by Eric Hornung
When I was younger, I wanted nothing more than to work on Wall Street.
The books I read, the Wall Street Journal, the aura of living in Manhattan. It was the goal. Then, at 24 years old, I did it. I moved to New York City and on my first official tour, I saw Wall Street. It was simultaneously marvelous and underwhelming. Like seeing the Parthenon or meeting Jim Brown. Legendary but not what it used to be.
Wall Street is a relic of a bygone era; one littered with Michael Lewis-style crashes and burnouts, crazy characters and intense negotiations, innovation and ego. One that captured the imagination and exploited the greed of the last century.
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Howard Marks, in his book Market Cycles, continuously brings up a quote attributed to Mark Twain: History does not repeat, but it does rhyme.
This is true in history
This is true in markets
Is this of innovation hubs?
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Allow me to be forthright on my background. I have never lived in Silicon Valley and this is my view as an outsider.
Upside is a podcast about the startup world outside of Silicon Valley. It is not a podcast that pits itself against Silicon Valley.
Silicon Valley and San Francisco (for purposes of this article we refer to the economic region of the Bay Area as Silicon Valley) have shown North America a future of innovation and a mechanism to sustain competitive advantage as a country, region, and city.
In line with the quick ascendance of the train, plane, automobile, and finance industries, the tech industry has, by all quantitative measures, provided incredible value to the average North American via consumer surplus, jobs, market value, and global competitive advantage.
The rapid growth of tech as a sector is a commendable yardstick. We should study and learn from Silicon Valley’s successes, failures and mistakes, and non-repeatable competitive advantages.
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It is without question that Silicon Valley is an economic powerhouse built on the backs of the Defense sector and the hippy movement that magically managed to lead the nation both in computing hardware and then transitioned to dominating in software.
So today, when the media covers Silicon Valley, it can be confusing to see the negativity and doomsday prophecies.
Everyone is leaving!
U-hauls are so expensive to leave!
This person lives in a tent!
When the media covers “the next Silicon Valley,” they often are making the implicit argument that Silicon Valley is dying.
But Silicon Valley doesn’t have to die for other communities to grow.
The truth is that Silicon Valley is progressing through what I will call the Innovation Hub Cycle.
The Innovation Hub Cycle has six loose stages:
- Traction Outside the Status Quo
- Early Innovators Fund the Next Generation
- Hype and Returns Draw in External Capital
- Conflict Between Growth and Capacity
- Dispersion
- Storied Relic
Although we have been spoiled in the last 200 years, Innovation Hubs are historically rare occurrences.
First, to be a sweeping innovation that affects the lives of almost everyone is a tremendous human feat. Second, most innovation happens across multiple geographies (for example, ship building, monetary systems, or industrialization of agricultural) at the same or similar time. Thus, mindshare is not monopolized for one region.
To be an Innovation Hub, a single geographic region must develop and maintain a near-monopoly on innovation in a given space. A simple test for whether or not a region is an Innovation Hub is whether or not you can or could use the name of the region as a clear replacement for the industry you want to allude to.
I’ve highlighted a few examples of Innovation Hubs below:
Modern financial markets in London in the 16th and 17th century
Restaurants in Paris in the 18th century
Automobiles in Detroit in the early 20th century
Financial products in New York City in the 1980s
The internet in Silicon Valley in the 1990s
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Let’s dig into one example and look at how the boom in financial products in New York allowed for financial innovation to skyrocket during the 1980s.
1. Traction Outside the Status Quo
There’s a great scene from the movie The Big Short that romanticizes one of these financial products, mortgage backed securities, and the impact it had on “boring old banking.”
“In the late seventies banking was not a job you went into to make large sums of money. It was a good stable profession like selling insurance or accounting. And if banking was boring then the bond department at a bank was downright comatose. We all know about bonds, give em to your nephew when he turns 16 and then we he’s thirty he makes a hundred dollars. Yawn. Bonds were for losers. That is, until Lewis Ranieri came on the scene at Salomon Brothers…”
2. Early Innovators Fund the Next Generation
Salomon would go on to fund innovation in dozens of other financial products spearheading the 1980s financial boom. The list of Salomon alumni includes a Who’s Who of financial innovators including Michael Lewis (financial media), John Meriwhether (Long Term Capital Management), Michael Bloomberg (Bloomberg), and more.
3. Hype and Returns draw in External Capital
There was a lot of other things that impacted the financial products boom, and I outline a few below, but the key point is that in the 1980s the innovation happened in, to, or for New York City.
