by Manuel Stagars, CFA, CAIA, ERP

Silicon Valley is the nickname for Santa Clara Valley, the South Bay portion of the San Francisco Bay Area in Northern California. In the last years, the term has become a synonym for innovation. Research parks often dream out loud of copying Silicon Valley. Occasionally, someone makes the mistake of publicly declaring that they will take it on head to head, only to silently fade into oblivion a few short years later. Moscow’s Skolkovo innovation center is a legendary example. Billions of rubles flowed into an entrepreneurship and research hub dubbed the “Silicon Valley of Moscow” with little certainty of success.

Even the residents themselves cannot explain how the success of their valley came about. According to author Deborah Perry Piscione, one has to go back to the year 1884 when Leland Stanford thought about what a university in his son’s honor could look like. Let’s do that and look at some the three main building blocks that made Silicon Valley what it is today.

Stanford University, the “MIT of the West”

Stanford University, located in the North of the valley, has been one of its defining elements. Its founder Leland Stanford insisted that “science provide direct usefulness in life,” which put the university in a league of its own. Stanford now runs its own industrial park, which over 150 companies call home. Most other universities ignored the relevance of science at the time, and unfortunately, not all that much has changed in the meantime.

After World War I, the U.S. military granted $450 million (in 1945 dollars) to weapons R&D. Several universities on the East Coast (such as Harvard and MIT) shared this money. Yet only $50,000 found its way to Stanford University, which did not have the reputation of a credible research center at the time. Frederick Terman, then Stanford’s Chair of Engineering, felt so personally offended that he vowed to recruit away from East Coast universities the best research talent available. He thus transformed Stanford into the “MIT of the West,” as author Steve Blank puts it. When the Cold War intensified after 1950, Stanford University became a full partner with the military, the CIA, and the NSA.

Stanford researchers routinely work with industry as paid consultants. This not only ensures that the latest technological know-how finds its way into the market. It also channels insight about business and industry trends back to students and researchers. So far, the university has spawned over 6,000 companies. Some of them include Charles Schwab & Company, Cisco Systems, Dolby Laboratories, eBay, E*Trade, Electronic Arts, Gap, Google, Hewlett-Packard, IDEO, Intuit, LinkedIn, Logitech, MathWorks, Netflix, Nike, NVIDIA, Odwalla, Orbitz, Rambus, Silicon Graphics, Sun Microsystems, Tesla Motors, Varian, VMware, Yahoo!, Zillow, and Instagram. Together they amount to hundreds of billions of dollars of market capitalization.

U.S. Military Funding Started a Chain Reaction

Most people believe the United States is leading the technology sector because of fiercely independent entrepreneurial minds. In reality, the government created all these sectors with a heavy hand which had a heavy influence on the destiny of Silicon Valley. By transforming hundreds of acres of farmland into a hub of cutting edge military technology, the U.S. Navy built Moffet federal airfield at the southern tip of San Francisco Bay in the 1930s. Large-scale subsidies by the military enabled the thriving electronics and semiconductor industry. Internet emerged out of a military research project. Heavy military funding started a chain reaction that led to the Silicon Valley we know today.

The electronics industry transformed the valley into a hotbed of innovation with Hewlett-Packard (HP) and Varian as its biggest success stories. They went public in 1956 and 1957 as the first Silicon Valley companies in history. Shockley Labs, set up in the heart of the valley, was the first company working on silicon semiconductor devices and gave the region the nickname Silicon Valley. Its eight leading scientists later left Shockley together to create a joint venture with Fairchild Semiconductor, which revolutionized the chip manufacturing industry. Many of the original founders of Fairchild Semiconductor set out to start their own companies in Silicon Valley. Robert Noyce and Gordon Moore started Intel. Jerry Sanders and John Carey started Advanced Micro Devices (AMD). These new companies had an inclusive culture with flat hierarchies, and in many ways created a new generation of companies.

The Growth and Profitability of Venture Capital

Wealthy investors started getting interested in Silicon Valley after the successful IPOs in the electronics and semiconductor industry. The passage of the Small Business Investment Act in 1958 enabled the large-scale financing of small entrepreneurial businesses in America. Another milestone was the establishment of the limited partnership as a business structure in the 1970s. This provided an opportunity for general partners of venture capital funds to legally charge a 1-2.5% management fee of the investment capital raised. In addition, they charged a 20% fee on all profits of the fund. This is the venture capital model still in existence today.

It becomes apparent that the birth of Silicon Valley was not an overnight affair. In fact, it took over one hundred years to transform an area of farmland into the epicenter of innovation as we know it today. Not only was large-scale military funding and government protectionism a big part of it, much luck and serendipity played into the success story as well. When a government announces that they will build “the Silicon Valley of XYZ,” then we must assume that they turn a blind eye on history. Many puzzle pieces needed to be in place over decades to make it happen. None of them can work out of context in a different environment to quickly force the same ecosystem into existence. If you have ever been in Mountain View, you notice there is a certain energy in the air. A few millions even billions cannot buy this energy. It cannot be summoned by willpower. No government can legislate this energy into existence. And no university can just say it would like to have this energy and then it magically appears.

Better forget about comparing universities or research parks with Silicon Valley. By aiming at the sun you may end up on the moon, this is true. But for startup entrepreneurship there are other proven ways to make it work. Simple, practical steps that led to success in hundreds of startups. Some of them are outlined in this book. Start applying them one by one, without trying to reinvent the wheel. Then your university and your startups will succeed.