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It’s not only the clash of investment cultures that tends to doom internal start ups. At least that’s what I told the Bellcore and SAIC CEOs at the post-mortem for the internal division that we had tried to run as a venture-backed business.

It’s also what I said to Bob — who you will recall — wanted to incubate an internal venture inside his Fortune 10 company that would match in excitement and star power the coolest gang of Sand Hill Road funded misfits. He would have to be willing to sacrifice a boatload of management principles that had served him well in his career. I didn’t think he would do that.

Like a generous parent, Bob was in a position to give the new kids everything they needed for success: mentoring, time to succeed, and ample resources. What he did not have was a clear idea of which exit to take. Bob’s idea of a venture failed the value test.  A new venture succeeds when the right leadership team focuses on a market need with staged funding.  The idea was doomed as soon as Bob said,“Look, I’m in charge of new technology and platforms and I’m going to be the venture capitalist funding a new product, so that when it succeeds we’ll be able to fold it back into our current business.

The moment someone in a large company forms a thought like this, the options for maximizing the value of the investment are narrowed to one.  The only exit is one in  which access to internal resources can be used to shoehorn a fit into existing businesses. I had seen the danger of this kind of investment strategy at other companies, and the results were not encouraging. This thinking had infected our Bellcore start-up, but I have been in the executive suites of a dozen West Coast technology companies when the discussion turned to how the value of an internal start up was going to be captured by an existing business line.  It always turned out the same:  because there were no choices to a successful exit, backers literally threw money at the new company. They were thinking way down the line about how to succeed.

There are other options, but they do not necessarily align well with Bob’s goal of internal commercialization:

  1. Sell the technology: it’s always possible that the upside does not justify continued investment.  But if you’ve made a large up front commitment–as opposed to small increments that are tied to market tests– it is hard to execute this option and capture value.
  2. Licensing: the main reason for choosing  licensing as an exit is that there are differing value expectations in the marketplace.  The technology may be used in many different applications by many different players, for example.  You can maintain a central IP position and benefit from this diversity.
  3. Resell your R&D effort: if the technology is a critical product component, there may be other vendors who would like to benefit from your near-term “deliverables.” An R&D contract gives up a little IP in the short run, but you not only recover your development costs, you also continue to expand what you know about the technology and its applications. This is such an interesting–and seldom used–exit strategy that it deserves a post all by itself.  Watch for it!
  4. Sell the right to market or form a joint venture to market and sell: this is a range of exit possibilities that allow you to keep the option of bringing the technology in-house at some later point.  Of course, the attractive thing about such partnerships is that they generate revenue while spreading the risk around several players.
  5. Spin-out/IPO: the obvious counterpoint to the internal start up is to kick the baby bird out of the nest to see if he can fly on his own. I don’t know why our Bellcore start up was not conceived from day one as a spin out.  Bellcore, after all, had a history of spinning out companies to commercialize research technologies.  Some of those companies (Telelogue for voice menus, Elity for CM analytics, and a host of companies for communication network traffic monitoring and tools) were quickly picked up by angel and venture investors who went on to ride the businesses to their own successful exits.

Why Bob was determined to retain ownership in an incubated business says as much about internal corporate culture and priorities as Bob’s own approach to innovation. What seems to be missing when managers fixate on internal startups is the recognition that there are other worlds involved in the success of a new business, and they often  have very different rules.The internal start up is an opportunity for worlds to interact rather than collide. Here is the value chain that Bob had to work with:

  • Creative engineering: internal R&D interacts with a larger, external innovation community.  It  is very good at coming up with gap-filling concepts that need to be externally validated
  • Venture funding: is useful for establising performance metrics based on value and focusing funding to meet performance goals based on those metrics
  • Corporate resources: the company itself is in the driver’s seat.  It sets out the strategy for value capture and makes the option calls that start chains of transactions that are key to success. And by the way, the creative engineers call it home.

