High-Tech Start-Ups And Industry Dynamics In Silicon Valley

High-TechStart-Ups andIndustry Dynamicsin Silicon Valley Junfu Zhang2003PUBLIC POLICY INSTITUTE OF CALIFORNIA

Library of Congress Cataloging-in-Publication DataZhang, Junfu, 1970-.High-tech start-ups and industry dynamics in Silicon Valley /Junfu Zhang.p. cm.Includes bibliographical references.ISBN: 1-58213-074-41. High technology industries—California—Santa Clara Valley(Santa Clara County)—Longitudinal studies. 2.Entrepreneurship—California—Santa Clara Valley (Santa ClaraCounty)—Longitudinal studies. I. Title.HC107.C23H5394 2003338.4'76'0979473—dc212003012491Copyright 2003 by Public Policy Institute of CaliforniaAll rights reservedSan Francisco, CAShort sections of text, not to exceed three paragraphs, may be quotedwithout written permission provided that full attribution is given tothe source and the above copyright notice is included.PPIC does not take or support positions on any ballot measure orstate and federal legislation nor does it endorse or support anypolitical parties or candidates for public office.Research publications reflect the views of the authors and do notnecessarily reflect the views of the staff, officers, or Board ofDirectors of the Public Policy Institute of California.

ForewordThe Bay Area economy is experiencing one of its most prolongedrecessions: Unemployment continues to climb, start-ups in Silicon Valleyhave declined from over 3,500 a year in 1998 to well under 1,000 inrecent years, and, nationwide, the high-tech sector appears to be facing afuture of excess capacity. These are certainly sufficient reasons for thegeneral mood of gloom that has settled over a region that was recently thefocus of international attention for its high-tech successes. Why thisdramatic turnaround in the economy of Silicon Valley? What are theprospects that the region will be booming once again?High-Tech Start-Ups and Industry Dynamics in Silicon Valley byJunfu Zhang is yet another contribution by PPIC to an improvedunderstanding of the California economy. This research project is oneof a series that PPIC has launched to gain a better understanding ofCalifornia’s new economies and of the dynamic processes that underlietheir cycles of boom and bust. Past PPIC studies have looked at the role ofimmigrant entrepreneurs and their linkage to Asia, the role of U.S. tariffpolicy and its effect on increasing export activity, and the role of exportsand foreign direct investment in building California’s economy for futuredecades.Zhang’s research concludes that, collectively, new firms represent amajor force in the economic dynamics of Silicon Valley. For example,firms founded after 1990 created almost all of the job growth experiencedby Silicon Valley between 1990 and 2001. Why, then, do we findourselves in the midst of the current bust cycle? The theory mostapplicable to the current situation was developed by Joseph Schumpeterin 1911. In The Theory of Economic Development, he explained, “Theeconomic system does not move along continually and smoothly.Countermovements, setbacks, incidents of the most various kinds occur,which obstruct the path of development; there are breakdowns in theeconomic value system which interrupt it.” And, he argued, these setbacksiii

lead to the development of new ideas, new entrepreneurs rise to theoccasion, and soon the cycle begins all over again. The cycle of firm startups, closures, and new start-ups is very much part of the economicdevelopment process, and the very entrepreneurs who are in abundantsupply in Silicon Valley will make the process happen all over again.For Silicon Valley, this cycle is as much fact as theory. In the 1950s, ahandful of firms supplied electronic devices to the Defense Department.In the 1960s, the region became a center of computer chipmakers. In the1970s and 1980s, the region developed and manufactured personalcomputers and workstations, and in the 1990s, the region helpedcommercialize Internet technology. For every major firm, such as theHewlett-Packard Company and Intel, there were thousands ofentrepreneurs starting little firms with dreams of one day becoming aleader in their field.Zhang concludes that start-ups in Silicon Valley have more rapidaccess to venture capital than comparable firms elsewhere in the nation;that large, established firms spin off more start-ups than firms in otherparts of the country; and that the high-tech sector is subject to rapidstructural change where “hot spots” of growth may appear in someindustries while firms in other industries are simultaneously dying out. Heobserves that a dynamic labor force has been, and will be, essential tosuccessful adaptation with each new structural change. In sum, humancapital, venture capital, entrepreneurial zeal, and product cycles allcontribute to the health and success of the economy of Silicon Valley.Although Zhang makes no predictions about the future, the fact that theregion has weathered these cycles in the past, that the basic ingredients arestill there in abundance, and that new demands for high-technology productsare following on a worldwide concern for secure environments suggests thatthe prospects are good for yet another rebirth of the valley. Zhang suggeststhat the dynamics of economic development favor Silicon Valley and that yetanother replay of the rebirth part of the cycle lies before us.David W. LyonPresident and CEOPublic Policy Institute of Californiaiv

