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Welcome to the Hotel California No Vacancy

It's goodbye Santa Clara and hello Cincinnati for an increasing number of Internet start-ups that would rather not deal with the Valley's insane real-estate costs and fickle workforce

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Viewlocity was coming to America. The global provider of business-to-business integration and trading tools was based in London, but late last year, one of new CEO Greg Cronin's top priorities was to move the company's headquarters to the U.S.

As a company in a hot market, backed by an international cast of A-list investors, Viewlocity had the luxury of locating anywhere. What's surprising is that from the start, California - and more specifically, Silicon Valley - was crossed off the list.


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Scott Tobin, a general partner in Battery Ventures' Wellesley, Mass., office, steered the company away from Silicon Valley and recommended Atlanta. "It's a nightmare out there," Tobin says.

Cronin agreed and has no regrets. "When we did the road show [seeking additional funding], the investment guys were excited that we weren't just another California company. I get the sense we come across as more up-front out here, more pragmatic. It's a little hypey out in Silicon Valley," he says.

In a sea change, venture capitalists such as Tobin are actively recommending that start-ups put down roots outside Silicon Valley. In the Bay area, they advise the grinding, merciless hunt for physical space and employees just takes too much out of a budding company.

No one is predicting that Silicon Valley is headed for an economic collapse. Most investors and entrepreneurs argue that the Valley, with its teeming venture capital and peerless talent pool, is and will remain the center of the tech start-up universe. But for a growing number of venture capitalists and high-tech start-ups, the Valley has lost its luster.

New e-businesses are locating in places such as Cincinnati, Tampa, Fla., and Atlanta. These technology pockets will center on local expertise (supply-chain outfits in the upper Midwest; wireless specialists in the San Diego area) - and feature strong, if informal, ties to local universities.

Not surprisingly, the venture capitalists' advice generally falls along geographic lines. "[Venture capitalists] outside the Valley say you'd be crazy" to launch a company there, says Paul Robinson, co-founder and president of NetByTel.com in Boca Raton, Fla.

"But the ones that are in the Valley - well, once you're there, you gotta be there, you know?"

Perhaps the most significant long-term shift is that more start-ups that aren't there are content to remain not there. Young technology companies outside the Bay area are finding it easier to attract investors and are gleefully leaving the outrageous recruiting hassles to Californians.

Unreal estate

Commercial real estate brokers say a vacancy rate of about 10% is average. In the last quarter of 1999, the rate in Santa Clara County was 5%. That's tight. In the first quarter of 2000, the rate plunged to 1.8%. That's beyond tight.

In Mountain View, entrepreneurs are happy to pay $96 per foot per year, and it's not unheard of for real estate brokers to request - and receive - stock warrants as a sweetener. In Palo Alto, rents near chi-chi Sand Hill Road top out at $144 per foot, per year (almost as expensive as downtown Tokyo and pricier than London's West End, not to mention the rest of the known universe). As a contrast, commercial rents in Boston - another expensive city with a low vacancy rate - now average about $49 per foot, according to realty firm Thompson Doyle Hennessey & Everest.

Sunny Vanderbeck, founder and CEO of Data Return in Irving, Texas, says top-shelf commercial space in the Dallas area runs $25 per square foot. "And looking out my window, without turning around, I can see enough room to build a two-million-square-foot office building," Vanderbeck adds.

The green-with-envy award goes to Boca Raton, where voice-recognition start-up NetByTel.com pays $9 per square foot for its funky, atmospheric, "Valley-style" headquarters.

Moreover, the Bay area ain't Detroit, where businesses such as General Motors simply moved back downtown when the suburbs got pricey. Valley start-ups need not look to San Francisco for relief; that city's Proposition M tightly limits new office construction. The search for space in San Francisco is a running joke among West Coast companies.

The only thing that looks preposterously expensive next to Silicon Valley commercial real estate is Silicon Valley residential real estate. A recent search of home prices in several Bay area suburbs found nothing less than $345,000, with some three-bedroom jobs running $598,000. (Actual ad: San Mateo. 2 bedroom/1.5 bath. Garage. $415,000.) Not much of a recruiting tool.

