The U.S. Environment for Venture Capital and Technology-Based Start-Ups
President, Adobe Systems
As often happens in these conferences, as I listen to the magnitude of the issues being discussed and the incredible insight that so many people have, both on the panels and in the questions they are asking, I begin to wonder whether there is much I can add. Today, I would like to give you a very brief perspective from someone who is in an industry and company supported by venture capital, and living in one of the ''sticky" environments that were talked about before. Silicon Valley is probably the biggest "sticky environment" in the world, certainly the biggest in the United States.
My perspective is very specific to the information technology sector. I am not an expert in biotechnology or in venture capital. But I do work in that environment and can at least give you an idea of our strategy and our attitudes toward what is happening in research and development (R&D) and the successful competitive positioning of U.S. companies and technologies.
Adobe Systems, of which I am the cofounder with my partner John Warnock, turned 15 years old in December 1997. We are a venture-capital-based company. Both John and I were veterans of Xerox PARC. Many of you have heard stories of companies started by folks who found it difficult to get their ideas into products within Xerox, and who spun out and started their own companies. We are one of those stories; a company that started out with two guys and the equivalent of a garage.
Our business is not based on natural resources, but on artificial resources and capital. In the software industry, successful companies typically generate a lot of cash. A prudent board of directors has to be very careful in what it does with that asset. It is typically invested fairly conservatively because we want to demon-
strate that we are taking good care of the asset. The difficulty is that the return on equity for the business begins to precipitously drop as it earns more and more cash, because conservative investments naturally produce conservative results.
We decided about three or four years ago to try and deal with two problems more or less simultaneously. The first problem being the conservative use of cash and not earning a fair return to our investors. The second problem, and the primary motivator in many ways, was the observation that several other presenters have made that we live in an environment that is captive to the 90-day performance report card. Every 90 days, we as a management team are responsible for generating revenue growth and profitability. The analysts do not want to know what my long-range view is until after I report this quarter's results.
This environment is not conducive to long-term investment, nor often to high-risk investment. So what we did is set aside a venture fund and became, in effect, venture capitalists. Within the software industry we were among the first to do this in a deliberate and disciplined way. Today, we manage about $80 million in the fund. We see dozens of business plans come through on a weekly basis. We try to target the investment of that asset, our cash, in ways that allow us to develop new markets, and in some cases acquire more direct access to new technology and integrate it with our product line. We find it an innovative way to do slightly more advanced research than we are likely to do on our own operating budget because of the 90-day phenomenon that I talked about. We have been fortunate so far to have invested in the prepublic stage of Netscape and a few other successes. While I do not want to predict that as future performance of the fund, it has given us an entry point into developing markets and a way to expand our business.
If you look at the technology business that we are in, basic research in very sophisticated areas of physics and chemistry and biotechnology does not usually drive our industry. More often, the important advances have been applications of relatively sophisticated but well-understood concepts underlying mathematics and systems design, and the integration of various pieces of research that have been developed independently into systems that provide solutions.
With that as background, there are a few issues I would like to raise to help you understand where we are positioned as a U.S. industry based in Northern California. First, as others have mentioned, it is not atypical for high-growth, high-technology industries to find themselves in a very constrained geographic environment. Certainly, Silicon Valley is a very constrained environment. Why does this happen? Well, it happens for a lot of reasons. One is the insight and investments made very early on, in this case by Stanford University, to look at what was needed to take technology being researched at Stanford and turn it into practical applications and corporate relationships. This is somewhat different, incidentally, than some other regions because in the formative stage there was almost no direct investment by government.
More important is the infrastructure that provides an incubation environment
for new businesses. This environment consists of more than the products and the key individuals who start the companies. It consists of mundane things that allow venture capital to be readily available, including the know-how that allows people to sign leases for equipment and facilities, to set up banking relationships and human resource support systems, and all the other things necessary to start a business. You can literally go to the Yellow Pages in Palo Alto or San Jose and get a sampling of a dozen or more vendors in each of those categories who are completely comfortable dealing with this. By contrast, in most places in America it is difficult to find the infrastructure to put together a high-technology business.
The other key ingredient, of course, is that as these ''sticky environments" grow, more people want to attach themselves. They know this is where the germination of ideas is. You cannot go to the grocery store, or clothes shopping, or to a cocktail party or restaurant without running into people and absorbing knowledge about what is going on in Silicon Valley. We are beginning to see this environment duplicated in other places, such as Research Triangle Park and Austin. Route 128 for a long time has provided a lot of pieces of this infrastructure.