This all started because Bob was worrying that normal, internal product R&D would not lead to  “breakthrough product ideas that do not align well with their core business.”  It is a common problem, but there are three fatal errors that doom most attempts to solve it. Here’s how to avoid those errors.

First, don’t set the new venture up for failure by limiting the end game to only those ideas that align well with the core business.  That was what got you in trouble in the first place, and can be avoided by considering up front the full range of exit options.

Second, don’t pretend that you are a venture fund.  The fundamental belief systems are different, and it is simply not possible for a large corporation–one that has to worry about quarterly results and long-term growth–to capture value in the same way that a VC does.

Finally, recognize the role that interacting worlds will play in the success of your venture.  External innovation networks, market-validating communities and the relatively heavier weight corporate resources and processes have a tendency to collide, when what is really needed is a strategy for working together.

Internal start-ups have all of the usual new business challenges.  They need products, customers, and a profitable way of getting customers to pay for the products.  But above all, they need cash, because even the best strategy will crash and burn if money runs out too soon.

[Production note: at this point investors should enter, corporate investors stage left, venture capitalists stage right]. They speak the same language and are genuinely interested in incubating  great new businesses, but don’t let that fool you.  They are from different worlds.

promised to talk about some of the things that doomed the Bellcore internal start-up which I briefly led.  There is no way of  knowing whether a VC-funded company would have fared any better. In fact, one of the companies that we might have merged with was a venture-funded operation that lasted only a few months longer than we did.  Nevertheless, we did learn a lesson or two about corporate sponsorship of start-ups:

Corporate sponsors of new ventures and VCs have different belief systems.  They are fundamentally incompatible, and without early, explicit steps to stop it, corporate attitudes, practices, and beliefs will overwhelm the fragile culture of the start-up.

Let me set the stage a bit.  In 1999, Bellcore (now Telcordia Technologies) was a small company (revenue creeping up on two billion dollars) that was trying to ride the internet wave, but it had inherited a corporate style from its previous owners that was, well, hierarchical.  Big deals dominated the business mix, and internal investment decisions were obsessively analytical.

Bellcore’s new owner was SAIC, a big company serving a hierarchical marketplace that was paradoxically entrepreneurial. Bob Beyster, SAIC’s founder, had insisted on a flat corporate structure in which managers were encouraged to develop independent business.  When my little start-up failed, I  made my wrap-up presentation to the CEOs of both companies.  One of them tended to believe that Bellcore’s internal investment machinery was the right way to grow a new business.  Here’s how it went.

  1. We spent a lot of  money on extensive analytics to gauge market potential.  It was how the investment decisions for Bellcore’s big operations support systems were made and every new round of funding was based on a rosy prediction of a complex market study. In reality, market behavior was unpredictable.  We should have evolved our concepts in the market.
  2. Except for the few top  technologists that I could steal from my own research staff, corporate investors would not permit top talent to be redirected from existing projects — where the  big customers were —  to this risky venture with uncertain prospects. Once both scale and success were clear, we could recruit internally, but until then, we had to rely on good-natured volunteers to help us out.  The only thing we could do was hire externally, but there was little upside to attract the kind of business team that we needed.  A VC sponsor would have known that new ventures do not succeed without a highly talented team.
  3. Speaking of success: the corporate sponsors were only interested if the likelihood of success was high, so we spent a lot of time on the success factors that would be convincing to them.  An angel investor or a VC would have known that, since the likelihood of success of a given venture is quite low, it is better to fail earlier rather than later.
  4. Corporate culture was a culture of ownership, so many business planning meeting focused on patents and intellectual property rights that would build walls around the business.  It was an unfortunate mindset.  This was a time of open standards and sharing, but shared ownership was not part of the equation for our start-up.
  5. Internal sponsors wanted to see scale.  Niche markets were simply not interesting. The business had to embrace all of telecommunications, so part of the operating strategy was to place many product bets simultaneously, a disastrous choice given the meager resources for product development and the lack of real experience on the part of our business development team.  A VC would have told us that a narrow, easily explainable, product focus was key to success.
  6. The corporate sponsors were all senior Bellcore executives, and they were focused on building the core businesses.  They believed that value creation had to be demonstrated by earnings. A VC would have told them that the market recognizes value well before earnings are even possible — it’s the single most obvious characteristic of early-stage investors to constantly seek those kinds of  market signals.

