In Tech, Some See Signs of a Bubble
Home prices are soaring at double-digit rates, unemployment has shriveled to barely detectable levels, and many are saying that the high-tech economy is recession-proof.
Welcome to Southern California, 1989.
Or Silicon Valley, 1997. Take your pick.
Southern Californians remember with painful clarity what came next. The region’s economy entered one of its worst slumps in history, shedding hundreds of thousands of jobs, prompting an unprecedented population exodus and sending home prices plunging.
So what portends for Silicon Valley? Is it possible the Southland bubble didn’t so much pop as migrate north and swell to even greater dimensions over a stretch of land that wraps around the southwestern edge of San Francisco Bay?
All the signs are there.
Unemployment rates in Santa Clara and San Mateo counties are less than 3%, half the rate in Southern California. Many Bay Area economists say there is actually negative unemployment--that is, more job openings than jobless workers.
Home prices are climbing a percentage point a month in those same two counties, with median prices hovering above $300,000, more than $100,000 higher than the medians in Los Angeles and Orange counties.
Perhaps most troubling of all, the mood in Silicon Valley at times this year has bordered on giddiness, with speakers and magazine covers forecasting an unending boom, a high-tech economy immune to the business cycles and downturns that plague other industries.
Meanwhile, signs of weakness have been emerging in the broader economy, with Asia’s currency crisis crimping sales for many technology companies. Stock prices in the tech sector have slid more than 20% since mid-October.
From afar, all of this looks like trouble.
“It sounds all too familiar,” said Jack Kyser, economist for the Los Angeles County Economic Development Corp. “We like to think everything is going to grow to the sky, but eventually it stops.”
But within Silicon Valley, analysts, executives and economists respond to these omens with a shrug. The high-tech capital of the world may not be invincible, they agree, but it is certainly not destined for a Southern California-style collapse.
“Silicon Valley is about 20 years into a 40-year expansion,” said Michael Murphy, editor of the Technology Stock Letter. “We’re not standing on the edge of a cliff, we’re standing on the edge of a prairie, and the horizon is a long way out there.”
For a variety of reasons--all grounded in Silicon Valley’s unmatched access to ideas, talent and venture capital--Murphy and others may be right. But even optimists agree that after a warp-speed run in recent years, the region seems to be slipping into a lower--and perhaps steadier--gear.
Silicon Valley endured a slump of its own during the early 1990s, brought on largely by the national recession. Bay Area housing prices tumbled so badly that they returned to their late 1980s levels only earlier this year.
The rebound was fueled by the explosion of the Internet. Since emerging as a mass market phenomenon in 1995, the Net has spawned hundreds of new companies, conferred unprecedented wealth on a legion of twentysomething entrepreneurs, and opened new vistas for some of the Valley’s giants.
The initial burst of activity was so intense, analysts say, that it was impossible to sustain. And although the Net remains the most important market force for almost every company in Silicon Valley, the initial frenzy is over.
The number of initial public stock offerings, for example, has tapered off dramatically, according to New Jersey-based Securities Data Co. In 1996, there were 79 technology-related offerings from Silicon Valley, raising a record $2.9 billion. Through November of this year, there were only 41 such deals, raising $1.3 billion.
Maturing markets have come to inevitably resemble games of musical chairs. Whereas there were a dozen or more companies hoping to sell Internet browsing software a few years ago, for example, it is now down to a two-way race between Netscape Communications and Microsoft. Similar consolidations have taken place in everything from Internet access to networking hardware.
And as Net activity has cooled, problems lurk in one of Silicon Valley’s newer trends: the move toward mainstream consumer markets. With PC penetration stalled at about 40% of American households, the computer industry is desperately searching for a way into the remaining 60%.
One way has been to bring prices down, and the sub-$1,000 category is among the fastest-growing segments of the market. But that’s just the beginning. The industry’s leading hardware and software makers are also increasingly enamored of new types of devices, such as television set-top boxes that will handle everything from traditional cable programming to Internet access.
But although mainstream markets mean bigger sales, they often also mean thinner margins. For that reason, many analysts believe the industry is heading toward an era of what Bruce Lupatkin, director of research at Hambrecht & Quist, calls “profitless prosperity.”
“A great irony of the technology industry is that as it leaves smaller, niche-oriented businesses, it invites all kinds of competition,” Lupatkin said. “Products become commodities.”
Consider Intel, whose microprocessors serve as the brains of at least 85% of the world’s computers. For a decade, Intel has scooped up much of its fat profits from sales of high-end chips that cost $300 to $400 apiece. But now the market is moving toward computers and computer-type devices that themselves don’t cost much more than $300 or $400.
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Intel has responded with plans to build a low-cost version of its high-end chip, the first time the company has done so. Intel also plans to supply chips for devices such as set-top boxes, with hopes that consumers will trade up to new, faster boxes every few years, just as they do in the PC market.
Even if those plans work, Intel’s future depends on selling far more products at significantly thinner margins.
The company can take some comfort in the potential for volume, though. The computer devices of tomorrow will cost far less than the average $2,000 a PC costs today, analysts say, but that’s not so bad if the number of computers in the world mushrooms from 240 million today to perhaps 2 billion within 10 years.