- Interest rates topped 17% and inflation neared 14%
- The SEC de-regulated trading commissions (1975)
- Unemployment halved from 1982 to 1987
- Junk bonds emerged
- Corporate Raiders (aka Private Equity) came into style
- Investment banking, stock brokering, and trading were highly-coveted careers
- CNBC went live and the Wall Street Journal expanded from one section to three
In short, the New York City financial scene was booming. External capital was flowing into the New York City ecosystem. It was peak Wall Street.
4. Conflict between Growth and Capacity
When you look back with that nostalgic view of the history of the financial industry, you forget what New York City was really like. It was dirty, crime-ridden, and the gap between the haves and have nots was massive. It was a mecca for privileged white male finance students and degenerates alike. This visual storytelling gives a little more color:
As the 1980s faded and the 1990s emerged, there emerged an elite set of brokerage houses and investment banks in New York City. Names that we still remember like Salomon Brothers, Merrill Lynch and Drexel Burnham Lambert that recruited the best and brightest from the top schools.
Calls for the decentralization of Wall Street into Class B neighborhoods started as early as the crash on 1987. Following the Great Recession, top tier firms began to move jobs from New York City to secondary and tertiary markets.
Does all of this sound familiar?
Today, Silicon Valley is combatting an inherent conflict between growth and capacity. This conflict breeds higher costs: costs of doing business, societal costs, opportunity costs. Eventually, those costs become too high and the dispersion begins
5. Dispersion
There are over 400,000 financial advisors in the United States and most of them don’t work in New York City. There are investment banks, private equity firms, asset management shops, and financial services companies in every major market in the United States.
The Googles, Apples, and Facebooks of the world open second headquarters and supplementary offices to mitigate those rising costs. Communities learn the playbook and emulate Silicon Valley the best way they can, becoming small tech hubs and recruiting talent using their own competitive advantages.
The nature of technology, as with finance, is that you don’t physically need to be anywhere. Network effects are powerful in certain instances, but they aren’t critical to success. Eventually, a tradeoff is made.
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6. Storied Relic
Silicon Valley is synonymous with technological innovation. It will always be the home to technology, the father of computing, and the catalyst for the consumer internet. Silicon Valley has a near monopoly on that mindshare. So much so, that the only way we could define the scope of the upside podcast is to say “outside of Silicon Valley.”
As we look to what this means for the future, I would expect the dynamics to mirror that of New York City. Still, to this day, New York City is the place to go for an early finance career. With New York City on your resume, your chances of landing a finance job elsewhere in the country increase tenfold, if not more. There is a societal heuristic built in to a finance job in that city.
I think the same will happen with Silicon Valley:
- People will move to Silicon Valley with exit plans; timeframes for leaving, strategic networks to build; certain skills to develop.
- Silicon Valley will solve its social problems in the next 20 years and become one of the nicest places to live in the country; it will still be expensive.
- Silicon Valley will act as the informal mothership for the dozens of other cities across the United States pursuing tech ecosystems; those with Silicon Valley backgrounds will rise faster in those ecosystems.
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We did not build The Up Company because we hate Silicon Valley. In fact, I admire the key components of the Silicon Valley culture that contributed to its rise.
A lot of the best parts of Silicon Valley can be – and will be – exported elsewhere. If this is the case, the entire country and Silicon Valley will be better for it.
History does not repeat, but it does rhyme. Silicon Valley, like every Innovation Hub before it, will follow the Innovation Hub Cycle. It is a natural progression.
It may lose concentration of the technology industry, but its reputation will only grow stronger over time. Stories will emerge and be told solidifying legends and villains. Characters will be brought to life. Silicon Valley will always be the crown jewel of the technology revolution.
One day, I hope to take a tour of Silicon Valley and stop in the Rosewood Sand Hill. When I walk in, I hope to be simultaneously marveled and underwhelmed.
Eric Hornung is the co-founder of The Up Company, co-host of the upside podcast, and co-editor of the update. Eric also works full-time for Duff & Phelps, a corporate financial advisory firm, in Corporate Bankruptcy Advisory and as project manager of Blockchain and Cryptocurrency. He lives in Cincinnati but has traveled the world and is a die hard Cleveland fan. His free time is cannibalized by studying to be a Chartered Financial Analyst (CFA) and tending to Hank, his new Bernese Mountain Dog puppy.