Tuesday, June 18, 2019

Industry Towns - Where You Start A Company Matters

Industry towns[1] emerge due to the critical mass of having employees, entrepreneurs, suppliers, business partners, potential customers, and investors in the same geographic location. Some industry towns are driven by their geography - for example manufacturing sites on the Mexican side of the US-Mexico border, Houston for oil & gas, or wineries in Napa (where the right conditions exist for grapes to grow). Other industry towns emerge due to early founding effects - for example Detroit largely emerged as an automotive center as Henry Ford and Ransom Olds happened to live there when they set up shop (Ford Motor Company and Oldsmobile)[2]. Other companies and suppliers moved to be close to Ford and Oldsmobile and an industry town was born.

If you were going into the movie business, you would be encouraged to move to Hollywood, Lagos, or Mumbai. If you wanted to go into finance, New York, London, and Hong Kong would be amongst the primary places to move. Industry towns exist for most major industries, including energy, finance, movies and entertainment and other areas.

Oddly, it is now controversial to say industry towns also hold true for tech - if you want to start a company that will be worth $10 billion or more, the best places to start it are Silicon Valley[6] (for the US), Beijing (China), and Bengaluru (India). There are also regional centers of excellence (Jakarta for Indonesia, Singapore, Sao Paolo for Brazil, etc.) and then secondary centers in the main markets (London, Stockholm, Paris, Berlin in Europe amongst others. Shenzen and Shanghai in China. New York, and to a lesser extent Los Angeles, Seattle, Boston, San Diego, Atlanta, DC and others in the US). This does not mean it is impossible to succeed elsewhere. Rather, startups (and careers) are hard enough as it is, so loading the deck in your favor matters.

On average, being in an industry town is more likely to lead to success than being elsewhere. There will, of course, be successes everywhere. However, market capitalization, revenue, key partnerships, and outsized talent tend to aggregate in industry towns.

Industry towns self-perpetuate as you have a critical mass of talent, suppliers, customers, investors, and know-how in a single geographic area. A cluster, once it exists is self perpetuating and attracts more of the same.

Why Move To An Industry Town?
If you want to go into the movie business and someone told you to go to San Francisco instead of Hollywood, you would think they are nuts. It does not mean that you could not have a movie career in San Francisco - but it would be more challenging[3].  Movies are written by authors who could live anywhere, are filmed onsite around the world, and could be digitally edited from anywhere. Actors could fly to any site in the world to act. But for the Western markets most of the critical mass of the industry still happens in Hollywood.

Technology startups have their own industry towns in places like Silicon Valley, Beijing, and Bengaluru. Secondary towns include London, New York, Shenzen, and Shanghai. On average, going elsewhere will make it harder to succeed in a career in technology.

Similarly, while you can build a technology company from anywhere, there is a real advantage to being in an industry town.

Using the data from CBS Insights on current unicorns, one can quickly see patterns in terms of where private startup market cap is concentrated. I posted a rough quick pass of HQ city data here, for anyone who wants to play around with it, or correct any errors I made. The Europe stat also includes the UK, but the UK is broken out to show its major contribution to Europe. SV = Silicon Valley. I also bundled Bellevue with Seattle, Silicon Valley as a whole, as well as other city suburbs around the world into the city themselves.

The table of raw data:

The table of raw data is below. Last Quarter IPOs for SV are just Uber, Lyft, Pinterest, Zoom as of 6/17/19. You can obviously ignore them if you want to stick to only private companies - I just thought it was notable how much market cap in Silicon Valley just went public.

One can always argue that current market is both a forward looking metric (as investors pay ahead for the best companies) and backwards looking (it takes many years to become a unicorn, so this is a view into where the best companies were being founded 2-10 years ago.

Note that some cities, like San Diego, mainly have unicorn market cap due to biotech. Almost half of New York's market cap is from WeWork, which is more real estate company than technology company - and another $10B or so is from DTC companies (indeed, NY is an industry town for next-gen DTC companies).

Nonetheless, the pattern holds - in every market one city takes most of the market cap. For example, London is 66% of the private unicorn market cap in the UK, Silicon Valley is 57% of US market cap, and Berlin is about half of Germany's.

If you add back the recent IPOs (Uber, Lyft, Pinterest, Zoom) to Silicon Valley, it becomes 65% of total US unicorn market cap.

