Silicon Valley’s Resurgence: Is It for Real?

A string of Silicon Valley technology companies recently reported better than expected fourth-quarter earnings. Many tech shares are trading at 52-week highs. Venture capitalists are reading business plans. And the highly anticipated initial public offering of search-engine Google is raising hopes that riches will once more rush into Northern California .

In short, Silicon Valley is percolating once again. While some caution that it’s too soon to know if the resurgence has staying power, others are more optimistic.

According to Raffi Amit, Wharton professor of entrepreneurial management, the turnaround seemed imminent a year ago, following the public offering of Seagate Technology, but never materialized. This time, he says, it’s for real. “It took a little longer, but we see a number of offerings that have happened recently and the Google IPO will be huge. There’s no doubt that the recovery is finally underway.” Rising tech stocks are not the only sign of recovery, he notes. Venture capitalists are investing not just in companies that are already in their portfolios, but are beginning to make investments in new ventures.

The recovery was triggered when businesses, after several years of uncertainty, returned to investing in new information technology after their own profits began to rebound in the third and fourth quarters of 2003. Orders from those customers are stimulating new investment. “Having purchase orders in hand and taking them to the venture capitalists is a very convincing proof of concept,” says Amit.

Leonard Lodish, a Wharton marketing professor and vice dean of Wharton West in San Francisco , agrees that the valley’s economic El Nino appears to be blowing over. “Innovation is alive and well. New companies are being started and the public markets have begun to open up. The mood of people is brighter and job prospects are [better],” he says, adding that the decline in real estate values and rents seem to have bottomed out.

Remember the Carnage

Paul Tiffany, an adjunct professor at Wharton West, is somewhat less ebullient about the latest signs of what he calls a “fragile” recovery. “This is not a recovery [based] on a strong foundation at this point,” he says. “The sense I get is that people are standing close to the door so they can exit rapidly at the slightest indication that this [rebound] is going to stall.”

It’s important to view the current recovery cycle with an appreciation for the carnage left behind in Silicon Valley when the technology bubble ran out of steam in March and April 2000, Tiffany adds. Many firms lost half their equity value and some shrunk by 90-95%. “The depth of the downturn after 2000 was unprecedented.”

In addition, improvements in Silicon Valley and the broader economy may fall off after the 2004 elections, he warns. Bush Administration policies have kept the price of the dollar down, benefiting manufacturers and export-oriented industries, a move that could bolster the President’s standing in key states. After the elections, the weak dollar may rise again, hurting U.S.-based companies. “Part of the rationale for recovery is on ground that could well go away after November,” says Tiffany, adding that another terrorist attack in the United States could also derail the current upward momentum.

According to Wharton marketing professor Jagmohan Singh Raju, companies that provide technology infrastructure, such as Cisco, Juniper Networks and JDS Uniphase, appear to be leading the valley’s recovery based on an upturn in business spending. “I think the recovery is more related to business buying than consumer buying,” he says, adding that companies have finally begun placing orders after working off excess capacity acquired in the boom years leading up to Y2K. “Better and better technologies are being developed. To remain competitive, companies have to invest,” says Raju, who adds that low interest rates and an expanding global economy also make this a good time to purchase new equipment.

Semiconductor companies are also doing well, but when it comes to software and other technology companies the strength of the recovery is mixed, says Morris Cohen, Wharton professor of operations and information management. Semiconductors, a notably cyclical industry, “are just coming off one of the worst – probably the worst – down cycles in their history. They were so low they had only one way to go.” In addition to business spending, consumers are driving up demand for chips to run personal computers and consumer electronics, Morris adds.

According to Amit, a particularly hot sector is wireless. “We see an enormous number of applications in the wireless sector, especially in wireless access to broadband.” Even telecommunications, which was hammered when the bubble burst, has begun to stir again. “Many of these firms have been suffering. but I think we will see a stabilization and recovery that will enable them to resume purchases of IT equipment.”