There were ways through this thicket.  That is one of the lessons for corporate leaders who want to launch internal start-ups: avoid colliding worlds by choosing the right corporate role.  Corporate sponsors need to be responsive to the needs of the new venture, but proactive support is just one more opportunity to infect the start-up an alien culture.  An internal start-up needs to be managed, but managing for value makes much more sense than managing to artificial revenue and earnings targets. And freaking out over the possibility of failure is also not helpful.  New business creation is a portfolio game, and any corporation that does not take a portfolio approach is betting against high odds.

An overlay to the story of every internal start-up is corporate machinery.  The milestones that mark the calendar for corporate sponsors are timed to fit the needs of much larger — and more visible — core businesses.  No billion dollar company can afford make its processes dependent on external business and market events.  But that is exactly what a start-up needs to do.  So, even if the new venture survives the Investor vs. Investor duel, it needs protection from the calendar, the  topic for my next post.

Dilbert.com

I had a conversation the other day with a senior executive — let’s call him Bob —  of a Fortune 10 company about their “internal start-up” culture. It seems that they are looking for breakthrough product ideas that do not align well with their core business.  The solution seems obvious: let’s create the same kind of  exciting, market-driven environment that you would find in a start-up!

Everything sounded fine for a few minutes.  They thought that the most creative people in the organization needed to have elbow room that would be difficult to achieve in the risk-averse culture of a hundred billion dollar company.  So how did they plan to achieve that?

  • Freedom to break some rules:  the start-up can use its own  product roadmaps and sales strategies
  • Freedom from process-driven corporate calendars and budgets: the leadership of the start-up is not bound by the revenue and earnings goals of their parent
  • Freedom to take risks: they have permission to fail

It didn’t take long for the discussion to go seriously off track.  When I started in with questions about how they were going to actually pull this off, Bob said: “Look, I’m in charge of new technology and platforms and I’m going to be the venture capitalist funding a new product, so that when it succeeds we’ll be able to fold it back into our current business.” I had seen this movie before.  It’s called When Worlds Collide. When I suggested that Bob lives on a different world and would make a terrible venture capitalist, things got a little heated. As I recall it, Bob said, “In your ear!” A surefire way to put a fine point on your argument.

Bob lives on a planet where the scale of his business creates a climate for successful development of new products that can be sold to familiar customers using existing channels and tried-and-true processes.  Above all, in Bob’s world, it is possible to make big bets. The examples are impressive. Everything from HP’s inkjet printing to the Boeing 777. Unfortunately for Bob and his start-up, none of those things matter.  The start-up lives in a world of new markets, which means new customers, new channels and new processes.

Even though Bob has all the talent he needs for market success,  the likelihood of failure is high. The Newton and the Factory of the Future did not fail because  because Apple and GE could not innovate.  They failed in large measure because corporations foster a system of beliefs that is fundamentally incompatible with  taking capabilities to new markets. When I asked Bob  how the start-up employees were going to be recruiteed and rewarded, whether they had a safety net for returning to the company in case of failure, and how many simultaneous bets he was willing to place, the answers were not encouraging.

I immediately did a deep dive into my archives, hoping to find traces of a long-forgotten venture that I helped steer into the ground.  In the late 1990s Bellcore was poised to enter the online services business, hoping to attract newer, smaller customers than the seven  Regional Bell Operating Companies who accounted for most of the company’s revenue.  This was a time when Bellcore’s Applied Research group was generating a blizzard of patents in e-commerce and software, technology that I have talked about before. We were as smart and nimble as any West Coast start-up, and best of all we had the cash to fund a new venture, the talent to staff it, and the power of an existing sales team to go after those new customers. I was asked to lead the new company.  We would be funded just like a VC-backed start-up…