Here is similar date by overall number of unicorns (versus percentage of market cap):
India is unique in having two cities of roughly equal unicorn market cap with 6 unicorns in Bengaluru and 8 in New Delhi together making up 78% of Indian unicorn market cap.

So why are industry towns so powerful?

1. Talent base. Great engineers, sales people, product people, etc. exist all over the world. However, the highest concentration of outstanding ones are concentrated in industry towns (just as the highest concentration of great actors in the USA live in Los Angeles). Similarly, the people who know how to scale technology companies are concentrated in the tech epicenters in the graphs above. Many companies come to the SF Bay Area to fundraise post product-market fit to access this talent base and know-how.

2. Early customers. For some industries your customers are mainly elsewhere. For example, if you are selling optimization software for oil well extraction, you do not have many customers in Silicon Valley. However, if you are selling generally useful enterprise software or Saas, many early adopters for your product exist in the Bay Area. Technology companies are more likely to early adopt new products than older companies for many categories of enterprise software. Similarly, many early consumer product influencers for technology products are based in the Bay Area[5]. Often, the best place to find early adopters of technology products are in a technology cluster.

3. Unique insights and know-how. What new paid and unpaid channels exist for your business? What are new coding or design trends? Which VCs are funding the NoCode/Devsumer or RPA market? What are the current terms for an M&A offer for a 5-person machine learning team? Industry towns tend to be where early adopters spread insights that an aggressive startup can take advantage of. While some online groups can create similar activity, running into people and serendipity in information spread, board meetings, angel/founder or founder/founder conversations cannot be over appreciated.

4. Smart investors. The best startups in NY, LA, DC, Boston, eventually come to Silicon Valley to fundraise. This is due to a concentration of knowledge, insight, and ambition, as well as dense networks for customers and talent bridged by the investor. Similarly, the best investors in India cluster in Bengaluru and in China in Beijing.

5. Service providers. Legal know-how, banking, and real estate providers with flexible terms or unique outlooks cluster in industry towns. What terms is a specific investor willing to capitulate on? Your lawyer should know. In industry towns they often do.

6. Living and breathing a craft.
Some people are obsessed with their craft. Quentin Tarantino worked as a clerk in a video rental shop and spent his free time watching movies and learning from old masters. The best biologists go to dinner with other biologists and spend all their time talking about biology[4]. Industry towns attract people who view their work and their craft and their hobbies as one thing. Hard work, ambition, and a singular focus are more likely to meet with success than taking it easy, a laissez fair attitude and wanting to do a little bit of everything. While many of the most interesting founders in Silicon Valley are polymathic, they spend the brunt of their time early in their startup journey on their companies and discussing technology trends. Industry towns attract a lot of people self-obsessed with whatever it is they love to work on.

Internet markets are 10X bigger than before. There will be more $1 billion tech companies everywhere.
Online software markets have grown at least 10X in the last 10 years. It has indeed never been easier to start a billion dollar company from anywhere in the world. A company that would have had $10M or $20M in revenue can now reach $100M in revenue due to the global liquidity and reach the internet provides. This means more companies than ever will reach $1 billion in market cap, and there will be more companies distributed around the world than ever before. For example, there are 82 cities in which the 360+ unicorns dwell, and 44 of the cities have only a single company worth $1B or more in them.

In parallel, technology market cap continues to grow most for startups in technology clusters or industry towns. While there are more $1 billion companies all over the world, there are more $10B+ companies in technology clusters. Market cap has historically aggregated to a small number of places. There is no clear "why now" to suggest the effects for industry towns listed above have shifted dramatically enough to displace them.

The rise of distributed teams means that more companies are hiring outside of their HQ city more quickly. If you distribute your team, you need to invest earlier in process. You will need to do goal setting, strong internal communications, and lots of in person meet ups, earlier than most small companies would. Distributed teams have a cost. In some cases the cost may be worth it. In many it is worth waiting until your startup has scale. As tooling becomes stronger we are likely to see even more distribution of teams over time. Over the next 5 years, HQs of the biggest new startups will largely be based in industry towns. 10 years out is always harder to predict.