So you move to the Valley and rent until your options vest, right? Wrong. Bay area apartments are precious commodities. Kurt Long, CEO of OpenNetwork Technologies in Clearwater, Fla., heard this typical story recently: "A [vice president] of sales for a [Silicon Valley] e-business told me they were trying to place a salesman. The guy showed up on a Saturday morning, right on time, to look at an apartment. There were 20 people already there."

Doug Perry used to work in the thick of Silicon Valley. In 1998, he was asked to move to Carlsbad, Calif., near San Diego, to become chief operating officer at Kinzan.com, a Web-site localization company. "I had the typical reaction" of a Northerner, he says: "San Diego? That's where you go to retire, not to start up a company." Perry made the move. He's talking from his home in San Diego. He's looking at the Pacific Ocean. Asked if he could afford a water view in the Bay Area, he just laughs.

They call them flippers

Dan Meyer grew up in Cincinnati, headed west to get his master's in business administration at Stanford University and stayed in the Bay area for eight years. There, one of his employers shared a parking lot with a start-up called Netscape. Last year, Meyer returned to his hometown as CEO of Giage, a Web information management software vendor that was founded in 1996.

"It's sort of fun to have conversations with my business school friends" who remain in California, Meyer says. "We're not fighting the same battle with retention - we have 3% turnover over three years. There's just an ethic here of being more of a builder than a flipper."

Recruiting and retaining workers in the Valley has grown insane. (Recently, the homepage at local jobs Web site BAjobs.com announced: Hey! Wanna start your new Bay area job with a Hawaiian vacation?)

When did Silicon Valley become a land of flippers? Meyer hesitates, reluctant to insult friends and former colleagues. "Even in the mid-'90s people were builders," he finally says. "But there's been this acceleration, people have seen their neighbors hit it big on IPOs. There's a savvy there now if you haven't gotten a second round [of funding] and you should have, even low-level engineers know there's a problem. And they'll flip."

While technology workers are at a premium across the country, the Bay area is clearly in its own circle of hell when it comes to recruiting and retention. Outside-the-Valley entrepreneurs universally hail low turnover as their favorite reason to stay where they are. "Our biggest edge is keeping our people," NetByTel's Robinson says. "I haven't lost anybody."

Kinzan.com's Perry adds, "We're finding it much easier to recruit in San Diego. Early on, an executive recruiter said we'd never find anybody who

wanted to move here, but we haven't had that problem. We just recruited this guy who [used to be] a proto-Valley guy. He got fed up with the congestion. Loves the move down here - no gridlock, and he found a great house. In the Bay Area, we had [job candidates] who, during the interview, would answer their cell phone to field a competing offer."

Giage's Meyer says he gets "fan mail" from fellow Stanford grads who envy his move back to Cincinnati. "They say, 'I'm from the Midwest too, and I want to go back there - it's good to see [venture capital] activity outside the Valley.'"

Small wonder that some venture capitalists now actively encourage start-ups to set up shop outside the Valley. Cliff Higgerson, a leading venture capitalist and a senior partner at Palo Alto's ComVentures, calls himself "a strong proponent of the idea that the Bay area has priced itself out of the market. Salaries are higher, the cost of doing business is higher. . . . Associated support and services are more expensive. If people and occupancy cost is 30% to 40% higher, who can absorb that disadvantage?"

Higgerson's advice to start-ups is, "All other things being equal, get out."

Hot spots

While some start-ups actively eschew northern California, for the most part, entrepreneurs launch their companies wherever they happen to live.

"There used to be only a few financial centers, but it's spreading out " says Ashok Kalelkar, a managing director at Boston's incubator I-Group HotBank NE, a Softbank affiliate. "Now if a company is founded in Atlanta, it's going to stay in Atlanta." What's really changed is that when start-ups reach a certain size, it's no longer a no-brainer decision to move to Silicon Valley.

"I was born here," says Kurt Long. "I've worked with people from all over - Silicon Valley, New York, Boston. I knew we were just as smart down here." Here is Tampa. After growing up in the area and attending the University of Florida in Gainesville, Long worked for IBM in Tampa. When Big Blue moved Long's outfit to Charlotte, N.C., he took a pass. In 1995, he founded OpenNetwork Technologies in Clearwater, a suburb. The company sells directory service software for moving enterprise applications and data to the Web. "I asked, 'Why can't we have a great company right here?'" he says.

