driving Cloud Computing as the next underlying computing architecture.

All Web Services for consumers or Software as a Service (SaaS) for enterprises will have to be provided from the “cloud” as a utility service. It is the most efficient way to deliver, update and tailor any product and service offering. Today, the new computing architecture is Cloud Computing. The new client is any mobile device. The new servers are distributed data centers that can be accessed through any wireless networks and the Internet.

Today new high-tech start-ups are mostly in any one of those four markets: social networks, mobility, Web services, and cloud computing.

The end of the infrastructure start-up

With much less venture capital to start a new company, much less infrastructure start-up companies are started in the areas of system software, core networking or information security except for cloud computing.

There are not enough infrastructure start-ups in Silicon Valley right now such as Flock developing a social networking browser, Cuil a search engine competing with Google or Arista Networks a new switch company from Andy Bechtolsheim, Sun Microsystems founder, competing with Cisco Systems.

With fewer infrastructure start-ups to the exception of cloud computing, established players such as Microsoft, IBM, Oracle, Intel, Cisco, HP do not have any competition from start-ups and have no need for acquiring start-ups to preserve their competitive leadership. But at the same time, they cannot count on emerging start-ups to create new areas of growth for themselves.

And new technology markets created by new start-ups are smaller and smaller

So without many infrastructure start-ups, the Social Networking, the Mobile Web and the Web services markets do not seem to lead to many $100M markets ahead for any new Silicon Valley start-up.

The latest high-tech markets created by new start-ups are getting smaller and smaller. As a consequence, fewer IPOs can still be anticipated if nothing changes in the foreseeable future.

That was obviously not the case in the 70s, 80s, and 90s where the complete computing infrastructure was being built and silicon (Fairchild, Intel, National, AMD…), system (Apple, Amdahl, Pyramid, Sun, SGI…), storage (Seagate, Network Appliance…), networking (3Com, Cisco, Madge, SynOptics…) and software start-ups (Borland, Oracle, Ingress, Informix, PeopleSoft…) could in a few years reach several hundreds million in revenues.

In particular, in the 70s and 80s, there were as well no incumbents. Start-ups were competing with themselves uniquely while now for instance in cloud computing start-ups are competing from day one with the incumbents such as Google, Amazon, Sun, IBM, and Microsoft.

But Silicon Valley can rebound at any time

Discoveries in science and technologies are never the fruits of detailed planning and design but always come unexpectedly such as Positive Gray Swans. Mr. Nassim Nicholas Talebdefines a Black or Gray Swan as a random event with three attributes:

“First, it is an outlier, as it lies outside the realm of regular expectations because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”

Like a Gray Swan, a disruptive technology always came from nowhere. If Tim Berners-Lee did not have the idea in 1994 to create the Web to share his ideas at the CERN, there will be probably no Internet today.

And a new technology leads always to another one. After Tim Berners-Lee created the Web, Marc Andreessen and a few students from the University of Illinois at Urbana-Champaign created Mosaic the first browser. And that how the Internet took-off in 1995.

So let’s hope that a positive Gray Swan will make Silicon Valley shining again soon!

Note 1: For more on Cloud Computing, please read: Cloud Computing from Your Mobile

Note 2: The picture above is a view of the Embarcadero from Market Street in San Francisco.

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