And besides, as many analysts point out, Intel and other high-tech companies have long thrived in markets ruled by plunging prices.
“Intel is going to be in for a tougher time,” Murphy said. “But Intel and other companies have spent their whole lives managing deflation. Prices go down every 18 months. . . . And yet they’re able to build these huge companies.”
But will such companies continue to be built in Silicon Valley if the costs of living and doing business continue to soar?
High-tech corridors in Texas, Utah and elsewhere have benefited enormously from their cost advantages over Silicon Valley, as well as their more stable employment markets. Turnover rates at many Silicon Valley companies surpass 30% annually, as workers swing from one lucrative offer to another.
Oddly, Southern California has not profited much at its northern neighbor’s expense, largely because the Southland also struggles to compete with the cheaper resources and lucrative tax deals available out of state, said economist Kyser. Manufacturing jobs have been fleeing Silicon Valley for years, creating a gentrified environment in which companies keep their brains in the valley but their moving parts elsewhere.
3Com, for instance, keeps just 3,500 of its 13,000 employees in Silicon Valley, and those tend to be the ones in the highest-paid positions--mostly engineers and executives. To keep employees from getting restless, the giant networking company offers standard Silicon Valley perks: an on-site Starbucks and fitness center, flexible work schedules and, of course, bucket loads of stock options.
Costs might be lower elsewhere, but the engineering talent 3Com needs is in Silicon Valley. Debra Engel, head of personnel, proudly notes that annual turnover at 3Com is only in the mid-teens, and that so far, the company has been able to find all the talent it needs, albeit at rivals’ expense.
“We’re one of the companies that feeds off the others,” she said.
3Com, which makes the routers, switches and modems that serve as the plumbing of computer networks, has flourished in the age of the Internet. Since 1995, its annual sales have more than doubled to $5.6 billion, and its profit has nearly tripled to $598 million.
But 3Com, like Oracle Corp. and many other powerful Silicon Valley companies, has been pinched by the economic turmoil in Asia. Plunging currencies have diminished many Southeast Asian countries’ ability to afford American technologies.
The Asian markets’ collapse has had a mixed effect on technology companies, hurting their overseas sales but reducing the cost of labor, land and building materials for their Asian factories.
The stock markets have not taken a mixed view, however. The Hambrecht & Quist index of 275 technology stocks, as of early last week, had lost about 22% of its value since mid-October, although it was still up 12% since the beginning of the year.
Even with Asian markets in turmoil, products moving toward markets with thinner margins and cost-of-living indexes spiraling, few see a downturn coming, let alone a Southern California-style crash.
For starters, analysts say, Southern California’s economy was slammed by the implosion of one industry--aerospace--that was largely dependent on one customer, the U.S. government. In Silicon Valley, there is no such concentration. It’s true that many of its companies are linked to the personal computer industry. But only one prominent computer maker--Apple Computer--is actually based in Silicon Valley.
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The rest of Silicon Valley is teeming with companies of amazing variety. They may be grouped into a category known as high tech, but they are pursuing markets that cover the breadth of commerce itself, from digital movie effects to high-tech farming to online stock trading.
The amazing accumulation of wealth at such companies over the last few years has spilled out the doors of high-tech campuses and washed up at the curbs of car dealerships, real estate offices and shopping malls.
At Stevens Creek BMW in Santa Clara, for instance, business these days isn’t much more complicated than passing out keys and collecting checks. Bill Ratcliffe, general manager of the dealership, estimated that sales have doubled over the last few years, and that at least 40% of the cars sold go to technology workers.
“I’ve never seen it quite like it is right now,” Ratcliffe said. “There’re a lot of people in their late 20s to mid-30s buying expensive automobiles. In the summertime, they walk in wearing shorts and a T-shirt.”
Ratcliffe may not write software or build hardware, but he and millions of others in Silicon Valley are part of the tech economy, and they keep a close watch on its pulse.
In fact, many of Ratcliffe’s theories on Silicon Valley echo those of veteran industry analysts. He believes that Silicon Valley emerged from the ‘90s recession in better shape than ever, leaner than overseas rivals and light years ahead technologically. Ask him about markets and he’ll tell you that data networks are bound to expand and that enormous foreign markets are still largely untapped.
“Only a fool would think the markets will stay at highs forever,” Ratcliffe said. “But the next couple years look very, very healthy.”
Of course, as Southern Californians know, bubbles are often hardest to see from the inside.
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Signs of a Silicon Bubble
Jobless Rate
Unemployment dropped below 3% in Silicon Valley in 1997. In high tech, economists say, there are more openings than jobless workers.
Santa Clara County-- Nov. 1997: 2.5%
San Mateo County-- Nov. 1997: 2.2%
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Existing-Home Prices
Home prices climb a percentage point a month in many locales, buoyed by stock options and signing bonuses. Quarterly, in thousands of dollars. Santa Clara County
San Mateo County
Orange County
Los Angeles County
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Hambrecht & Quist Technology Index
High-tech stocks have dipped lately amid troubles in Asia and fears that tomorrow’s technologies may bring lower profits. This index covers technology stocks, most for firms based in Silicon Valley.
Dec. 23: 1,115.03
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Sources: Bloomberg, Acxion/DataQuick, California Economic Development Department.
