Silicon Valley Inc. Needs a Turnaround Expert, New PR Firm

What’s wrong with Silicon Valley? It’s a question BusinessWeek asks on the cover of its January 12, 2009 issue.

According to BusinessWeek reporter Steve Hamm, “A road trip finds risk aversion, short-term thinking, and a few bold ideas.” Given that some believe technological innovation is going to lead the United States out of its economic mess and restore its global competitiveness, those aren’t exactly the findings one probably wanted to receive.

I, of course, have been criticizing Silicon Valley for some time on The Drama 2.0 Show. While Valley inhabitants have celebrated consumer Internet startups like Facebook and Twitter and have demonstrated irrational exuberance over businesses they clearly don’t understand (like energy), as an outsider I haven’t been able to help but notice that there hasn’t been much real innovation taking place.

This isn’t entirely surprising. Scientists and experienced technologists in the Valley have been forced to compete with hipsters and Harvard dropouts. Forward-thinking venture capitalists have been forced to share Sand Hill Road with young VCs who carry MBAs and list companies like McKinsey and Bain on their resumes. Substance has been forced to compete with hype. A desire to build real companies that produce real wealth in the form of profit has been forced to compete with the desire to “fund and flip.”

Former Intel CEO Andy Grove has a bachelor’s degree in Chemical Engineering and a Ph.D. in Chemical Engineering. He was Intel’s third employee and did more for IBM during his career than perhaps any other person.

In his article, BusinessWeek’s Hamm relates Grove’s frustration at the state of Silicon Valley. Grove tells Hamm:

Intel never had an exit strategy. These days, people cobble something together. No capital. No technology. They measure eyeballs and sell advertising. Then they get rid of it. You can’t build an empire out of this kind of concoction. You don’t even try.

Cobbling something together. Hmm. Do you hear that, Paul Graham?

If you have followed the voices in the blogosphere, the Twittersphere, the mainstream media and the conference trail over the past several years, you may have been led to believe that there was a golden era in Silicon Valley.

Innovation was everywhere. Lower barriers to entry made it easier to launch a new company and raise financing on favorable terms. A more “democratic” funding environment made it possible for virtual nobodies to play ball. And the struggles of stodgy old companies in dinosauric industries somehow inured to the benefit of Silicon Valley upstarts looking to dethrone them.

I’m sure the excitement was palpable for those who found themselves in the midst of the second coming of the Internet but as an outsider, it was difficult for me to see how the companies and trends Silicon Valley was latching onto were all that important. How were social networks going to revolutionize an already sophisticated, complex and competitive global ad market? How were microblogging services going to revolutionize personal communications? How was citizen journalism going to replace the expensive exercise of covering the news without the financial resources held by major media organizations?

The bigger question I had: how was any of this going to make the type of money the venture capitalists funding it needed it to?

It wasn’t, and now that this is clear to all but those who rely on social networks, social media, citizen journalism, et. al., to pay the bills, the question for Silicon Valley becomes: where did we go wrong?

There are a number of contributors to the flawed thinking that is now pervasive in Silicon Valley.

The Allure of Advertising Masks A Lack of Innovation

I’m not sure why everyone in Silicon Valley is so enamored with advertising as a business model. Perhaps it’s that Silicon Valley entrepreneurs and VCs have heard such fabulous things about the parties major brands and ad agencies throw at the Super Bowl and they hope that they’ll one day be invited. Or perhaps they like the fact that, on paper, advertising revenues seem potentially unlimited. The more you grow, the more you can make.

A great formula comes into focus: give something “cool” away for free, spark viral growth, hit critical mass, sell lots of advertising, profit. If only it were that simple.

To be sure, the advertising market is absolutely huge. And if you think like a VC, all you need is to capture a small sliver of it to make a lot of money. But selling advertising can be a real bitch and there’s a reason that it’s the big who tend to get bigger in this market. The existence of massive ad spend doesn’t guarantee you’re going to get any of it, there’s still a lot that’s driven by relationships, buying is cyclical and, of course, as everyone is now realizing (again): the fate of the advertising market is correlated quite closely with the fate of the economy.