When the dust settled and I reported lessons learned to the Bellcore’s CEO Richard Smith and later to Bob Beyster, CEO of SAIC,  Bellcore’s parent company, the first thing I said was that there had been no structural reason for failure.  A team from McKinsey had already given us the range of possibilities. We could have set up an independent business unit or spun 0ut a company in which we retained minority ownership.  Setting up a new incubator would have required more time than we thought we had, and, in any event,  Applied Research was already in the incubation business. We had chosen to bypass corporate reporting structure and create a company-within-a-company with direct oversight by a CEO who was committed to our success.  It was exactly the Hughes DirecTV model.

There are three reasons that internal start-ups like ours tend to fail.  Bob was not in the mood to listen because he is banking on success, but the topic comes up in every large enterprise, so I thought it might be a good time to repeat the conclusions here:

  1. Failure is common: Building new business is a portfolio game in which 90% of the returns come from 15% of the investments.  It is fundamentally unlike product development. A “big bet” strategy only succeeds when there is high degree of confidence in your ability to sort out winners and losers.  In a new market, that just never happens.
  2. Market-driven milestones drive success in new ventures.  An internal start-up — even one with strong support at the top — cannot divorce itself from processes that are timed to fit corporate needs.
  3. Corporate sponsors of new ventures and VCs have different belief systems.  They are fundamentally incompatible, and without early, explicit steps to stop it, corporate attitudes, practices, and beliefs will overwhelm the fragile culture of the start-up.

I want to spend the next several days elaborating on these ideas.  I hope Bob is reading.

San Jose Mercury News (CA)

December 23, 2001
Section: Business
Edition: Morning Final
Page: 1F

VC LEGEND LEADS CHARGE FOR HP-COMPAQ
WITH TIES TO BOTH COMPANIES, PERKINS HAS UNIQUE PERSPECTIVE
MATT MARSHALL, Mercury News

Thirty-six stories above the placid blue waters framing Alcatraz Island and the Golden Gate Bridge, Thomas Perkins fidgets in his chair. If conversation lulls, his thumbs twiddle impatiently. He is a man driven by ambition. Perkins, 69, has turned his Silicon Valley venture capital firm, Kleiner Perkins Caufield & Byers, into the most successful VC firm in the world. Kleiner Perkins has returned around $20 billion to investors over its 30-year history. But Perkins‘ impatience comes from his latest, unexpected challenge: the bitter battle over the proposed merger of Compaq Computer with Hewlett-Packard. As a board member of Compaq — and former executive at HP, the Palo Alto computer firm where he cut his teeth more than four decades ago — he has become one of the most outspoken backers of the merger. But some HP heirs — sons and daughters of founders William Hewlett and David Packard — have signaled their intent to vote down the deal, saying a merger doesn’t make economic sense. They also say the layoffs likely in a merger threaten to ruin HP‘s vaunted tradition, the so-called HP Way, which they say emphasizes company loyalty…

…A merger will create a mammoth company that can take on giant IBM — and beat it. HP and Compaq, he explains, have better ties with Microsoft and Intel — two other key protagonists in the computer industry drama. Together, he says, the foursome create an industry standard that can easily outdo IBM. ”Microsoft will be the software department, Intel will be the hardware department, and HPCompaq will be the marketing-customer delivery department,” he says. ”Wouldn’t you go for it?” In part, Perkins is fighting for Compaq. But he also is fighting for his right to interpret the legacy that Packard and Hewlett left for Silicon Valley..

I remember opening the paper a couple of days before Christmas, 2001 and feeling like I had just been kicked in the stomach.  It was not the best time to be an officer of HP. Bill Hewlett’s son and HP board member, Walter, had come out swinging against the HP-Compaq merger, and Carly Fiorina, my boss, was under incredible pressure to sell the deal despite howls from the local press, the Hewlett and Packard families, an active message board for HP employees, and now a fractious board of directors. And there it was in black and white in the morning paper:   Tom Perkins, a Compaq board member and a driving force behind the merger had a plan to turn HP — the company whose logo said “invent” — into the marketing department for Intel and Microsoft.  I had to think hard about how I was going to face my own Technology Council and reassure HP’s 12,000 engineers that — despite what Perkins said in the  interview —  the company was not backing away from its commitment to innovation.

