An Old Hotbed With New Crops

This time around, the Valley is nurturing startups that combine info tech with emerging technologies.

For nearly 50 years, Silicon Valley has been a marvel of reinvention through innovation. Every decade or so, a new generation of companies has come along to spark the local economy. After the granddaddies of the Valley's high-tech industry, such as Hewlett-Packard (HPQ ) and Fairchild Semiconductor International (FCS ), there were Intel (INTC ) and Apple Computer (AAPL ) in the wild early days of the personal computer. Then computer networks became de rigueur in corporations, and Cisco Systems (CSCO ), Oracle (ORCL ), and Sun Microsystems (SUNW ) rose to prominence. In the 1990s, Netscape Communications Corp. cooked up a spiffy Web browser and started the Internet revolution. Even today, years after the dot-com bubble burst, Valley Net companies like Yahoo! (YHOO ), Google (GOOG ), and eBay (EBAY ) are changing the way people do business.

But along the 45-mile stretch of Highway 101 from San Francisco to San Jose, there's a nagging question these days: What's next? The anxiety is fueled by the employment picture. The number of jobs in the region has plummeted 20% since 2001, to 840,000, the steepest loss since the Valley's fortunes were fashioned from silicon. The tech industry's prospects offer little comfort. While some analysts believe the information-technology industry can resume growing at its historical average of nearly 10% annually, others see it languishing at only 3% to 5% annually for the foreseeable future. That's the kind of growth expected from Rust Belt businesses, like the automotive industry.

Is Silicon Valley becoming the digital Detroit? Or can it reinvent itself one more time? Look closely and you'll see that the process is already beginning. University labs are bubbling with unorthodox ideas. Entrepreneurs are building startups of a different species than traditional high-tech companies. And venture capital is following. The Valley's best and brightest are heading off in new directions, blending info tech with biotech and emerging material sciences such as nanotechnology. This cross-pollination is producing hybrid companies that will play a critical role in the region's efforts to remain the center of gravity for innovation. "The key is to look in the white spaces between disciplines," says John Seely Brown, the former head of the famed Xerox Corp. (XRX ). Palo Alto Research Center and now a visiting scholar at the University of Southern California's Annenberg Center for Communication.

Think of this as Silicon Valley: Next Generation. A new crop of startups offers a peek into the future. XDx Inc., in South San Francisco, Calif., is using information technology to improve the monitoring of heart-transplant patients' immune systems. Silicon Genetics, based in Redwood City, Calif., has developed software tools to make it easier to research human genetics. And Santa Clara's Peribit Networks Inc. is applying biological research to data networking.

LURE OF INDIA

The valley's startups aren't being built in the same old ways, either. Increasingly, they're hiring many of their employees elsewhere -- often overseas. Two Valley venture firms, JumpStartUp Fund Advisors and WestBridge Capital Partners LLC, even specialize in so-called cross-border startups that split their staffs between India and the Valley. The top execs, along with the sales and marketing staffs, typically are in the States, to be close to customers, while the engineering staff, including most of research and development, is in India. "Over the next five years, there are going to be quite a few of these companies funded," says M.R. Rangaswami, co-founder of Sand Hill Group, a Valley-based consulting company specializing in Indian business.

The new regime in Silicon Valley means this round of reinvention won't be anything like those of the past. In particular, there's unlikely to be the kind of job growth that followed the personal-computer and Internet booms. The cost of living in the Valley is now so prohibitive that cash-strapped startups can't afford to hire many people here at the salaries they need. The median price of a single-family home has shot up 240% over the last nine years, to $640,000. The result: Only 21% of the people who live in Silicon Valley now earn the median income necessary to buy a house, down from 36% in 1995, according to Leslie Appleton-Young, chief economist at the California Association of Realtors. That's one reason why the Valley is expected to see just 1% to 2% growth in employment for the next several years, according to Economy.com.

Still, there's little question that the Valley will continue to create important, innovative companies. The region has been blessed with a rare combination of venture capital, good weather, and institutions such as Stanford University and the University of California at Berkeley that are loaded with academic and research talent. Most of all, the Valley has fostered a culture of risk-taking, where talented hotshots itch to turn great ideas into corporate winners. This ethos is alive and well in the Valley and continues to draw ambitious entrepreneurs from far and wide. "We have a habitat for new companies here that's unique," says William F. Miller, a professor emeritus at Stanford and the former chief executive at SRI International. "All the services are here, and they all specialize in dealing with startups -- the banks, the lawyers, the marketing firms. It all permits a company to move more quickly and get good advice."

And don't discount the value of money, mountains and mountains of it. Venture capital, so important to nourishing the ideas of young entrepreneurs, is still Valley-centric, with its epicenter along Palo Alto's famed Sand Hill Road. About 38% of the venture funding in the U.S. in the second quarter of 2004 went to companies in the Valley. That's twice the share of the runner-up, Boston, and almost exactly the same rate as it was 10 or 15 years ago. "It's very difficult to find an area where there's more brewing, at least for a U.S. investor," says Michael Moritz, a partner at the venture-capital firm Sequoia Capital.

