Falling costs enable new regional hubs

By Nic Brisbourne on September 20th, 2012

As we all know, the last ten years has seen a near-total collapse of the innovation cost curve, thanks to the perfect storm of open-source, cloud infrastructure, and “free” global distribution via search, social and app stores. At the same time we have seen the start-up ecosystems in New York, London and Berlin emerge as meaningful competitors to Silicon Valley.

It’s no coincidence that these two developments have come together. The former enables the latter. Ten years ago, it took a million or two to get a business to any scale. That meant going to VCs at the plan or early prototype stage. Those VCs were nearly all situated in Silicon Valley and most companies couldn’t get very far without going to them.

So those VCs didn’t have to worry that they were missing out by only investing in companies they could drive to. (Don’t interpret this as a sign of laziness: many VCs work very hard. But they choose to invest in local businesses because they will make better investment decisions when they know the entrepreneurs, their friends and advisors, and where they can have more frequent face to face contact post-investment.)

In other words, the geographic concentration of capital in Silicon Valley caused a similar geographic concentration of innovation. This was the situation for 30 to 40 years, during which time this natural logic of innovation clustering around capital was re-enforced by the success of companies like Intel, Apple, Cisco and Yahoo!.

The wealth and experience created in these companies propelled Silicon Valley further ahead of its global competitors as the easiest place to found a startup, and Boston, the only meaningful competing start-up centre, fell by the wayside.

When the cost to start a company fell dramatically things started to change. Many entrepreneurs still moved to Silicon Valley to start their companies, but staying nearer home became an option for those who were motivated to do so, usually for reasons of family or geographic loyalty.

These entrepreneurs, at companies like Skype, Etsy, and Tumblr, were able to prove a lot with a little and Silicon Valley had to sit up and take notice. In an anomalous, parallel development, the 1999-2000 bubble spawned local funds who were able to support these companies to a point, and to introduce them to their Californian counterparts.

(Draper Fisher Jurvetson (DFJ) were one of the first Valley funds to respond to the globalisation of innovation when they started building the DFJ network of funds around the world, which my partnership, DFJ Esprit, joined in 2007.)

Fast forward to 2012, and we have increasingly vibrant tech ecosystems in many locations supported by increasingly competent local venture capitalists. Additionally, the proliferation of high quality tech blogs is giving entrepreneurs all around the world access to much of the advice that was previously only accessible through personal networks in Silicon Valley.

But most of the local funds are small and the local ecosystems sub-scale. They are unable to provide for the needs of some companies as they grow. Some companies are able to raise all the finance they need locally, while others are able to raise money from Silicon Valley funds investing outside their home turf – an increasingly common occurrence. Sometimes the companies simply struggle and grow as best they can with inadequate financing.

This lack of late-stage capital is now throttling the geographic dispersion of innovation just as it was getting started. Unfortunately, the US venture market is in a period of contraction at the moment, which will exacerbate the problem by reducing the appetite for deals far from home.

The best solution to this problem is to have more and larger local funds in each ecosystem. Governments worldwide understand this now and are supporting their venture industries with tax breaks and direct investment, but the real shift will come when the existing local funds show through good returns that venture capital outside of Silicon Valley is a profitable endeavour.

Only then will innovation be truly dispersed, and only then will we be able to focus on what we’re doing here without always having half an eye on what is going on “over there”. That means it’s on us, the current crop of VCs and the entrepreneurs we’ve backed, to demonstrate that our local ecosystems work.