Earlier in the month, Carly had invited us to her house for a very low-key holiday celebration — much more subdued and informal than the elegant holidays parties that were the custom when the company was doing better.  Carly had paid for much of it out of her own pocket.  It  turned out to be a  tense and not not very festive evening.  Carly was running on a few hours of sleep, and the rest of us were trying to tie down the ship’s rigging in the middle of a storm. There was an air of uncertainty. We sat around smaller tables with our spouses as dinner was served.  Carly and her husband Frank were at an adjacent table.   As much to break the tension as anything, the discussion at our table turned into a silly  guessing game over which actors would be cast to play which of us when the HP-Compaq Merger Movie was made (West Wing star Allison Janney was the consensus choice to play Carly).   We must have been loud, because I could see Carly stiffen.  Carly didn’t know who on her own staff she could trust, and it must have sounded like we were tossing off the seriously difficult times that would be coming for HP and its employees.  We weren’t.

I spent virtually all of my time that winter keeping our major technology initiatives on track, promoting strategic product directions with customers, and talking to our engineering teams around the world.  The outcome of the proxy fight was uncertain and there would have been antitrust repercussions if HP and Compaq had gotten too cozy, so Webb McKinney, who was in charge of HP’s side of the integration team and the clean room that allowed the companies to begin planning merger details without violating antitrust laws, kept most of us with day-to-day management  responsibilities in the dark about post-merger plans for technology and products.

Once shareholders approved — by a hair’s breadth — the merger, Perkins was named to the board of the new HP.  Compaq’s  Shane Robison was named to a new position that combined my old CTO role and a Chief Strategy Officer position that had not existed before. I was still concerned about the Perkins comments from his December interview.  My first encounters with the Compaq technologists were not encouraging. I got into a shouting match with one of Robison’s staff members about how much HP should be investing in security for its products.  This was less than a year after the 9/11 attacks, and I had been working closely with CTO’s of other Silicon Valley companies and federal agencies to forge a comprehensive strategy for information and communications security.  The official Compaq position was that this was a problem for Microsoft, not HP, and I was told to keep quiet about it.

Imagine my surprise when Perkins and Robison led an effort to form a Technology Committee for the HP board to oversee and track R&D the same way that Audit, Governance, and Compensation Committees oversee financial  and operational matters.  I didn’t always agree with the direction it took, but it seemed to breathe new life into a technology governance process that had been stalled for many months.  Prior to that, HP — like most companies — did not place much visible  faith in its board to integrate technology into corporate governance.   There were a few public boards that had technology committees. They had been prominently featured in the  magazines for directors that wrote about best board practices, but those articles were disappointing:  most existing technology committees were for  informal oversight of technology spending by CIO’s.  What Perkins was  proposing was something different — and so at odds with his public statements about the value of a merged HP and Compaq that it took me a little while to catch on.   The HP Technology Committee would not only monitor  technology developments, it would help educate the board about new trends and directions that would impact board-level decisions and provide informed advice on the technology implications of financial and personnel decisions, including how to maintain a workforce advantage.

A committee like this would have been helpful years before, because HP had a history of plunging into technology investments and acquisitions that, to most technology observers, made little sense.  HP’s  decision in 2000  to purchase a middleware/software company called Bluestone was one such decision.  A distant fourth in a crowded and fragmented marketplace, the idea behind the Bluestone acquisition was based on a faulty reading of HP’s current capabilities in the space, the ability of any small entrant to alter the dynamics of the marketplace and the needs of HP-UX customers who felt themselves always last to the trough when third-party software developers released new products.  After two years of chaos and the dismantling of HP’s web services organizations, Bluestone was dumped at a $400 million  loss.