SummaryAfter extraordinary economic success in the late 1990s, SiliconValley entered a deep recession in 2001. Today, policymakers, academicresearchers, and the general public continue to puzzle over what madeSilicon Valley such an enormous success. More important, they wonderif the region will ever experience such strong growth again. This studyseeks to answer those questions by examining Silicon Valley’s high-techeconomy in a dynamic context. Using two unique longitudinaldatabases, we investigate firm formation, growth, mortality, andmigration in Silicon Valley during the 1990s and explain how theregion’s economy evolves and operates through such dynamic processes.This study not only helps us better understand Silicon Valley’s success inthe past but also reveals insights into how Silicon Valley can ensure itsfuture prosperity.Major FindingsNew firms are important for Silicon Valley. As with other hightech centers, Silicon Valley hosts a wide variety of firms. A multitude ofsmall firms coexist with medium-sized and big firms; and each year,many new firms are founded, which collectively are a major driver of theeconomic dynamics in Silicon Valley. In fact, firms founded after 1990created almost all the job growth during 1990–2001. Young start-ups inSilicon Valley consistently attract a large amount of venture capital.Successful start-ups have remade and will continue to remake SiliconValley.Start-ups in Silicon Valley have quick access to venture capital. Onaverage, it takes 11.6 months for Silicon Valley’s start-ups to completetheir first round of venture finance, five months faster than the nationalaverage. In addition, the quicker access to capital is found in every majorindustry in Silicon Valley. This gives start-ups in the region a headstart—an important advantage in high-tech industries that advance at av

very fast pace. This large first-mover’s advantage implies that start-ups inthe valley will have better chances to survive, all else being equal.Established firms in Silicon Valley spin off more start-ups.Compared to their counterparts in the Boston area, big companies inSilicon Valley have more previous employees who start their ownventure-backed businesses. Since engineers in successful firms are in thebest position to grasp and commercialize cutting-edge innovations, ahigh rate of spin-off helps open new markets and creates new jobs.Previous research discusses Silicon Valley’s high incidence of firm-levelspin-off based on anecdotal evidence and has identified cultural and legalfactors to account for it. Although the causal factors remain unclear, forthe first time we have confirmed with empirical data that there areindeed more firm-level spin-offs in Silicon Valley than in other high-techcenters.Firm relocation is not a serious problem. High-tech start-ups valuethe hotbed of innovation because that is where new ideas emerge andentrepreneurs cluster. Silicon Valley is a perfect environment for startups whose major objective is to develop innovative ideas. On the otherhand, when firms become mature and enter the phase of massproduction or routine services, their major concern becomessustainability and they naturally care about operating costs. For thosefirms or, rather, for certain operations of those firms, Silicon Valley isunattractive. We have investigated whether firms leave Silicon Valleywhen they have evolved out of the start-up stage. We find that indeedmore establishments move out of Silicon Valley than move in, andestablishments moving out tend to be older. Establishments still tend tostay close to the valley when they move out. When firms move acrossstate borders, Silicon Valley does see a net job loss, because more jobs arerelocated to other states than are relocated to Silicon Valley from outsideCalifornia. However, the data suggest that firm relocation involves arelatively small proportion of the labor force. Firm birth and death causemuch more turbulence than firm relocation. In other words, once firmsare established in Silicon Valley, they are very likely to remain there.Intensive entrepreneurial activities certainly compensate for the jobs lostthrough firm relocation.vi

Successful firms in the valley are branching out. Althoughrelocation does not occur at significant levels, established firms in SiliconValley frequently set up branches elsewhere. For many large high-techcompanies headquartered in Silicon Valley, their employment withinSilicon Valley itself is only a small proportion of their total employment.Since Silicon Valley is already tightly packed with thousands of firms,fast-growing start-ups are more likely to expand outside the immediatearea. As firms begin to expand, they potentially benefit the rest ofCalifornia by setting up branches elsewhere in the state.The high-tech sector experiences rapid structural changes. Thehigh-tech sector consists of several industries, which follow differentdynamics. On the one hand, the fluctuation of the macro economy hasdistinctive effects on different high-tech industries; on the other hand,technological innovations in different industries, the drivers of growth inthose industries, do not arrive simultaneously. As a consequence,different high-tech industries may follow unsynchronized business cycles.Therefore, at different points of time, the “hot spot” of growth mayappear in different industries. For example, the 1990s saw a boom in thecomputer industry along with a decline in the defense industry. To catchupturns and avoid downturns in high-tech industries, a high-tech centersuch as Silicon Valley must accommodate rapid structural changes. Thisimplies that a dynamic labor force is necessary. Previous research hasemphasized the “high-velocity labor market” through which workersmove frequently from one job to another within Silicon Valley. Such alabor market certainly helps the region’s economy adapt to structuralchanges. In addition, a set of infrastructure and institutions that enablesthe labor force to quickly move into and out of Silicon Valley is alsocrucial for structural changes in the high-tech sector. For example,employment in the software industry in Silicon Valley increased from48,500 to 114,600 between 1990 and 2001, a phenomenal 136 percentgrowth rate. It is impossible to train such a large number of technicalworkers within such a short period of time. This kind of rapid growth ina certain industry is achievable only through massive migration of theneeded labor force.vii