The Reason Silicon Valley Beat Out Boston for VC Dominance

Despite the East Coast roots of technology entrepreneurship and venture capital (VC), by the 1990s Silicon Valley had gained a major advantage over the Cambridge-Boston area. In 1995 Silicon Valley’s share of all VC investments in the U.S. stood at 22.6%, more than twice New England’s 9.9% share. It is less well-known that Silicon Valley’s share of U.S. venture capital has skyrocketed since then, unaffected by wide fluctuations in the total pool of VC investments during this period. With an almost 50% share, the Bay Area now towers over New England, whose share has stayed put at around 10%.

The causes behind the initial divergence between the two regions have been amply documented. In her pioneering research on Silicon Valley’s advantage over Route 128 circa 1990, AnnaLee Saxenian identified some of the major differentiators, from cultural factors to state-level policies. Silicon Valley benefited from a more free-wheeling, less hierarchical, and more risk-taking culture than New England. Additionally, unlike Massachusetts, the state of California prohibited noncompete covenants in employment contracts. These policy differences fostered the emergence of a less loyal, more footloose talent pool in Silicon Valley. As a result, Bay Area companies were almost always more paranoid and under pressure to run at a faster pace than their East Coast peers.

What other factors account for Silicon Valley’s growing divergence from the Cambridge-Boston area during the last 20 years? We propose three mutually reinforcing hypotheses.

First, digital transformation is rapidly engulfing almost all industries. The transformation that started in retailing, music, and movies in the 1990s has now spread to education, financial services, cars and trucks, transportation services, energy and the environment, hotels and lodging, life sciences, all types of manufacturing, and even shipping, to name just a few. The same underlying technologies (e.g., sensors, search, social media, and artificial intelligence) cut across all of these industries.

Silicon Valley dominates these platform technologies. In contrast, New England has increasingly become a hub for ventures in life sciences; the first three-quarters of 2016 saw almost 60% of VC investments in New England go to ventures in biotechnology and medical devices. This is why, given a choice, a growing number of technology entrepreneurs prefer to launch their ventures in or migrate to Silicon Valley. This is also why Silicon Valley has become the go-to place for the digital labs of companies from a diverse array of “traditional” industries (such as GE, Walmart, Daimler-Benz, and the like).

Physical proximity to technology creators, cutting-edge engineering talent, complementors, and even competitors matters. Geographic distance can become a major impediment when you don’t know who you need to talk to and when you’re trying to tap into people’s only-half-formed ideas about the technologies and products they’re trying to develop. You need to be plugged into the local informal networks. Doing so requires being there. The result has been a growing agglomeration effect in Silicon Valley.

Second, as LinkedIn cofounder Reid Hoffman has persuasively argued, Silicon Valley has developed a comparative advantage in the art and science of scaling up. Once Silicon Valley surged ahead of New England and other regions in creating and growing new ventures, it found itself with a growing pool of experienced entrepreneurs and senior executives who were ready to start, join, invest in, or otherwise help other new ventures. Witness the career trajectories of the founding team at PayPal, which included Elon Musk, Hoffman, Peter Thiel, and other now-notable serial entrepreneurs. Their success has encouraged startups founded elsewhere to relocate to the area; the most famous of these is probably Facebook, which Mark Zuckerberg launched in his Harvard dorm. Lured by Silicon Valley’s ability to help the company scale up faster, he and his team moved to the Bay Area.

Third, as the market for private capital has grown and matured, new ventures can raise extremely large sums of capital without the necessity of a public listing. Witness the case of Uber, which has a market valuation exceeding $60 billion and is still a privately held company. Given its wider array of startups and an advantage in the art and science of scaling up, Silicon Valley has become a prime beneficiary of this new development in capital markets. On average, tech ventures in Silicon Valley scale up faster, thereby attracting much larger sums of expansion and later-stage funding.

The very same factors that are propelling Silicon Valley’s growing dominance within the U.S. ecosystem are also at play in other major economies. Software hubs are stealing a march over hardware- or domain-focused hubs. As a result, tech venturing and VC investments are growing faster in Beijing than in Shanghai or Shenzhen, in Bangalore than in Mumbai or Delhi, and (until the Brexit vote) in London than in Berlin or Paris.

The likely trend in global technology entrepreneurship? Even as tech venturing and venture capital take deeper root in regions outside the U.S., we should expect an increasing concentration in a small number of software-centric hubs. As of now, the likely candidates outside the U.S. appear to be Beijing, Bangalore, Tel Aviv, London, and Berlin.

Tech entrepreneurs of the world, take note. In our view, unless you are launching your venture in a domain-focused hub — such as New England for life sciences — you may want to consider relocating to one of the world’s software hotspots. By all accounts, software is likely to keep devouring the world.