HP’s decision to sell its considerable VLSI design assets to Intel was also  made for financial reasons, although it was widely known in HP’s technology community  that the success of its 32 and  64 bit  processors, including  Itanium,  depended on custom chipsets that HP had invested  in for many years.  The original architects of Itanium were on my staff,  and it was hard to peel them off the ceiling when the announcement was made, especially since they had virtually no voice in the decision-making process.

Officers were invited to sit in on the  entire HP  board meeting, except for the closing executive sessions.  Even so,  it took me awhile to realize how rare technology discussions actually were. After a particularly fiery Industry Analysts’ Meeting, during which I made a slash-and-burn  presentation on our competitive advantages over Sun Microsystems —  that made the analysts smile but our marketing folks queasy — Carly asked me to reprise the talk for the board.  Patty Dunn (who would later take over as Chairman  in a controversial  tenure after Carly’s dismissal in 2005) and others approached me to say how much they appreciated the competitive information and the willingness to be combative in defense of HP product strategy.  They claimed, incredibly, that it was the first time they had heard this kind of presentation.

The Perkins proposal would have given the board a lens to look at issues like these — necessary in  a company where financial forecasts are only as good as the underlying technology.  HP was not only one  moving in this direction.  Motorola and other technology companies  had — at about the same time — formed Perkins-style Technology Committees.  Ram Charan’s book  Boards That Deliver helps explain why technology companies need to take the Technology Committee seriously, more importantly, how they can help  a board move beyond the role of compliance to a deeper assessment of health and prospects:

Financial health, operating performance and risk each require separate attention.  A company can show good operating performance while financial health…is in decline. Dot-com companies, for example, were notorious for delighting their customers with fantastic (or fantasy) products and services while bleeding cash.  Similarly financial health can appear to be sound when in fact the guts of the business have been severely compromised.  Any risk can be underestimated, especially when it is assessed piecemeal, rather than in totality.

The reason that the Technology Committee is a good idea for  public technology companies is that the worlds of innovation and execution are going to collide, and a board cannot deliver value by simply checking off a box on a governance worksheet.   What do you know, for example, about the real performance of key technology executives  without a deep insight into how they would be evaluated by their peers  and competitors?  How do you know that an acquisition based on a couple of good financial quarters and self-congratulatory product  press releases has no market advantage over an in-house solution?   That’s not the kind of question that due diligence is going to ask. After I left the company, I watched the downsizing of research and heard often from former friends and colleagues who thought one decision or another was wrong-headed, and I often  wondered about how effectiveness the committee actually was.  And then I would see something preserved that made no short-term financial sense, although everyone knew how important the technology would be some day.

When I joined the board of RSA Security, I was definite about my plans.  “Look,” I told CEO Art Coviello, “RSA’s performance is a three-legged stool, and the board needs to be as informed about the technology and markets as it is about finance and operations.” Ram Charan would have said the three legs are Finance, Operating Performance and Risk. I said the risks are Technology, Markets and Organization. Both Art and Chairman Jim Simms were on board, but it was not an easy proposition to sell to the rest of  RSA’s board, although I did.  The RSA Technology Committee had a big impact on board dynamics and ultimately on the long-term health of the company.  It is one of the WWC success stories that I will tell in more detail in a later post.

I can’t think of any reason that the board of directors of  a public company — especially a technology company — needs seven CFO’s, but that is the profile of far too many companies.  Even  on boards where the majority of the non-management directors are CEO’s, financial expertise overwhelms all other skills, and it is not healthy.  It’s hard to find a technology company that has failed in recent years where the  roots of failure were not widely known on that other planet outside the boardroom.  I emphasize public companies only because they are great targets.  Later stage privately held companies would also be wise to pay attention to board dynamics and find some way get a handle on the company’s technology.

Once I got over the stomach ache that Tom Perkins gave me, I realized why technology had a seat at the table of his boards.   Kleiner-Perkins got to be the world’s greatest venture capital firm by delving deeply into the  technology implications of business decisions.  Engineers have the impression that board rooms are filled with accountants who know very little about the details of the  business but are not shy when it comes to talking about it.  Enter the Technology Committee.

