Big enough, fast enough? John Freeman on the Silicon Valley entrepreneurship model

Silicon Valley: An Innovative Business Area.
John Freeman, Helzel Professor of Entrepreneurship and Innovation, Haas School of Business, UC Berkeley.
March24, 2004
Summary: Introduction to the Silicon Valley and how the entrepreneurship works here. Key is growing companies so that they get large enough, good enough, fast enough – so they can compete when the giant companies decide they want to get in. John has a background in sociology and has observed the Silicon Valley since the early 90s. Very interesting talks, laying out how the Valley works and why it is hard to copy to another place – say, Norway.

Berkeley has had had a course in entrepreneurship for about 40 years, which evolved into a full entrepreneurship program in 1992. We link link students to companies, have a series of educational programs, and a monthly meeting called entrepreneurs’ forum. There are about 750 students in entrepreneurship, every student take 1.2 courses in entrepreneurship on average, which is very high. 12-20 companies per year are generated out of our classes. An executive class they have has 60 students, 50 of them have been part of startups, 15 of them are CEO/Founders who are going back to take an MBA after having had success.
Silicon Valley is very hard to copy, even within the US. Partly this is for legislative reasons, partly how the financial institutions work in the US. But the underlying principles of Silicon Valley are portable. Lessons for Norwegian companies: What can you do if you come here, what will competition look like if it comes from here.
Incidentally, Silicon Valley is not just the area from San Jose to Palo Alto, where Stanford is, but also the San Francisco and Berkeley area, with biotech clusters all the way up to Sacramento.
Silicon Valley is good at some things and bad at others: Very effective in exploiting new technologies and markets very quickly, lots of companies (most fail), invests a lot of money in companies that fail, the risks are high. Good at rapidly moving people and capital into new technologies or markets. Like a firehose – can turn in a week – herd-like behavior – fashions in investment. Silicone Valley generates companies that capable of growing very rapidly – that is, perhaps, the only thing unique for this part of the world: Companies that grow 200% for 8 years – compounded.
Important to understand that Silicon Valley is a community with a social structure, and companies grow by being plugged into this community.
The strategic game: With bigness and complexity comes slowness, even in the best high-tech companies in this area. Entrepreneurs attract their own competition – the hotter the area, the faster the competition moves in. If you are in a less visible area, you can run by yourself for many years: SAP existed for 20 years before it took off, because the world just wasn’t ready for enterprise software. The question is, you must get big enough, good enough, fast enough, so that when the giants come, you can compete. So rapid growth is a compulsion around here.
How does innovation start in a large company vs. in Silicon Valley? When a market is identified, then resources must be mobilized. In large companies this means justifying this to the hierarchy, a process that can take 2 years. If you are an innovator and go to a VC to start a company, the VC can give you seed money right away – money to quit your job, start working, develop a business plan. Get $2m in 5 months, build a prototype, spend that money in 6 months, get 5m to go to market.
The little guy knows that he is faster than the big companies, but that when they come, they come with money, marketing, brand, and alliances. Typically, when they come, the come well organized and managed, with overwhelming marketing and brand.
Why is it so hard to do corporate innovation? First, the business is too small for the large company to look at. Secondly, there is often a business model conflict, such as channel conflicts in retailing. The inability to resolve this conflict has led many companies to retract from eCommerce. Top managers in large companies are often focused on short-term issues, such as next quarter’s profits. Hard for them to sit down and imagine the future, the bigger the corporation is, the more likely the top management is to be insular and slow to adjust. So, the mindset is, we’ll watch this and maybe buy it.
If the system works, the entrepreneurs can make their mark on the world, which is very important to many of them. They can also make a lot of money, which does not escape their attention, either.
This is one of the few places in the world where you find people willing and able to help entrepreneurs.
There are favorable tax and labor policies: The burden of proof of intellectual property theft is on the employer, when someone leaves to start a company. So, people can move with their knowledge and their technology fairly fluently. Tax policies treat growth favorably – currently 15% for long-term capital gains. Also, you are not taxed on stock options when they are granted, but when you sell it. There are supporting social and economic institutions – for instance, a secondary security market for small companies, so investors can get liquidity. Incidentally, these companies are built to be sold – not to grow large under personal ownership, and everyone understands that. Culture – individualism, lots of role models, people think “I can do that!”. There is less disgrace for failure – lots of serial entrepreneurship of varying success. Lastly, build it to sell it.
So, what is rapid growth? Sustained growth of 200%/year. There are lots of global technology companies here – Intel, AMD, eBay, yahoo, etc. Generates employment and taxes. Firehose (herd) mentality means the US has a tendency to get out of old technologies and industries fast. But there are some big mistakes: On average, 30% of VC investments fail, 30-40% are walking dead, 30% doing OK, maybe 1 in 10 becomes a huge success. Some examples of failures: Vebvan (online grocery and delivery company, used $1b but 30cents/dollar went to subsidize your groceries, they couldn’t make the warehouses efficient enough), (selling pet food over the web, overestablishing in the market, bulk market with thin margins).
Dirty little secret of Silicon Valley: The companies commonly outgrow the competence of the founders. So they leave, either because they realize it, they are not good at it, they hate dealing with the press (public companies can’t talk like they used to).
What is the price of this rapid growth phenomenon? Just about any management problem is exacerbated – just getting the 20 or so new people that show up for work every Monday equipped and started becomes a problem. Loss of control for the entrepreneur. Management of the corporate culture. Getting experienced management.
Where does the money come from? Venture capital and business angels. Profit taken in growth. 15 times more angel money than VC. Key thing: VCs have operational experience, they know what they are talking about. This contrary to VCs in Europe, who tend to have either banking or management consulting background – very few have operational experience.
What are entrepreneurs good at? They are gatherers of resources – walking around talking to people, gathering resources, such as capital, people, resources, access to markets. They are not managers – managers allocate resources. Entrepreneurship is about getting resources, not so much about using them efficiently. As they get bigger, they need to become managers.
Key is the infrastructural community: All the firms in the Valley will say, yes, we can do our services for you, but we can also introduce you to the others you need (lawyers, exec search firms, investment bankers). Everyone links to everyone else, deal with each other on the basis of trust, which comes from having done deals before.