Leveraging Relationships

Social networking firms, such as Friendster, the dating and friendship site, and LinkedIn, aimed at business networking, are gaining attention from venture capitalists, says Rob Coneybeer, a venture partner with New Enterprise Associates (NEA), a venture capital firm with offices in Silicon Valley .

“VCs are excited about the idea that people will use these Internet-based tools to leverage their relationships,” he says, adding, however, that this category of investment is probably already over funded. He estimates that for the business plans of the top five social relationship companies to succeed, the population of the United States would need to be more than 1 billion. “All the companies aren’t going to survive … Over funding of markets in general is a sign that there’s a real market and real opportunity there.”

Another trend among the new generation of Silicon Valley start-ups involves firms that build applications for use with already existing platforms, such as Microsoft Outlook. Firms, for example, are developing products that update Outlook contact information and provide e-mail backup, says Coneybeer. “The real key is that people are not only looking at Microsoft Windows as a platform, but at some of the applications that you can build other applications into.”

An important consumer market in the future will be the addition of cameras to cellular phones, he predicts. “It’s going to be more profound than people realize. People are used to carrying a phone everywhere; they are not used to carrying a camera everywhere. I think it will change the behavior of how people take pictures, share pictures and store pictures.”

So far, the Silicon Valley up tick remains largely a jobless recovery. Companies are hiring only cautiously and many firms are moving production jobs, as well as some software engineering positions, overseas where they can pay workers less. A quarter of Silicon Valley employers plan to hire more employees in the first quarter of 2004, while 18% plan to reduce their workforce, according to the Manpower Employment Outlook Survey. Of the remaining firms, 39% expect to maintain their current staff levels and 18% are not certain of their hiring plans.

“There is an ongoing restructuring underway with companies outsourcing non-core functions,” says Cohen. “The trend is continuing at an even higher rate as companies pull out of the recession and focus their energies and resources on those aspects of the business where they see the most competitive advantage.”

Wanted: Experienced Managers

Although the business climate feels upbeat these days, some observers note that the meltdown in 2000 hasn’t been forgotten. Silicon Valley , it seems, is paying attention to past mistakes.

“The mindset has changed,” says Amit. “Most investors and managers have learned a very costly and important lesson from the burst of the bubble. Today, unlike the past, every penny counts. People are being very conscientious when it comes to making hiring decisions about how to spend their dollars.”

This back-to-basics philosophy is flourishing in other technology hubs throughout the country as well, including the Route 128 corridor outside Boston and areas in Austin , Tx. and Northern Virginia , Amit adds. “Companies now understand they need to focus on developing their products – their technology – and invest in getting traction among customers rather than spend heavily on brand building as they had done in the period of the bubble. Burn rates are much lower now. A dollar will last a lot longer.”

A more fundamental approach has also returned to the executive suite in Silicon Valley where during the boom years 20-something entrepreneurs were calling the shots, and having business experience or an MBA was viewed as a management drawback. It used to be thought that “all you needed was a kid with a business plan and enthusiasm,” says Tiffany. “People have caught on that enthusiasm is not enough. There has been a restoration of real management. You need someone with experience.”

Tiffany argues that the lack of seasoned management may have made Silicon Valley ’s tech crash worse than it might otherwise have been. “If companies had had better management control systems they could have read some of the signs better and done some forward planning.”

Meanwhile, with $50 billion in venture funds focused on technology, venture capitalists remain reluctant to spend until they see a clear exit strategy to recoup their investment, says Amit. In the boom years, billions were made selling companies to the public markets with rich initial public offerings. The excitement over the Google public offering is palpable in Silicon Valley , but venture capitalists are increasingly designing deals to cash out by selling to established firms. “In the past the Holy Grail was an IPO. It may very well be that we are observing a profound change in the mindset of the venture capitalists,” he notes.

Coneybeer suggests that by hitting rock bottom, Silicon Valley has paved the way for the birth of a new generation of companies that are fueling the current upswing. The crash drove down the cost of rent and labor in Silicon Valley , making it a competitive location to build new companies, he contends. “As a result, there are a lot of companies that started in the past year and that are getting started right now.”