The reality: ad-supported businesses have been so popular in Silicon Valley of late because the Valley folk have known, either consciously or unconsciously, that there aren’t a whole lot of people willing to pay a whole lot of money for most of the products and services they’re developing.

The best innovations are rarely subsidized by advertising. Because innovations offer a new way of doing something – whether more effectively, more efficiently or at lower cost – they’re typically something their end users will pay for.

Let’s consider a handful of the greatest innovations of the 20th century, as named by Forbes: sneakers, the television, the mass spectrometer, the personal computer, frozen food, the transistor, point of sales data, the discount brokerage firm, Tupperware, “the pill”, the disposable diaper, the catalytic converter, the world wide web.

How many of these are paid for by their end users? All of them. For those interested in the subject of innovation, it’s an instructive exercise to go through Forbes’ list of the 20th century’s greatest innovations and to place each one of them in one of two columns: paid or ad-supported.

After doing so, you might be inclined to agree with Drama’s Law: the more innovative a product or service, the more willing its end user is likely to be to pay for it.

Unless you’re clueless and believe that this trend will change in the 21st century (even as we head into a deep recession), the question must be asked: why are so many of the Silicon Valley personalities widely publicized as being at the forefront of “innovation” spending so much time working on “innovations” that they clearly don’t believe end users would find valuable enough to pay for?

The logical answer: these people are not at the forefront of innovation.

Bubble 2.0, Stupid VCs and Short-Term Thinking

As the financial crisis unfolded, a lot of Web 2.0 types shouted “This isn’t our bubble!” To be sure, overvalued tech stocks didn’t produce the first half of the mother of all financial meltdowns (yes, there’s more to come). But to understand why Silicon Valley has been overrun by “me three” companies that produce little real innovation and even fewer profits, you need to understand that venture capitalists were able to raise such large amounts of money because of the economic bubble that was inflating around them. As I’ve stated before, Silicon Valley isn’t a walled garden insulated from the global economy.

The limited partners who invested huge sums of money in the venture capital “asset class” over the past decade have largely been the same entities (i.e. pension funds, funds of funds, wealthy individuals, etc.) that were beneficiaries of the inflationary system that produced all of the economy’s illusory wealth in the first place. It was a vicious cycle: as almost every asset class rose in value, there was far more money to pump into all the asset classes.

This did three things in Silicon Valley: it led to oversize VC funds, it led to more VC firms and it led to a “fund and flip” mentality.

It’s important to recognize that most VCs are not investors so much as they are money managers paid by their limited partners to allocate capital, and like most money managers, they are prone to herd mentality. A trend develops and before you know it, every VC wants exposure to the trend, especially if there has been any M&A activity that supports the notion that a lucrative new market is emerging. When there are too many firms with too much money chasing too few ideas, herd mentality can be a very destructive thing.

First, lots of capital piles on in areas where it really isn’t needed. One need look no further than the number of social networks and video sharing services that have been funded over the past four years as an example. Today, there are a handful of winners and potential winners in these spaces and a whole lot of losers. Hundreds of millions (if not billions) of dollars that could have been allocated to more worthwhile investments were instead wasted on acquiring “exposure” to hot trends in hopes of funding the next YouTube or MySpace. This explains why VCs have been taking in more money than they’re generating in returns.

Second, herd mentality discourages forward-thinking investments. Remember: venture capitalists are money managers, not true investors. They therefore have a great incentive not to stray from the herd. If you’re a money manager and every other money manager you’re competing with is investing in social networks, online video, solar or biofuels, investing in “oddball” companies that are trying to do something different and bold is a potential liability. If those companies don’t succeed, you don’t have the plausible deniability that is created by looking like all the other members of the herd.

Exacerbating the problem is the fact that most VCs are ill-equipped to spot something truly unique and forward-thinking. The word “innovation” is thrown around so much by VCs that it’s clear they have no clue. The word itself is almost meaningless in Silicon Valley these days.