The growth of high-technology business brings problems as well. For example, we have a less than 1 percent housing vacancy rate at the moment in Silicon Valley. Our freeways, if you know anything about queuing theory, have passed the critical point. It is difficult to get in an accident because you cannot move on the freeway. Employee retention is a problem. We are an old company in Silicon Valley, so we are not growing as quickly as a start-up company. We have to make special efforts to retain employees.
What are companies in Silicon Valley doing to respond? We are beginning to diversify geographically. We are fighting the "sticky" phenomenon, at least internally, and setting up engineering groups in remote locations, both in the United States and in the rest of the world. This is what is causing R&D money to move out of the United States. We have opened a development lab in Norwich, England, and are moving into India. We have already set up a development group in Japan. You will see more of this happening simply because of the constraints in Silicon Valley that I described.
The next issue, which is very important in our component of the high-technology industry, is the scarcity of domestic talent. We see this everywhere. When I talk to groups of fresh bachelor's degree holders that we bring out for interview trips to attract them to our company, I typically ask how many were born outside of the United States. The answer now is typically in the 30 percent range. I suspect that this percentage of foreign-born employees applies across our entire company. Because our business is based on intellectual capital, the educational process that produces candidates to work in the company are critical. They are critical for us to be successful, so we have to go anywhere in the world to find talent that will fuel our growth. U.S.-born talent is not only scarce in engineering, so is management talent to run the business. I know that venture capitalists must
from time to time struggle with young companies that cannot grow talent fast enough inside. How do you acquire that talent and bring it into the company? Because we all compete in the global marketplace, international marketing expertise is also necessary to be truly successful. Today more than 50 percent of our revenue is outside the United States, and will probably grow to two-thirds or three-quarters in the long-term.
In terms of what we look for in national policy and support from the government, Dick Thornburgh mentioned the national standards for securities litigation, which is important for us to reduce the legal costs associated with running our business and working with our shareholders. More important in our business, frankly, is intellectual property, including the application of copyright and piracy issues. Our revenue at Adobe would easily more than double today if piracy were eliminated on a worldwide basis and my suspicion is that it would go up by a factor of three. That would turn us from a $1 billion company into a $3 billion company. It is a big issue, even in the U.S. government because they have not yet adopted the policy to eliminate piracy there. It is difficult for me to sit across from a minister in China and tell them I am upset with the fact that we only sell, in effect, one copy of our major software programs in that market and he will ask me what the U.S. government policy is. Unfortunately, I cannot give a good answer today.
As for investing in R&D, my personal belief is that the government should focus on longer-term basic research and the production of intellectual capital rather than try to pick the technological winners. Frankly, I think that our industry does that pretty well. We would prefer to see the government produce the raw materials we use, which are talented, educated people. It is also important for the government to understand what is necessary to foster competition in this new economy. I have talked with regulatory agencies and have seen them apply economic models that work well in natural resource industries and smokestack industries but make no sense in intellectual-property-driven businesses.
Finally, I would like to talk about foreign competition and what we see in the future. We have had a great run in our industry. Today, the United States is by far the dominant supplier of products and software for PCs. Thanks to Bill Spencer and others who have worked so hard at it, we are also strong in the sophisticated silicon processing businesses. You always worry when you are at the front because everyone paints a target on you.
What we have seen in Europe, for example, is not a lack of intellectual capital, which is fairly uniform across the world within a certain range. Their difficulty is that they have never really embraced the notion of letting the people who are the pioneers actually own the assets of the company. They could learn to change that, but it will be a long-term process. In Japan, similarly, it has not been possible to allow venture capital and ownership in the hands of entrepreneurs to the extent that we see in this country. In addition, the risk-taking culture, which is almost a badge of honor in Silicon Valley, is not present in Japan.
In terms of emerging cultures, I personally believe that in the software industry China will be very competitive in the future. The culture is very entrepreneurial. Their universities are improving rapidly. For example, one company I know of was essentially venture-capital-funded by Beijing University and run by professors and students. The university transferred partial ownership to the management, which has taken the company public. The next step is to move into the global market. They understand almost all the issues that the other geographic economies seem not to have quite put together in a complete package. So I think, going forward, that China will be a formidable competitor.
Finally, the last thought I will leave you with is this. When you look at our experience of the past several decades, we all point to Xerox PARC as the incubator for the personal computer (PC). Frankly, it was the Advanced Research Projects Agency research investments of the last half of the 1960s and the early 1970s that created the intellectual capital that has allowed the current PC industry to flourish. The question I have, almost a rhetorical question, is where is the comparable investment coming from today to create the industry that will be the anchor of growth for the first half of the twenty-first century? If I knew the answer, I would share it with you, but I don't.
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