I always liked the scene in Annie Hall where Alvy Singer, the Woody Allen character,   is getting more and more annoyed by a guy standing behind him in a movie theater line who is carrying on about Marshall McCluhan, trying to impress his date:

Man in Theatre Line: It just so happens I teach a class at Columbia called “TV, Media and Culture.” So I think my insights into Mr. McLuhan, well, have a great deal of validity!
Alvy Singer: Oh, do ya? Well, that’s funny, because I happen to have Mr. McLuhan right here, so, so, yeah, just let me… [pulls McLuhan out from behind a nearby poster]… Come over here for a second… tell him!
Marshall McLuhan: I heard what you were saying! You know nothing of my work!…How you got to teach a course in anything is totally amazing!
Alvy Singer: Boy, if life were only like this!

Innovation works best not when worlds collide, but when they are shared. Sometimes sharing takes place because there are no good alternatives.

At one time the public schools in California were among the best in the nation. No more. In 1978 two-thirds of the voters, in what has become a chaotic practice of bypassing normal legislative channels to amend the state constitution, approved a tax reform referendum known as Proposition 13. Championed by a politician named Howard Jarvis, Proposition 13 or “The People’s Initiative to Limit Property Taxation,” capped property tax rates and required a 2/3 supermajority in both houses of legislature for any future tax increases.  The immediate effect of Prop 13 was a 57% decline in property tax revenues. Despite strong evidence that it is a root cause of the current fiscal crisis in California, Proposition 13 remains a wildly popular measure among Californians.

Less controversial is the impact that Proposition 13 had on the state’s public schools, which on the average lost half of their tax revenue. Before Proposition 13 and a ballot initiative known as Proposition 98 (which had the unintended effect of capping overall school expenditures) California’s per-student annual expenditures were about $400 above the national average.  By 2000, per-student spending had dropped to $600 below the national average. That trend continues, and today a declining percentage of personal income in California is directed to K-12 education.  A 2005 study by the Rand Corporation concluded: As recently as the 1970s, California’s public schools were considered to be among the nation’s best. Today, however, there is widespread recognition that the schools are no longer top performers. As a consequence, many Californians share a growing sense of alarm about the ineffectiveness of their public education system and the generation of children whose educational needs are not being met.”[1]

This is a dismal assessment. As a former California resident who experienced firsthand the inadequacies of K-12 education in the state I don’t want to appear to be endorsing the gutting of public schools, but the 30-year decline in quality of California’s K-12 public school system had one positive effect on innovation in Silicon Valley, because there was a consequence of Prop 13 that no one could have foreseen.  It helped to flatten what could have easily become an exceedingly hierarchical technology community into a more or less free-flowing social network.

Engineers of all stripes who want quality education for their kids have only two alternatives. They can either fork over a lot of money to a private school or move into a more affluent community where parent associations can raise extra dollars to supplement inadequate public funding.  In both cases, engineers find themselves elbow-to-elbow with industry executives, entrepreneurs, venture capitalists, and professors.  This is one way worlds are prevented from colliding in Silicon Valley.  It’s hard to maintain a strict hierarchy when – as they were in our local elementary school — CFO’s and programmers are working together on the PTA’s next silent auction.  Technologists and business leaders attend the same football games and school plays.  They mingle at holiday programs and parties and first-day-of-school orientations.

