All is Not Well in Silicon Valley

It is certainly a depressing endeavor to read the business section of the newspaper these days. With the economy in truly serious trouble and so many other problems globally, it's hard to imagine how we'll ever get out of the hole we're in. Sitting in the heart of Silicon Valley, one might think that we can take solace in the fact that the United States will have a competitive advantage in the high-tech sector for at least a few years to come. Technology has, after all, brought our economy to incredible highs in the past. Yet if my lunchtime conversations of late are any indication, we shouldn't be counting on the Valley to get us out of the slump anytime soon.

In 1999, a confluence of factors led to the formation of many start-ups that lacked substance, had no viable business model, and generated an immense amount of hype based on the number of visitor "impressions" that their respective web sites yielded. Anyone who read the newspaper or watched television during that time can remember how these companies achieved astronomical valuations, which then tanked even faster than they had initially risen. With this in mind, I have been wondering of late why I feel such a sinking feeling every time I talk to people in the Valley, and I think I have found the answer: even worse than a full-blown bubble is a sustained, partial bubble -- one in which the first three components are present (no substance, no profit, and plenty of hype), but the fourth (the wide proliferation of insanely high valuations) is not.

One might wonder why this is a problem. Simply put, the end result is the technological equivalent of treading water; it's that fourth component that is necessary to make a bubble burst. Otherwise, without a clear indication from the market, entrepreneurs and engineers are given incentives to keep working on the same types of projects, even when it's clear that there are no real economic benefits to be had from investing in them. Venture capitalists, who act in a herd mentality (often to their own detriment), tend to invest in whatever is popular. So long as the status quo remains fairly popular, they keep on investing. Right now, the status quo is social networking, and though it definitely can be useful depending on the implementation, none of the current implementations even come close to taking advantage of the underlying theoretical potential. Instead, sites like MySpace and Facebook have utterly failed to improve any significant aspect of the American economy--and have "succeeded" in the meantime at wasting millions of manhours that could have instead gone toward boosting our national productivity. Nonetheless, many venture capitalists simply won't entertain the thought of investing in anything else. Even if they claim otherwise, their actions, tied to millions of dollars, speak louder than words.

There is a fundamental problem with the investment environment when venture capitalists, the ultimate risk-takers, are unwilling to assume any risk out of fear of another post-bubble collapse. In the high-tech world, often the riskiest ventures tend to be the ones that actually succeed, netting the highest rewards. Yet in a conservative scenario where venture investors are more cowardly than usual, rewards would be few and far between, and indeed, according to the National Venture Capital Association, a total of zero venture-backed companies went public in Q2 2008. Ironically, most venture capitalists think that they are minimizing risk by grabbing up as many different kinds of social networks as they can for their portfolios, but in effect, they are maximizing it. As many others have pointed out, social networking is not a business, and so what might seem like portfolio diversification on the surface is actually a good example of putting all of one's eggs in one basket. Sadly, that basket is going nowhere.

Some investors, unwilling to consider the benefits of larger, more ambitious ideas, have even turned to investing in technologies that are a decade old without realizing it.

"This guy I met created this amazing new technology," one venture capitalist told me earlier this week. "It lets you monitor applications you design on the desktop, but deploy in the cloud, from the cloud," he said.

"I'm not sure what that even means," I replied, surprised that I had missed reports of this groundbreaking achievement. He explained that he was talking about a web site that let you monitor your own web site's status; if your site went down, it would send you an e-mail.

"Ah, right," I said, finally understanding. "People have been using those since 1998. For free."

The same venture investor went on to argue that Facebook would eclipse the profits of established enterprise software companies such as Oracle and SAP any day now. All of the available evidence points to the contrary. It seems to me as though the National Venture Capital Association's main problem is that too many of its members have drunk social networking Kool-Aid when our country really needs other products, such as supply chain software that reduces the amount of gas we use to ship goods where they need to go. (Coincidentally, this is the kind of software I have been pitching to investors, to no avail.)

Perhaps I'm wrong though. "Look at Slide," said the venture capitalist, who has considerably more business experience than I do, referring to a hip Bay Area company.

