Still the Center of This World

But Silicon Valley remains a ferociously expensive place to do business, and something's got to give

When Ben T. Smith started organizing a tech startup called Spoke Software last year, he couldn't imagine locating it anywhere but Silicon Valley. The Valley had the engineers, the tech marketers, the lawyers, and, most important, the venture capitalists. "There is nowhere else like this," he says. "Everything I need is right here."

Everything but an affordable place to do business. By the end of 2003, Smith plans to move 30% of his software engineering, or the next 10 hires he makes for his 50-employee company, out of Spoke's headquarters, a walkup space on a side street near Stanford University in Palo Alto.

Why? Despite an unemployment rate hovering at 8.5% and an office-vacancy rate that has quadrupled over the past three years, to more than 20%, the Valley is still one of the costliest places in the world to run a business. Sure, office space can be had at a quarter of what it fetched during the bubble. But a typical engineer still costs about $150,000 per year when health care and office gear are added in. "The economic model in the Valley no longer allows you to have all of your employees here," says Smith. So Valley execs are considering shipping jobs to places like Bangalore, Beijing, and Prague, where talent can be had for one-third the price. Even Boston is 20% cheaper.

What's ahead for Silicon Valley is not a pretty picture: a place where entrepreneurs start to fulfill their dreams, only to ship rank-and-file jobs to the hinterlands as soon as possible. Certainly, Spoke's hiring strategy doesn't indicate a rebound from the Valley's economic meltdown. From December, 2000, to April, 2003, greater San Jose lost 17.4% of its jobs, says Inc. It was the biggest drop from peak employment for one region since the Great Depression -- bigger even than the four years of losses, starting in 1978, that cut Detroit's workforce by 16.5%.

Confoundingly, local housing prices, the single biggest reason why employing people in the Valley is so darn expensive, haven't dropped with the rest of the local economy. The median price for a single-family home here was $565,000 in June -- four times the national average, and up 3.7% from the month before.

Moreover, the biggest job losses of the past three years have come in the healthiest local sector of the 1990s: software. From 1992 to 2001, the software industry's share of the local job market tripled, to 21%, says Joint Venture Silicon Valley Network. Since then, it has been in a tailspin. Total Valley employment in software now hovers at around 100,000, some 22% less than its peak. Making matters worse, the area's biggest software makers are eager to hire in India. On July 10, database giant Oracle Corp. announced plans to double its Indian workforce, to 6,000 -- just 1,500 less than Oracle's total in its Redwood Shores (Calif.) headquarters.

But before anyone writes off this 45-mile corridor between San Jose and San Francisco, there's a strong case to be made that the Valley will rise again. Although it has never before been taken down so hard or for so long, the local economy has always experienced wild booms and busts. In the mid-1980s, when the PC industry consolidated around a handful of companies, the area lost nearly 10% of its jobs. And while people tend to think of the '90s as the days of vintage wines and Ferraris for the local digerati, they were anything but that until Internet pioneer Netscape Communications Corp. went public in August, 1995. "When I got to the Valley in '94, it was flat dead," says Marc Andreessen, Netscape co-founder. Hurt by missteps in a tech fad called pen computing, greater San Jose's unemployment rate climbed for three years, peaking at 7.3% in 1993. It didn't dip below 5% until the month after Netscape went public. The Web breathed new life into the Valley.

What followed was an historic run. By December, 2000, more than 140,000 jobs had been created in the San Jose area, according to the Labor Dept. Then the bottom fell out. By April, 2003, eight years' worth of job creation had been wiped out. The total labor force also had shrunk -- down 9% from its peak in 2000. That explains how the population of San Francisco, where many Silicon Valley commuters live, shrank 1.5% last year, the biggest decline of any major American city. San Jose's declined 0.6%.

But has the Valley's influence been erased along with the jobs? Not quite. "I think the smart money will be on Silicon Valley," says Roger B. McNamee, a founder of Silver Lake Partners, a private equity firm in Menlo Park. Optimists believe another job-exploding technology will emerge because many sectors -- the Internet, wireless, the digital home -- are far from played out. One or more of those, they say, will give the Valley yet another lease on life. After all, there's nowhere else in the world with such a dense concentration of the engineers and other specialists it takes to launch a company, literally, overnight.

Valley veterans also are quick to note that Silicon Valley is still where the venture-capital community is putting its money. In 2003's second quarter, 33.6% of the country's VC funds went to Valley startups, two points higher than its share in 1996. Venture capitalists, beaten and bruised though they may be, haven't gone away. "Silicon Valley occupies the same central place that it always has" with investors, says John Doerr, a partner at Kleiner, Perkins Caufield & Byers.

That's important because startups, not mature companies, create jobs. In the '90s, new Valley companies hired 258,796 people, while existing companies lost 120,559 jobs, according to the Public Policy Institute of California. Even now, the best of the Valley's next generation of companies are hiring at a decent clip. While total numbers are hard to come by, search giant Google Technology Inc. has doubled its workforce, to 1,000, in the past year. Internet auctioneer eBay Inc.'s staff is up 72%, to 4,400, since December, 2001. And inc. has nearly doubled its local workforce, to about 325, over the past year. Recruiters for even small startups claim the local job market is showing signs of life. "The phone is starting to ring again," says Jenny Harris, a recruiter for startups funded by Mobius Venture Capital.

Add it all up, and Silicon Valley is likely to remain the Hollywood of high tech. Smith's hiring plans for Spoke Software are not just about shipping jobs overseas. He's trying to offset the high-dollar creative talent he believes he can find only in the Valley with low-dollar rote jobs, such as product testing, that can be done outside the country. Entrepreneurs like Smith still believe that if you want to start a company and aspire to join the pantheon of tech stars -- including Intel Chairman Andrew S. Grove and Apple Computer Inc. co-founder Steven P. Jobs -- you need to be based in the Valley. "The general consensus is that the Valley is going to continue as the center for innovation in the world," says Kiran Karnik, president of the National Association of Software & Service Companies, a tech trade group in India. "Frankly, we'd like to move that to Bangalore, but I'm being realistic."

Will a new technology pop up to replace the 28,000 jobs lost at software companies, the 16,000 lost semiconductor positions, or the 15,600 lost computer-manufacturing staff? Oracle CEO Lawrence J. Ellison says the Valley's next big employer could be biotech outfits. Certainly, biotech has fared better than any other tech sector, losing just 100 jobs. But it's hard to imagine total biotech employment, now only a third of the software industry, making up the difference. For the Valley to thrive again, something will have to pick up the slack. Of course, no one knows what that Next Big Thing will be, but you can bet more than a few of Silicon Valley's die-hard entrepreneurs are working on it.

By Jim Kerstetter

Contributing: Linda Himelstein in San Mateo, Calif., and Timothy J. Mullaney in New York

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