Which isn’t surprising. Look at the website of most VC firms and you’ll inevitably find more MBAs and finance types than you will mechanical engineers and physicists. You’re far more likely to meet a VC who went to Stanford and worked at McKinsey than you are to meet a VC who went to CalTech and worked at the Department of Energy. While you don’t need to be a scientist to recognize innovation, if you’re funding biofuels companies, for instance, it probably helps if you have more exposure to, say, chemical engineering than financial engineering. That makes it a little bit easier to spot a technology with real potential instead of one that will serve as the basis for a hot PowerPoint.

So what do you do when you’re clueless, flush with cash and find yourself in the middle of a bubble economy? Fund and flip, baby.

Why go out of your way to fund companies that are bold but risky? Why fund companies that have substantive potential but may take years to realize it? When times are good, VCs have little reason to take intelligent risk. Big jackpots that produce immediate returns, which VCs got their first widespread taste of in the late 1990s, seem well within reach. And since everybody loves easy money, “fund and flip” is a lot sexier than “fund and fiddle.” It’s good for VCs, it’s good for their limited partners and it’s good for entrepreneurs who have a simple pitch (i.e. “we run a YouTube for dance that was co-founded by MC Hammer”).

In short, it pretty much boils down to this: if the VC market had a healthier (read: smaller) number of firms and a healthier (read: lower) amount of capital available to invest, the venture capital “asset class” could have remained the niche asset class of technology innovation that it should have been instead of yet another get-rich-quick scam. Capital would have been allocated more selectively to forward-thinking companies by more knowledgeable VCs.

Conclusion

If Silicon Valley was a corporation named Silicon Valley Inc. (SVI), I’d provide the following advice: hire a turnaround expert and retain a new PR firm. Now.

SVI needs a new direction. Its strategy is shot and the products it has lost much of its relevance in the marketplace. And before you think that cleantech is the answer, consider that a shockingly large percentage of the Silicon Valley eco-entrepreneurs don’t seem to realize that Moore’s Law doesn’t apply to energy.

There’s also a lot of dead weight in Silicon Valley. From hipster CEOs like Kevin Rose, who, after 4 years and no profits, relayed to BusinessWeek that Digg is “stepping up its innovation game”, to VCs who don’t know the difference between a proton and an electron, SVI needs to re-examine its recruiting practices. Metaphorically-speaking, there are far more people sitting around the water cooler than there are productive employees.

In short, SVI’s turnaround expert will help it define its core competencies, refocus on them and cut the slackers.

Once that’s done, SVI’s new PR firm will help ensure that Silicon Valley is sending the right messages to stakeholders, the public and the media. No more hyping novelties and no more “How This Kid Made $60 Million in 18 Months” cover stories.

SVI would instead highlight all the substantive innovation it is engaging in. It might even earn a cover story that reads “How This Technology Saved The Department of Defense $600 Million in 18 Months.” But it would never lose sight of the fact that its job isn’t to inspire people with press releases and fluff but to help individuals and businesses while making a profit.

Fortunately, SVI does not need to restructure completely from the ground up. There is innovation taking place. Large companies like IBM and Intel haven’t thrown in the towel on R&D. And there are entrepreneurs, like Jeff Hawkins, the creator of the Palm Pilot and the Treo, who are working on bold new ideas. Hawkins’ newest startup, Numenta, which BusinessWeek mentioned in its article, is developing computer memory system modeled after the human neocortex. It hasn’t raised venture capital. Apparently most VCs just can’t wrap their heads around the concept (no pun intended).

Of course, IBM, Intel and Numenta aren’t as sexy as Facebook, Digg and Twitter or all of the cleantech companies that are holding off on their innovations until a government bailout arrives, but if SVI wants sex appeal, it should change its name to Silicone Valley Inc. and relocate its corporate headquarters about 350 miles south to the San Fernando Valley. At the very least, the companies in Chatsworth could teach it a thing or two about making money.