If you have an advantage in hiring in a local market, you can put your HQ in an industry town and your engineering office in the local market. For example, many Israeli startups will eventually move their HQ to Silicon Valley but keep an engineering team in Herzliya. In some cases, the primary market for talent is the industry town - for example Jakarta seems to attract many of the best or most experienced engineers in Indonesia - so it is not as easy to split the HQ from the rest of the company.

Exceptions that prove the rule
Seattle has spawned two of the most successful companies in tech. Microsoft was originally headquartered in Albuquerque and then moved to Bellevue/Seattle in 1979, and Amazon was started in Seattle in 1994, in part due to its tax rules. Notably, the founders of Microsoft Bill Gates and Paul Allen were born and raised in the Seattle area and then moved back for their startup - just as Ford and Olds created the auto cluster in their hometown of Detroit. While it is likely Seattle will create another mega company some day in the future, its startup scene today is smaller than Silicon Valley, New York, Los Angeles, and other US cities.

Similarly, Warren Buffet is pointed to as an example of how a great finance person does not need to live in NY - since he lives in Omaha. While correct, there are significantly more successful finance people in NY (with spillover now into Connecticut) than there are in Omaha.

I am not arguing that it is impossible to be successful outside of industry towns, but rather there are network and knowledge effects that both pull incredible talent to clusters, and help them succeed faster than they probably would elsewhere. There are always exceptions, but the data on private unicorn market cap above demonstrates the high concentration of the best startups in industry towns.

Some people in tech have a visceral reaction to the suggestion that tech has industry clusters just like any other industry. This is largely driven by their own personal journey "I left the Bay Area for [cityname] and I am doing great in life, therefore this overall thesis is wrong". Or, "I live in [x city] and it is great for my startup." If that is the case, more power to you and congratulations on your success! While great people can be successful anywhere, market cap, venture capital raised, and other data all suggest that industry towns (and their outsized success) are here to stay. As mentioned above, that does not preclude success elsewhere. Technology entrepreneurship is not zero sum.

San Francisco governance - will the tech cluster move elsewhere in the Bay Area?
The city of San Francisco has two potential paths ahead of it. It can create one of the best run, best funded, most progressive and diverse cities on the planet. With an ever growing tax basis, a burgeoning population, and an amazing geographic location, San Francisco should be one of the great cities of the world. Alternatively, a lack of affordable housing, growing homelessness, poor transit infrastructure, and rising open drug use and petty crime can continue to be problems.

The last few years have seen a generational transfer of wealth from pension funds and endowments to San Francisco landlords. Endowments and pension funds back venture capitalists, who fund startups, who hire employees, who give much of their salaries to San Francisco landlords. People who own buildings in San Francisco have made enormous amounts of money while homelessness increases. San Francisco (and indeed, much of California) have building unfriendly regulations that are preventing housing supply from being built where it is direly needed.

It was just 10 years ago in 2008/2009 that few major technology company outside of Saleforce were based in San Francisco. New startups were just moving up to the city or getting founded there. Over the last decade, those startups have grown up into Uber, Airbnb, Lyft, Twitter, Pinterest (which moved from Palo Alto), Stripe (which moved from Palo Alto), Square and others.

From ~1994-2010, most leading Internet companies in the Bay Area were in San Jose, Mountain View, and Palo Alto. From ~2010-today the best new companies have been based in San Francisco. Ten years from now, will we be talking about all the technology startups still in San Francisco? Or will the epicenter have shifted yet again to Oakland, South San Francisco/Burlingame, or another part of the Bay Area instead?

If San Francisco is not able to drop housing costs and the general affordability of living in the city, residents and companies will eventually go elsewhere. While others parts of the area are increasingly expensive, the city in the Bay Area that seizes the initiative on affordable housing, transit, commercial space and infrastructure could become the new tech epicenter of the world.

My hope is San Francisco is able to correct its problems, and that technology companies and employee-residents play their civic role in supporting the city as it transitions.

[1] Also known as "clusters" see for instance https://en.wikipedia.org/wiki/Business_cluster.
[2] Notably, the automotive industry was considered one form of "high tech" in its day.
[3] For example, Robin Williams lived in the Bay Area for big periods of his life.
[4] And, if single, they may also talk about their dating lives.
[5] There are obvious counter-examples in "middle America" products - like Pinterest & Wish.
[6] I will use "Silicon Valley" and "San Francisco Bay Area" interchangeably in this post.

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