Long spent much of the late 1990s defending that decision. "Even in early '99, there was a stigma associated with being outside the Valley," he says. "People would say, 'Why Tampa?'" Long confesses to a "period of professional difficulty. I thought, 'Hey, we're really paying a penalty for being here.' "

But that's changed. "In the last few months, we've seen more receptive audiences," Long says, adding that venture capitalists and investment bankers no longer balk at driving through Tampa to see who's hot. Recently, he says, a very high-profile venture capitalist (whom Long refuses to name) "flew in on a Lear jet for one day. He said it's saturated in the Valley - no room for money, no room for a new fund. And there's only so much talent out there."

Where the money is

There's no denying that the pile of venture capital money available remains one of the Bay area's big draws.

"In the back of the mind of every Boston entrepreneur is, 'We would have gotten more money on better terms if we were in California,'" says David Friend, CEO of eYak, an IP telephony application provider in Boston. He has launched several start-ups.

"A lot of [venture capitalists] in California still won't invest in the Northeast," Friend adds. "Mostly because of wear and tear on [venture capitalists]." That wear and tear comes in the form of monthly (at least) plane rides for board meetings and other hands-on involvement, which is often most needed when a company is at the raw start-up stage. Others agree that investors' need to be close to the action is a key reason for venture capitalists' pro-Valley bias.

Battery Ventures' Sherman says, "Sure, we would favor a company that we're closer to. It's easier for us, and it's easier for the company." He hastens to add, "that doesn't preclude us from investing elsewhere. Great ideas happen all over the world."

Meyer says Giage enjoys the best of both worlds: its lead investor is local - Cincinnati's Bluechip Venture Fund ("four blocks from our office") - but has a national presence. That's a rare stroke of good fortune for a start-up that's not in the Bay area, Boston or New York.

For its next round of financing, Meyer says, Giage will turn again to Bluechip Venture Fund but will also "definitely look to the coast. It's important as we try to get to the next level and position ourselves for an IPO." Make no mistake: The big do-re-mi remains in California. And every entrepreneur knows it.

It's important not to discount the sheer, teeming - if flipping - mass of skilled workers in the Bay area, too. They're the ones who made the place crowded, after all. "That's the other side of the coin," Battery Ventures' Sherman points out. "The traffic, the real estate, the fickleness - that's all because there are so many talented people here." The companies he calls the "anchor tenants in the Mall of Talent" are the perfect breeding (and raiding) ground for start-ups. Forming a hardware company? Snatch bodies from Sun and Hewlett-Packard. Database company? Oracle. Internet? Yahoo. And on it goes.

"There's something to be said for second- and third-generation Internet talent," Giage's Meyer says. "They've worked in Internet time, they understand the value of options. We don't always get that here [in Cincinnati]. On the other hand, people here understand the fundamentals of the old economy. That was lost years ago in the Bay area."

What's next?

It would be foolish to predict Silicon Valley will crumble or even relinquish its technology dominance. The region has one of the greatest concentrations of smart, wealthy, motivated problem-solvers in the world. This is a place where things that need to get done, get done.

As with any thriving metropolitan area, what's considered Silicon Valley is expanding. Until recently, the area was roughly defined as the corridor running from Burlingame (site of San Francisco International Airport) south to San Jose. Out of necessity, the East Bay, Napa Valley and even tony Marin County are seeing more development, locals say.

But the real key to Silicon Valley's future is New York's past. "Silicon Valley looks like New York did in the 1920s and '30s," ComVentures' Higgerson says. Then, companies' manufacturing facilities stood cheek-by-jowl with their headquarters in Manhattan. As the cost of living there soared, the plants were moved elsewhere - but headquarters remained. San Francisco and the Bay area will follow a similar path. Higgerson predicts "high value-adds will stay - corporate [headquarters], attorneys, Web designers."

Battery Ventures' Sherman agrees. For certain types of companies that require lots of employees at less-than-stratospheric salaries - he points to call centers as an example - "I could see having senior management and the sales center here in Valley, but other significant operations elsewhere."

That may happen, but for the time being Silicon Valley will remain overloaded, overcrowded and understaffed. And a fair number of start-ups will give Silicon Valley a big thmbs down.

Related links

Ulfelder is a freelance writer based in Southborough, Mass. He can be reached at sulfelder@charter.net.

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