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.

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.

It’s funny how the same reading of  history leads to different conclusions. The young investor in the 1840s Punch cartoon above stands in a back alley outside the Capel Court stock exchange asking a purveyor of dubious scrip how to honestly make £10,000 in railways. It is the end of a technology hype cycle in which the modern-day equivalent of $2 trillion was pumped into an investment bubble.  The picture on the right is a desolate and economically insignificant outpost connected by some of the 2,148 miles of railway capacity that entrepreneurs built during the British railway investment mania of the 1830s. The conclusion is that early investors in British railway companies were played for suckers.

The mania probably started with an announcement in the May 1, 1829 edition of the Liverpool Mercury:

“To engineers and iron founders

The directors of the Liverpool and Manchester Railway hereby offer a premium of  £500 (over and above the cost price) for a locomotive engine which shall be a decided improvement on any hitherto constructed, subject to certain Stipulations and Conditions, a copy of which may be had at the Railway Office, or will be forwarded. As may be directed, on application for the same, if by letter or post paid.

HENRY BOOTH Treasurer Railway Office, 25 April 1829

The Liverpool and Manchester Railway was not the first railroad in England, but the competition drew enormous interest.  Contestants used everything from “legacy technology” — horses on treadmills — to lightweight steam engines that could reach up-hill speeds of 24 miles per hour. The legacy technology defeated itself when a horse crashed through a wooden floorboard. It did not hurt that Queen Victoria declared herself “charmed” by the winning steam technology.

Business innovation  — ticketing, first-class seating, and agreements allowing passengers to change carriers mid-trip — was rapid and fueled as much by intense competition as by a chaotic, frenzied stock market in which valuations soared beyond any seeming sense of proportion, causing  John Francis in 1845 to despair: “The more worthless the article the greater the struggle to attain it.” When the market crashed during the week of October 17, 1847 — in no small measure due to to the 1845-6 crop failure and potato famine — and established companies failed, financiers like George Hudson were exposed as swindlers. Thomas Carlyle demanded public hanging.

The collapsing bubble is not the end of the story. Between 1845 and 1855 an additional 9,000 miles of track were constructed.  By 1915 England’s rail capacity was 21,000 miles.  British railways had entered a golden age. The lesson that observers like Carlotta Perez and others draw is that there is a pattern to technological revolutions:

  1. Innovation enables technology clusters, some  of which transform the way that business is done.
  2. Early successes and intense competition give rise to new companies and an unregulated free-for-all that leads to a crash.
  3. Collapse is followed by sustained build-out during which the allure of  glamor is replaced by real value.
  4. This leads to a golden age that results in more innovation as lives are structured around the new technology.

This is a Schumpeterian analysis of innovation that is reflected everywhere, but particularly in the economics of the new technologies of the late twentieth century.  The stamp of the the 1840s British railway mania can be seen in Gartner’s technology hype cycle and in nearly every discussion of the 2000 dot-com collapse.  It is an analysis that is a special problem for angel and other early-stage investors because there is no real guide to tell you when the bubble will burst. Unless you are George Hudson, what investor will find the risk acceptable? A rational early investor will steer clear of technologies that radiate this kind of exuberance.

But what really happened to all that investment in the 1830s? I was amazed to see the recent article by my long-time colleague Andrew Odlyzko at the University of Minnesota who analyzes the British railway mania example and concludes that the early investments did quite well:

The standard literature in this area, starting from Juglar, and continuing through Schumpeter to more recent authors, almost uniformly ignores or misrepresents the large investment mania of the 1830s, whose nature does not fit the stereotypical pattern.

Andrew enjoys taking contrary — often cranky but always well-thought out–  positions on conventional wisdom, so I approached his article with cautious interest.  After all, I thought I knew a little about the railway mania episode.  I had used it myself to illustrate innovation cycles. Like most people, I had focused on the disaster of the 1840’s, so I was drawn immediately into Odlyzko’s argument that during the mania of the 1830’s,  “railways built during this period were viewed as triumphant successes in the end.”:

After the speculative excitement died down, there was a period of about half a dozen years during which investors kept pumping money into railway construction. This was done in the face of adverse, occasionally very adverse, monetary conditions, wide public skepticism, and a market that was consistently telling them through the years that they were wrong.