Even so, the Valley must contend with the likelihood that it won't be the world's singular nexus for the funding and development of innovation. Silicon Valley's share of biotech spending in the second quarter, for instance, was 29%, just seven percentage points ahead of Boston. "There was a time when venture capitalists cared about where they were investing," says Daniel Primack, editor-at-large at Venture Capital Journal, part of the research firm Thomson Financial Venture Economics. "But venture capitalists are looking everywhere for deals now."

They have to. Critical masses of talent are forming far outside the Valley's borders. Bangalore, India, and several regions in China, for instance, are emerging as important centers for software development, tech services, and low-cost manufacturing. These high-tech workforces are beginning to create their own entrepreneurs, and both financiers and high-tech companies are taking notice. "The innovation's still bubbling in Silicon Valley," says Shane V. Robison, chief strategy and technology officer at Hewlett-Packard Co. "I think it always will. It just isn't the only place that it's happening."

EUREKA MOMENTS

The most successful startups may be those with one foot firmly planted in info tech and the other in emerging technologies. Peribit Networks is one such hybrid of the Valley's past and future. The Santa Clara company was founded in 2000 by a Stanford doctoral student, Amit P. Singh, who was doing bioinformatics research, designing algorithms and computational models to speed up the analysis of DNA sequences by recognizing hidden patterns. When Singh finished his PhD, he was wondering what to do next. His "eureka" moment came when he realized his work could be applied to routing computer traffic over networks. "They took technology designed for the genetics world and moved it into the communications world," says David Ladd, a general partner at Mayfield, one of Peribit's investors.

At Singh's alma mater, they're trying to make those breakthroughs a lot more common. Stanford opened the 146,000-square-foot James H. Clark Center in October, 2003, to provide a place where experts in info tech, biotech, and the material sciences can share ideas and, just maybe, spark a few business plans. The space age-looking center, part of Stanford's interdisciplinary biosciences program called Bio-X, will house 600 entrepreneurs and researchers when it reaches capacity. The school is providing two-year, $150,000 grants for people who want to do interdisciplinary research. "The health of the Valley depends on really new things coming along," says Matthew P. Scott, a cancer researcher and biologist who heads the Bio-X program.

The Stanford research center also has an eye toward the business community. About 10% of the spaces in the center will be reserved for visiting academics and people in private industry. Scott knows that whatever comes out of the Clark Center, or similar centers being built at nearby University of California campuses in San Francisco, Berkeley, and Santa Cruz, won't turn into big companies overnight. But he has an eye on the long term. "The growth of the Valley has been driven by a small number of very powerful technologies that utterly transformed the world. But these are outgrowths of technologies that have been developing for many, many years," he says. The original programming protocols for the Internet, for example, were developed 26 years before Netscape went public.

While such initiatives could pay dividends down the road, some startups are going it alone. In a warehouse district of Redwood City, sandwiched into a row of auto yards, is Silicon Genetics. The company's programmers and genetics experts are working on software tools that make it easier to make sense of the volumes of data unearthed in human genome research. It was founded by Andrew Conway, a biochemistry researcher at Stanford. Conway grew frustrated with the lack of good tools to help him do his job. So he built his own and created a company to sell it with about $100,000 he made playing the stock market. "That is what you do around here," laughs Conway, a 34-year-old Australian who came to California for graduate school.

It's little companies like Silicon Genetics that are necessary to breath life into the Valley and its more mature companies. On Aug. 23, Agilent Technologies Inc., the tech-equipment giant that was Hewlett-Packard's original instrument and measuring business before it was spun off in 1999, acquired the five-year-old company and its 50 employees for an undisclosed sum. Palo Alto-based Agilent plans to add Silicon Genetics' two main software products to its growing portfolio of biomedical research software. The room full of programmers and PhDs will be moving out of the little office and getting new digs with the rest of Agilent by early next year. Agilent is turning to a startup to help it reinvent itself around genomics research.

Reinvention takes time, however. And some wonder if the Valley has the patience to wait for those new things. Valley investors are especially wary of biotech and materials research companies because of the inconsistency of the payoff. Roger McNamee, for example, the co-founder of Silver Lake Partners, prefers to steer clear of biotech. "The capital intensity is very high, and the probability of success is very low," he says.

A LITTLE HERE, A LITTLE THERE

Still, many entrepreneurs are forming companies in innovative ways that don't require as much capital as was needed before. Some are opting for offshoring jobs from day one. Take Conformia Software Inc. Based in Redwood City, the three-year-old software company has about 30 employees in Silicon Valley, including the executive team, marketing, and sales. An additional 50 to 75 employees are in Bangalore, including nearly all of Conformia's engineering. "When you're a startup and you're trying to conserve capital, it makes sense," says co-founder Neil K. Kataria.

It's the new Valley startup model: Keep your top engineers, sales, and marketing people local. If other jobs can be done elsewhere for less, send them there. Of course, that won't lead to a lot of new jobs for the local folks. But as long as Stanford and Berkeley have creative students, as long as San Jose averages 300 days of sunshine per year, and as long as the venture-capital community pours dollars into local startups, the Valley should continue to lead the world in joining invention with a business plan -- the most tangible definition of innovation. From a region so accustomed to reinventing itself, the world should expect nothing less.

By Jim Kerstetter with Robert D. Hof in San Mateo, Calif., and Bruce Einhorn in Hong Kong

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