A Shadow Falls across the Valley

Companies are slashing spending, and confidence in the region is slipping

Driving around Silicon Valley, you would hardly guess that the technology economy is imploding. The highways are still jammed, housing prices are still outrageous, and the Valley's unemployment rate was just 2.2% in March, by state estimates. Venture-capital spending in the Valley, though slowing, is still way above its long-term average. Even sales of fancy cars remain strong. Says Ron Burton, general sales manager of Carlsen Motor Cars of Palo Alto: "We've taken over 60 orders for a $400,000 Porsche Carrera GT that they're not even producing yet. Guys are coming here and giving us $10,000 deposits just in case they do build them."

But there are growing fears that very tough times lie ahead for Silicon Valley, a region whose economic output has doubled since 1990 and now tops that of countries such as Hungary, Ireland, New Zealand, and Portugal. Despite the apparent prosperity, the global slump in tech demand is starting to hit home. The latest sign: the Apr. 16 announcement from Cisco Systems Inc. (CSCO ) in San Jose, one of the ruling giants of Silicon Valley, that for the quarter ending Apr. 30 it expects a 30% decline in sales from the previous quarter. And there's probably more bad news to come. Says Richard C. Carlson, chairman of Spectrum Economics Inc., an economics consulting firm in Palo Alto: "I don't think we've reached the bottom of the pit of gloom."

The plunge in tech stock is already chilling confidence in a region where 4 in 10 workers get part of their pay in stock options--vs. 1 in 10 nationally. People who used tech shares as collateral for big loans, for instance, are discovering the downside of leverage. "In the next six months, we'll see hundreds of personal bankruptcies," predicts one Valley CEO who has suffered big losses in the market. "Your banker, who used to be your best friend, suddenly sounds like Tony Soprano."

FOR RENT. Commercial real estate, which is highly sensitive to expectations for growth, is also marking the leading edge of a slump. Average asking prices for office space have fallen 25% since the end of 2000, and vacancies have doubled from 3.4% to 6.8% since the first of the year, according to Cornish & Carey Commercial/Oncor International. The vacancy rate is expected to climb as technology giants and startups alike curtail or scrap aggressive growth plans. For example, Internet software developer Inktomi Corp. (INKT ) is building a 380,000-square-foot operation in Foster City. But the company, which recently warned of layoff and earnings shortfalls, is expected to try to sublease much of the space rather than occupy it. The same goes for Excite@Home (ATHM ) and BroadVision Inc. (BVSN ), which have collectively put 500,000 square feet of space back on the market.

Meanwhile, the San Jose area unemployment rate, while still only 2.2%, is up substantially from its bottom of 1.3% in December, according to state figures. And it's likely to keep rising. Companies that spent the past few months working off their backlogs are running out of work. Job cuts appear to be spreading across all sectors that feed off the tech economy, from investment banking to software to public relations. Technology investment bank Robertson Stephens Inc. laid off 80 bankers in March. "The pie is getting a lot smaller pretty quickly," says Tracy T. Lefteroff of PricewaterhouseCoopers, who notes that his office's staff tripled in the past 18 months. "Many firms won't be able to carry the head count that they currently have."

Those in the job market say the hunt is getting tougher. When Wells Fargo & Co. (WFC ) advertised for a Web-development job last October, it got five applicants. When it posted the job three months later, it received 100 resumes. "In terms of the number of opportunities out there, they're getting scarce," says Gary Gonzalez, who in November was laid off by Net marketing upstart Vicinity Corp. (VCNT ) and landed at Oracle Corp. (ORCL ) after a three-month search.

Even pink-slip parties, Silicon Valley's answer to job fairs for out-of-work dot-commers, aren't bearing much fruit. "It would have been more helpful if the recruiters I spoke to [at the party] weren't working for companies with hiring freezes," says 34-year-old Mary Moss, laid off from a Net company.

Could things get worse? One scary scenario would be a temporary drying up of venture capital--the money that seeds the region's entrepreneurial zealots and is essential for the next wave of innovation and business development. So far, VCs have continued to pump money into startups despite the slowdown and the dearth of initial public offerings. In the final three months of 2000, venture spending in the Bay Area, while down 26% from the third quarter, was still more than the total for 1998, says researcher VentureOne Corp. That has helped keep the local job market relatively strong. If VCs cut back on funding startups and their big ideas, one engine that could keep Silicon Valley afloat would quickly sputter out.

Equally devastating would be a further slowdown in foreign economic growth. Silicon Valley accounts for 34% of California's nonagricultural exports, or $35 billion, says Joint Venture: Silicon Valley Network, a nonprofit group that studies the region. Cisco, which earns half of its revenue outside the U.S., warned that demand is softening overseas. "If the world markets decline along with domestic markets, it's a worst-case scenario," says Douglas C. Henton, president of Collaborative Economics, Palo Alto consultants. "There's no way the Valley would do well. The export factor is a big one."

JUST A BLIP? To be sure, these are big "ifs." For now, most economists and Valley veterans believe that the approaching slump, even if it's bad, won't be as crippling as those of the early 1980s and early 1990s. Unemployment rates in Santa Clara County peaked at 9.7% in January, 1983, and 7.4% in July, 1992. In contrast, says Regis McKenna, a Silicon Valley marketing legend: "I don't think this will be remembered as more than a blip in 10 years."

The case for long-term optimism is based on the region's relentlessly entrepreneurial culture, its deep reservoir of human capital, the diversity of technologies it creates, and the presence of so much hometown financing power. Of the $93 billion in venture capital raised nationally, $39 billion, or 42%, was raised by venture investors in Northern California, according to researcher Venture Economics. When times get tough, venture capitalists tend to invest closer to home, says Geoffrey Y. Yang of Redpoint Ventures in Silicon Valley. Adds Praveen Madan, a senior principal in the Santa Clara office of consulting firm A.T. Kearney Inc.: "The talent pool is significant, and the networking here is critical."

Many Valley veterans would even welcome a mild slowdown--which could help alleviate traffic and bring down housing prices. According to Joint Venture, just 16% of the homes in Silicon Valley are affordable for workers earning the median income in the area, down from 31% in 1999. And 30% of the area's freeways rate among the worst in the nation in terms of congestion. Venture capitalists hope they can complete more deals once entrepreneurs stop holding out for unrealistically high valuations. Some people argue that the slowdown will clear out the mercenaries, the incompetent managers, and the dumb ideas. "It's a classic bubble," says Henton, of Collaborative Economics. "The economy should never have sped up to the point it did."

True enough. But bubbles don't always deflate gently. If this one pops violently, it could produce devastation far worse than what most of Silicon Valley, for now, is counting on.

By Linda Himelstein, with Douglas Robson, Peter Burrows, and Catherine Ross, in Silicon Valley

    Before it's here, it's on the Bloomberg Terminal.