In other words, the end result of the wildly speculative exuberance of the  1830s was the “creation of a productive transportation system that had a deep and positive effect on the economy.” Investors saw great returns. A shareholder in London and South Western Railway (LSWR) who in 1834 paid a £2 deposit on a share worth £50 and who paid all subsequent calls (totaling £95.5) would have watched the investment grow to 2.31 shares valued at  £200 by mid-1844 and would have received in 1843 alone £4.62 in dividends — a 9.68% annual return.  This defied the more rational demand and cost forecasts:

at the start of the period…in June 1835, such investor would have paid £10, and seen the market value it at £5.5. In fact, over most of the next two and a half years, the market was telling this investor that the LSWR venture was a mistake, as prices were mostly below the paid-up values.

Andrew Odlyzko is a seasoned mathematician who knows better than try to prove a general principle by example.  He says as much in his paper. On the other hand, railway mania has been used for years as an illustration of an innovation cycle, and  Odlyzko has a very different reading of history. The conclusion that is usually drawn from the Railway Mania may lead markets and investors astray because it seriously misrepresents actual patterns. The whole point of a cycle — hype, innovation, or investment mania — is that it can be used as a risk-averse template for rejecting sales pitches that start with “This time is different“.  But that does not mean that it is never different.

Georgia Tech’s Danny Breznitz and Mollie Taylor just completed a study of how communal roots and a rich complex of social networks can impact the health of high tech clusters and entrepreneurial activity.  Entitled The Communal Roots of Entrepreneurial-Technological Growth? Social Fragmentation and the Economic Stagnation of Atlanta’s IT Cluster, the preprint of their report has, as you might expect from the title, already attracted some attention in Atlanta.

One conclusion of the Breznitz-Taylor report is that the effects of social networks often dominate the availability of other, more quantifiable resources in determining the long-term health of  industries in a region.  Since I devoted my first post to exploring the impact of fluid social mixing on the Silicon Valley culture, I thought it would be interesting to sit down with Danny Breznitz to get his thoughts on why he thinks this is so.

A former Fellow at MIT’s Industrial Performance Center, Danny’s book Innovation and the State won the 2008 Donald K. Price award for the Best Book in Science and Technology Politics.

Danny started out by telling me he had already thought about it in terms of colliding worlds: local economic development and technology entrepreneurs.

Q: My premise in “Proposition 13” is that social mixing is evidence of many other social networks that come into play when new companies are hatched in Silicon Valley.  Do you think that’s true?

A: Yes, we argue in our paper that these kinds of networking relationships increase social capital in a region and that a cluster rich with social capital actually binds key companies and individuals to the cluster. That not only makes it harder for them to leave the region, it increases the supply of specialized talent that startups need,  as well as the ability of disparate players to meet and come together with novel ideas across domains of knowledge.

Q: Your paper has an intriguing title.  What does it mean?

A: We studied the IT industry in the Atlanta metropolitan area to find out why so many apparently successful Atlanta companies leave the region for California or other states.  This is true even for companies that came out of places like Georgia Tech or were founded by Atlanta natives so you would think that the ties to the region were strong.  This is what we mean by stagnation.  The answer seems to be that without a a rich multiplex of social networks cluster development will stagnate.

Q: You say that Atlanta’s High Tech cluster is stagnant.  In what way?

A: Stagnation is a way of describing what happens to a region when there are no local clusters with sustained growth.  Atlanta is still a global leader because of the many technology initiatives that attract entrepreneurs, but over the past ten years or so many of the most promising companies have decided to leave the area altogether.  What is especially problematic is that the most promising high tech startups — the source of future grown — are the ones that are most prone to move away.

Q: Can you give examples?

A: Every data set we looked at told the same story: technology startups with consequence tend to leave Atlanta.  If you look at the Atlanta Business Chronicle’s list of “Top Venture Capital Deals” from 1999 to 2007, for example 42% have left Georgia. In fact, 40% leave within the first three years of getting their first round of VC investment, and hence we become a feeder cluster if you will.  We are in real danger of becoming one big technology incubation center whose successes are raided by other regions.

Q: In the same way that MASPAR left Boston for Silicon Valley?

A: Exactly.  In the case of MASPAR it was the ready availability of all the people, talent, money, and other resources that would be needed to grow a successful company. In the case of Atlanta companies that leave the region, California and the New York/New Jersey areas are by far the most frequent destinations:  California because it is the leading technological cluster and New York because it is the leading financial center. These are also two major sources   of venture capital for the Atlanta technology industry.

