Silicon Valley’s New Bubble

A few years ago, Jawbone, the nearly defunct maker of wearable technology, was handing out its brightly coloured fitness tracking wristbands like lollipops to VIPs at Davos.

Today, it is selling itself off piece by piece. You could argue that the company was a victim, such as being too early into the market (it launched Bluetooth-enabled devices in the late 1990s), or realising too late that things like sleep monitoring and step tracking would be apps that live on the largest platforms run by groups such as Apple and Google, rather than standalone technologies that would warrant their own devices and ecosystems.

But you could as easily argue that this Silicon Valley unicorn, which at its peak boasted a valuation of $3.2bn and attracted money from the world’s most successful venture capitalists such as Sequoia Capital, Kleiner Perkins Caufield & Byers, Andreessen Horowitz and Khosla Ventures, was a victim of its own success.

The company burnt through so much money and reached such sky-high valuations that it became like one of its users: too rich and fat for its own good.

Last year, the company had to turn to the Kuwait Investment Authority to keep running, never a good sign given that sovereign wealth funds are not exactly the smart money in Silicon Valley. They tend to come in big but late, offering loads of cash when others will not.

A company with a lower valuation that had burnt through less cash might have made a good acquisition target, or might have done a successful initial public offering. Instead, the demise of Jawbone has become yet another sign of the bubble economy in the Valley.

It’s a bubble that is different — but the same — as the last time. In 2000, start-ups like pets.com were able to go public and jack up share prices even as they were losing hundreds of millions of dollars. The digital ecosystem has since grown, changed and deepened. Today it is harder for companies to receive funding just by sticking “.com” behind their names.

But now, as then, you do not necessarily need profits or paying customers to draw investor interest but rather “users” in a hot market niche. Compelling narratives develop around these sectors (wearables, electric cars, the “sharing” economy). Companies send market signals about their own “value” with announcements that play off these narratives, for example, Uber’s $680m purchase of self-driving truck firm Otto).

Venture capitalists and private equity investors keep the bubble going by buying into it at higher and higher valuations. The smartest ones guarantee their own success by taking rich advisory fees along the way and exiting before disaster via the secondary market for private shares. And this is, as behavioural economist Peter Atwater recently pointed out to me, unusually liquid thanks in part to central bank-enabled easy money.

The virtual money, generated by valuations that are based as much on narrative as fact, is used to salaries: it can cost upward of $2m in cash and stock options to recruit a driverless-car engineer in the Valley. These then distort the price of property, services and labour. You’ll weep when you see the prices of depressing ranch-style homes off Highway 101, which runs through Silicon Valley. The whole cycle is straight-up “madness of crowds”, as described by Charles Mackay in 1841.

“In some ways Jawbone reminds me of Palm [the former personal digital assistant maker], in the sense that there was a real market there,” says investor Tim O’Reilly, the chief executive of O’Reilly Media and author of a forthcoming book about the role of Silicon Valley in our bifurcated economy. “But in another way, it reflects the financialisation of the tech sector. Jawbone rode a wave of enthusiasm that was ultimately speculative in nature and reflective of the ‘tulip’ quality of the tech market right now.”

The problem with investing in the New New Thing is that typically only a few firms win. As the tech-phobic Warren Buffett once pointed out, 2,000 or so car companies operated around the time that Henry Ford started his assembly lines. Investing in the auto sector was correct. But investing in most of those companies was not.

These days, a glut of money eager to bolster gains in a low-return world has lifted the economy of Silicon Valley to ridiculous heights. Yet the real winners are likely to be the small number of platform groups such as Amazon, Google, Facebook and Apple that can use their network effect to capture and control the data, which have become the new oil in our digital economy.

Indeed, research by Google, in conjunction with Carnegie Mellon University, shows that it’s not so much the brilliance of an algorithm but the sheer amount of data that you pump into it that allows for everything from more accurate searches to better facial recognition to sharper cancer research.

I’d look carefully at the valuations of most technology groups, private and public, aside from the platform giants. The latter can marshal that data to dominate the hottest sectors in tech — and potentially every other industry. It’s their bubble economy. We’re just living in it.

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rana.foroohar@ft.com

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