Of course, it’s not just schools that flatten the hierarchies of the Northern California technology community.  A young VLSI designer with a newly minted degree from Michigan might find himself seated behind former Sun CEO Scott McNealy at a San Jose Sharks hockey game because McNealy’s seats are in the stands, not a glassed-in corporate box. Sand Hill Road runs for four miles behind the Stanford University campus, so it is not unusual to see a partner in a legendary venture firm wandering the halls of the Gates Building and striking up a discussion with whatever graduate student happens by.  Technology innovators and business leaders serve together on boards of the Tech Museum and the Computer History Museum and the Exploratorium.  The excellent cafeteria at Google’s main Mountain View campus is a virtual soup of corporate leaders, academic celebrities, and undergraduate interns.  There are legendary meeting places.  Il Fornaio in Palo Alto serves breakfast, and sometimes a chance meeting at 9AM can turn into scribbles on napkin that in turn catch the attention of a retired Intel executive at the next table who is happy to spend a few minutes coaching the founders of a new startup.

The definitive answer to why this open culture is a competitive advantage can be found in Annalee Saxenian’s 1995 study of innovation Regional Advantage.[2] Everyone who is serious about building a culture of success should read it, and I am constantly amazed at the number of people leading strategic regional initiatives who are unaware of its existence.  In comparing the economic performance of Silicon Valley on the one hand and Boston’s Route 128 corridor on the other hand, Saxenian notes that social mixing is just one part of an open system of exchange that has not been successfully duplicated in business cultures where vertical integration and clear boundaries are common.  Decade after decade, the blurring of boundaries in Silicon Valley has given it an advantage in the rate of new start-ups and the speed with which new products can be brought to market.

Bill Hewlett and Dave Packard were to some extent responsible for an open corporate culture that welcomed startups even from within the company’s ranks.  While rummaging through some files one day at HP, I came across a series of memos from Apple co-founder Steve Wozniak.  On April 28, 1976, Wozniak wrote: ”I am seeking a written release from HP to market a product based on circuits I designed over the last year.  The circuits were originally designed on my personal time for personal use (hobby)…I “lobbied” for a similar product idea within HP management…without success…I have no objection to licensing the circuits to HP if necessary for any reason.”

A few days later, HP’s General Counsel, replied: “We are happy to release this invention to you subject to a worldwide royalty-free license to Hewlett-Packard Company and its present licensees…”

Wozniak and Steve Jobs set up camp nearby and became part of an innovative explosion that benefited HP and the entire industry.

Digital Equipment Corporation was the closest thing to HP that existed on Route 128, but like many other local businesses its corporate culture was far less open to sharing intellectual property, information, and skills. When Jeffrey Kalb left Digital in 1987 to found a new computer company called MasPar, it was a blow to DEC.  Kalb moved from Boston to Silicon Valley and by implication away from Digital.

Even at this late date, it is still a subject of considerable interest in northern New Jersey, Atlanta, Austin, Raleigh, and Minneapolis how to recreate the innovative environment of California’s Route 101. These are all regions with great universities, access to capital and a track record of building successful businesses.  Atlanta leads in many of the traditional measures of innovation but today lacks even one major source of venture capital. New Jersey was the intellectual center of the telecommunications industry, but there is a wide social gulf between the remaining scientists at the central research labs and the gated mansions of Bedminster.  Like Route 128, Austin, Raleigh and Minneapolis grew around companies with hierarchical cultures. A lesson of looking at things through the WWC lens is that innovation works better when worlds are shared.  Easy social mixing – whether spurred by a common concern for local schools or simply blurred horizontal and vertical boundaries – builds trust and collaborative networks.

In case you think all this talk about culture is some sort of gauzy way to paint contrasts where none really exist, Jeffrey Kalb pointed out one of the enduring business advantages of shared worlds: “There are a large number of experienced people [in Silicon Valley] who have retired but are still active in the industry and are available as consultants, members of boards or directors or venture capitalists…There’s just about anything you want in this infrastructure.”

To the extent that large corporations mimic entire societies, there are sociological reasons why sharing worlds is important for innovation.  Open innovation helps, too.  More about these ideas in later posts.


[1] California’s K–12 Public Schools: How Are They Doing? By Stephen J. Carroll, Cathy Krop, Jeremy Arkes, Peter A. Morrison, Ann Flanagan, RAND Corporation, 2005.

[2] Regional Advantage by Analee Saxenian, Harvard University Press, 1994 (Revised 1995)