Q:  Atlanta touts Georgia Tech, GRA, the proximity of universities, transportation and infrastructure as reasons high tech companies should locate here.  Do you disagree that these are important factors?

A:  This is called “factor availability”. The availability of factors like universities is definitely important for technological entrepreneurial growth. So not only do I agree that these are important but I think that Atlanta and Georgia have been doing a great job in this regard. However, our research indicates that societal variables are just as important and maybe are even more important. There is a growing body of thought among researchers that supports this view from a theoretical standpoint as well. Our findings suggest that if we do not come up with new ideas and policies to change the societal environment of the technology center in Atlanta, we will not enjoy the fruits of our own investments.

Q:  It’s been over a decade since Analee Saxenian noted that flattened hierarchies helped explain the economic disparities between Route 101 in California and Route 128 in Massachusetts.  How does your study add to her insight?

A: Saxenian’s study concentrated on the structure of the high tech industry in Silicon Valley and Boston’s Route 128 and we agree that hierarchical companies make it more difficult to share knowledge and talent. We wanted to understand the situation in Atlanta and to bring all the tools of modern social research to bear on the problem.  In fact, you can argue that Saxenian’s book was talking about social capital, although she did not use that term.

Q: Do you think Atlanta economic development planners have taken those effects into account?

A: We think that the planners have done a good job at emphasizing factor availability which is important in beginning new companies, but corresponding attention has not been given to the health of the local community. Although the factors are necessary, they are not sufficient.  Without a better supply of social capital it will be difficult to sustain cluster growth. On the positive side, the initiatives and leadership of The Enterprise Innovation Institute suggest that Georgia Tech leadership has reached the same conclusions.

Q:  Why the gulf between Entrepreneurs and Economic Development Offices?

A:  I am not sure it’s a gulf. It’s a difficult question because policy planners can only do so much to help.  Economic Developers can influence variables through programs like GRA.  At some point, for example, the personal involvement of top executives from Atlanta’s leading companies needs to be promoted. We should also remember that companies are for profit organizations – if companies believe that they have better chances of maximizing profits or returns for their investors somewhere else they will be under immense pressure to leave. We must realize that and tailor our policies to ensure the these pressures are mitigated and that the perceived advantages of other regions do so not seem to be so high in the eyes of  the people who made relocation decisions: the founders, boards, investors and customers.

Q:  What are the three things that could be most helpful in reinvigorating Atlanta’s high tech cluster?

A: We have to look in the mirror.  It’s easy to reflect on how well we’re doing, but it’s more difficult so say:  “Well, we need to add more attention in these other areas too because what we’re doing now is just not enough.” First, I think a new set initiatives anchored around Georgia Tech should be developed to focus on how current and future large Atlanta companies can maintain closer connections with Atlanta’s high tech industry.  Second, I would like to see renewed attention to stimulating a more local VC industry. VC’s are critical to shaping the social network of the companies in their portfolio and as long as those networks are located somewhere else, local companies will always be at risk for relocating closer to the networks.  Third, I would like to see Atlanta executives more involved at all levels of entrepreneurial activity.  Executives who have “made it” invest their own money in Atlanta, which is important, but that is not same as the many different kinds of social involvement that it would take to embed startups in the region. A leadership group that took on this challenge would be a very good thing for Atlanta.

Q: What should Atlanta business leaders be doing to take advantage of the city’s strengths?

A: In addition to the leadership group?  I think promoting the kind of social mixing that you were talking about in “Proposition 13” and has been so important in other healthy clusters would be a good first step.  The Enterprise Innovation Institute at Georgia Tech has funded us to continue this research, expand and update our databases, and provide more focused policy recommendations.  I hope Atlanta business leaders will also help as our study goes forward.

Q: Are there lessons learned from the situation in Atlanta that can be applied  in other cities?

A: Our findings are based on social networking theory and an approach to data analysis that synthesizes information from many sources.  We think there are lessons from studying the relationship between business-social structure and entrepreneurial growth.  Comparing the findings for Atlanta with other regions would help us understand, for example, whether there are geographic factors that come into play or whether the international environment is important.  I think the main lesson, not only for Atlanta, is that you have to go beyond the traditional view of what is crucial for  high tech growth and take a hard look at the health of your community.

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)