"What do they actually do?" I asked. He paused, sputtered for a bit, and then continued.

"It depends what you really mean by 'do,'" he said, "but man, do they get a lot of impressions!"

If it doesn't sound familiar, it should. The problem is that the collapse of this unbelievably flawed mindset does not appear to be on the horizon any time soon.

So, don't count on us. We in Silicon Valley are too busy making and counting on-line friends to invest time or money in solving the nation's myriad problems. But fear not! We as a country can always turn to someone else for a break from our economic woes. I'm sure the Chinese would love to help. Wall Street seems to be really good at coming up with creative financial instruments. And in a time of crisis, we can always rely on Big Oil.

Aaron Greenspan is the author of Authoritas: One Student's Harvard Admissions and the Founding of the Facebook Era.

Comments

[Rule Of Law]

As I said yesterday, but seems to have evaporated into the ether--A fool and his money are soon parted!

A few stupid VC's plus a few less than stellar tech-nerds does not mean that Silicon Valley is melting.

What it means is that, just in the go-go nineties, there will be winners and losers, visionaries and those who keep reinventing the wheel. Now that Bush has sold off most of this country's heavy manufacturing base, tech is just about all we have left. And last time I looked, Silicon Valley's stalwarts were doing just fine.

[Cathexis]

Mr Greenspan (unfortunate monicker, I'll bet you get razzed a alot), you state: " ... sites like MySpace and Facebook have utterly failed to improve any significant aspect of the American economy--and have "succeeded" in the meantime at wasting millions of manhours that could have instead gone toward boosting our national productivity."

1. I'll confess that I get irate when I hear phrases such as "Boosting national productivity." basically it is because I have become painfully aware that American Business has consistently privatized profits and externalized costs/efforts (mostly to employees and consumers), at least ove rthe past several decades. To be blunt, I find I no longer give a damn about "boosting national productivity."

2. Because dollars are the easiest metric to count, that is all that American Business ever uses to measure. However, I would argue that dollar return isn't the only "significant value to the American economy."

[Aaron Greenspan - Huffpost Blogger]

See Aaron Greenspan's Profile

Hello,

I'm referring to "national productivity" in the same way that an economist would. It's a somewhat arbitrary index of how much we're actually getting done, and no one is quite sure what the ingredients are that go into it. You should care about it being high (rather than low), however, because bad things tend to happen to the country when it's low--like recessions. This is of course a gross oversimplification, but it's always better to be productive as opposed to not.

I agree that there's more to life than dollars and profits, but when it comes to figuring out which businesses we should invest in as a society (using venture capital as a proxy), dollars and profits turn out to be pretty important.

Aaron

[BADEN]

Develop a self-sustaining battery.
Develop an integrated grey-water system for commercial application.
Deveop a federally funded WPA-style program to completely enclose our main power grid distribution system UNDER GROUND.

Agriculture MUST get over it's water and fuel addictions. Sustainable Agriculture IS possible today.

There ya go.
And Whirled Peas.

[nudger]

As the marketing manager once said - "half my budget is wasted, I just don't know which half". The engineering manager calls that a signal to noise problem.

The signals - true innovation - have always been hard to pull from the noise in Silicon Valley because the noise out there isn't random. It's highly correlated - and as any engineer knows, that's the hardest kind to filter out.

The high correlation in Silicon Valley noise is due to that fact that VCs - and the media that follow them and their investments - are inherently herd animals. So when something is hot, they overhype and overfund it, generating lots of (correlated) noise.

The bottom line is that most VC investments and practically all media coverage in Silicon Valley are (noise-dominated) lagging indicators. They don't say anything about the innovation that's buried underneath. But it's there - you just have to be a little more sophisticated about the filters you use to find it.

[KillTheMessenger]

Last time I went to a venture meeting, all the VCs basically said

"If you have a Web 2.0 company, make it work with your own money, show us that you can generate a positive revenue stream, and then we will fund you to scale it up to a data center sized operation."

Nobody was willing to even listen to an idea that had not been implemented yet and wasn't running online for at least a couple of months. In other words... you could have just gone to your bank and gotten a business loan for 8% annual interest and be done with it.