Silicon Valley’s Resiliency Might Get Tested

San Francisco Chronicle
September 21, 2008
By Deborah Gage

For the last two years, with the economy collapsing all around it, the technology sector and Silicon Valley in particular have proven to be particularly resilient.

But that might not be the case forever. Sooner or later, as the economy contracts and everybody cuts spending, the companies that power Silicon Valley – the startups, venture capitalists, banks and big producers of technology – are bound to be affected.

“Black Sunday (a week ago) was really a watershed – we’ve crossed a Rubicon,” said Paul Saffo, a Silicon Valley forecaster. “I think it will change everybody’s attitudes about deregulation, toward the landscape of risk and toward all these new age investments – these derivatives and hedges. …

“In the short term, people will be risk-averse. In the long term, it will make people get back to the basics,” said Saffo. “We have risk that people can understand – a startup that gets risk capital. They do well if they deliver something of value to the purchaser, not because of a complex mathematical formula living inside a computer.”

In Silicon Valley, Wall Street’s problems have fostered widespread uncertainty. The financial contraction hits just as the valley is in the midst of remaking itself into a worldwide center for clean technology, which takes years to develop and requires more capital than the hardware and software startups the valley has produced in the past.

The growth of that new sector could be stunted now that capital is harder to get, especially for companies that have already designed products and are ready to build prototypes, said Marc Gottschalk, a partner at Wilson Sonsini Goodrich & Rosati in Palo Alto who works with clean-tech startups.

A biofuels company, he said, needs a sizable chunk of cash to start scaling up plants. “Venture capitalists might think twice about going down that path where they wouldn’t a few months ago.”

Business spending

Spending on enterprise (business) technology is also slowing, partly because two big purchasers – Merrill Lynch, which was acquired by Bank of America last week, and Lehman Bros., which filed for bankruptcy – are probably not shopping for products.

A third, Bear Stearns, was acquired by JPMorgan Chase in May with help from a loan by the Federal Reserve, and a fourth, Morgan Stanley, has its own financial problems stemming from the credit crisis.

Forrester Research last week lowered its prediction for how much technology spending will grow in the United States next year to 6.1 percent, down from 9.4 percent. Gartner said worldwide technology spending will grow 8 percent this year – 4.5 percent if you figure in the decline in the value of the dollar – but a big chunk of that spending will come from outside the United States.

“What causes nerves among Bay Area CEOs is watching the economies (in Asia and Europe) cool down,” said Brian Brennan, director of member services for the Silicon Valley Leadership Group.

Many of Silicon Valley’s biggest companies sell enterprise computing products, such as Hewlett-Packard, Cisco and Intel. Many of the valley’s biggest rivals – who have operations here – also sell to big business. Think IBM, SAP and Microsoft.

Some smaller technology producers claim to be doing well despite the shakiness of some customers. Stephanie DiMarco, founder and CEO of Advent Software in San Francisco, which sells specialized software to Wall Street firms, including Lehman, said business is up strongly because Advent’s software makes these companies more efficient so they can cut costs.

Cisco said last week that it is sticking to its long-term growth target. But Dell warned of weak demand, Hewlett-Packard said it would lay off 24,600 employees as it integrates EDS, and other big companies didn’t want to discuss the economy.

A Microsoft spokesman declined to comment, Oracle and Sun Microsystems didn’t return phone calls seeking comment, and a spokeswoman for SAP said executives were unavailable for comment.

Regional economy

Job growth in the Bay Area has also slowed, Brennan said. Companies are still adding jobs – Santa Clara County added 4,700 in July – but that’s less than half of the jobs added in July 2007.

So far there’s no end in sight to the economic downturn. John Shoven, director of the Stanford Institute for Economic Policy Research, expects a soft economy for at least a year. Richard Irving, who co-founded Pond Venture Partners, which has offices in San Jose and the United Kingdom, said the softness could last two years.

“There’s generally a freeze on the capital markets – the magnitude feels unknown and very large,” said Mike Guthrie, the managing director of Symphony Technology Group in Palo Alto. “Things have come to a bit of a halt on the deal side.”

But this downturn may not be as painful for the tech world – and for the valley as a region – as the deflation that followed the bursting of the dot-com bubble in 2001, when Internet companies vanished and people sold their assets and fled, several people said.

“I don’t think it’s the end of the world or the beginning of a depression,” Shoven said. “I think a short, sharp contraction is what we’re in the midst of because of the real estate bubble bursting.”

Consumer spending

Another big segment in the valley is consumer technology. Companies like Apple, HP and Palm sell technology and gadgets to regular people. As the credit crisis spreads and consumer confidence wanes, fewer households may feel comfortable buying a multimedia entertainment center or desktop computer or even cell phones for the kids.

In short, the digital living dream that this segment has chased for years might be put off yet again.

There are signs of a consumer pullback. Best Buy, for instance, said last week that it would cut costs after its profit for the second quarter fell 19 percent, worse than analysts expected. Sales for the rest of the year are expected to slow.

Demand should be better in the rest of the world, said one venture capitalist. “In certain areas, like mobile in Europe, there’s a lot of spending happening,” said Irving.

Startups and exits

But not all is gloom and doom. Mergers and acquisitions are still happening.

A small South San Francisco company is planning an initial public offering on Monday.

Fluidigm, which makes biomedical research tools, had scheduled the IPO for last week. But when Lehman, one of its pre-IPO backers, declared bankruptcy and lead banker Morgan Stanley sought refuge in merger talks, the decision was made to postpone the offering.

Fluidigm said the hitch lay not with the company’s troubled backers but with distracted investment firms considering purchases of the shares.

An investment banker in San Francisco, Ron Lissack of Catapult Advisors, said he’s busier than he’s ever been, partly because of concern in Silicon Valley over how well Lehman Bros. will be able to carry on its business.

Lehman, like other investment banks, underwrites public offerings and handles mergers and acquisitions, the primary exit for startups this year because so many can’t afford to go public and can’t attract enough capital to stay independent.

“I’m on the board of a few companies, and we will certainly not trust our investment banking business to too large a firm with too much exposure,” said Jon Fisher, a business professor at the University of San Francisco who sold a company to Oracle last year and sought advice from Lissack.

Despite the pressures bearing down on technology, Silicon Valley is still doing better than much of the rest of the country, several people said.

The valley’s economy depends on investors who take risks, which at times creates bubbles – with copycat startups that chase a good idea and ultimately fail. The latest financial shenanigans on Wall Street make Silicon Valley look sensible and old-fashioned, Saffo said.