BUSINESSWEEK ONLINE : AUGUST 30, 1999 ISSUE
INFORMATION TECHNOLOGY

Between Silicon Valley and Silicon Alley


Just a few years back, the future looked bleak in Washington. Big Government was in decline as political power shifted to state capitals. To make matters worse, federal agencies were shedding thousands of employees, depressing both real estate values and the city's spirits.

While the rest of the country may still think of it as a snake pit of legislators, lawyers, and lobbyists, Washington is quickly morphing into a high-tech hotbed. Entrepreneurial fever is sweeping the Potomac. Hundreds of new companies are being started, particularly in the communications and Internet industries. Who cares who the latest House Whip is? Executives such as America Online (AOL) CEO Stephen M. Case are replacing politicians as the city's stars. The result is ''Silicon Swamp,'' where the big fish swim and only the swift survive. ''Silicon Valley is still the nation's technology nerve center, but Washington is next on the list,'' says Marc Andreessen, a founder of Netscape Communications Corp. who has moved to AOL as chief technology officer.

A bit of boosterism? Sure. But not by much. With 208,700 technology workers, the D.C. metro area ranks as the third-largest high-tech center in the country after Silicon Valley and Boston, according to the economic consulting firm Regional Financial Associates Inc. That's up from ninth-largest in 1985. Tech employees now outnumber government drones, a PriceWaterhouseCoopers study shows. And the rate of the industry's growth is so speedy that the Commerce Dept. estimates that Virginia's technology workforce will increase nearly 10% annually, to 135,100 in 2006. ''D.C. is the only place outside of the Bay Area where people are willing to take a risk,'' says Vinod Khosla, a partner at Silicon Valley venture firm Kleiner Perkins Caufield & Byers.

And how. Last February, startup Teligent Inc. (TGNT) in Vienna , Va., hosted a job fair to find skilled telecom staffers to launch a national wireless phone network. CEO Alex Mandl, former president of AT&T Corp. (T), expected about 100 prospects, but more than 1,000 showed up. Cars gridlocked outside, and Teligent President Buddy Pickle had to run out and direct traffic. ''It was a disaster,'' says Mandl. ''But we hired a lot of experienced people.''

FERTILE GROUND. To be sure, the boom in technology is buoying many parts of the country beyond the Beltway. Between the traditional poles of Silicon Valley and Boston, Denver is becoming the epicenter for telecom upstarts like Qwest Communications International Inc. (QWST) and Level 3 Communications Inc. Austin, Tex., Raleigh, N.C., and New York's Silicon Alley also are thriving. But the impact on Washington is perhaps the most dramatic because it has always been a government town. ''Networking in Washington used to mean cocktails in Georgetown,'' says Mark Zandi, chief economist at Regional Financial Associates. ''It now means building the Internet infrastructure for the next century.''

How did Silicon Swamp get to be such fertile ground? It all started with the federal government. MCI Communications Corp. (WCOM) first located in D.C. because it was so critical for the company to lobby regulators to break up AT&T's long-distance monopoly. Since then, telecom startups such as Teligent have followed in MCI's footsteps to wangle everything from favorable rules to airwave licenses. Similarly, many satellite companies have settled into the region because getting government authorization is such a large part of their businesses. ''Satellite companies are here for the same reason that gold mining companies are in South Africa,'' says Noah A. Samara, CEO of D.C.-based satellite radio company WorldSpace Corp.

Even more important, the Pentagon's creation of Arpanet, the precursor to the Internet, has hatched a slew of local startups that have become Net heavyweights. Rick Adams, a former federal worker who invented one of the first methods of linking computers to Arpanet, founded UUNET Technologies Inc. in his Fairfax (Va.) home in 1987. Since then, UUNET, now part of MCI WorldCom Inc., has grown into the world's biggest commercial Internet service provider. PSINet Inc. (PSIX) founder and CEO William L. Schrader moved from New York to Reston, Va., to attract engineers with Internet experience. And from its original Commerce Dept. contract for registering Internet addresses, Network Solutions Inc. (NSOL) of Herndon, Va., has matured into a $100 million E-commerce power. There was a little luck involved too: Online Goliath AOL ended up in Dulles, Va., because D.C. was founder James V. Kimsey's hometown.

SERVICE STAR. With so much government influence, the nature of the tech industry in Silicon Swamp is different from anywhere else. The Valley, built on the foundation of the chip and computer industries pioneered at Fairchild Semiconductor Corp. (FCS) and Hewlett-Packard Co. (HWP), has the broadest technology community anywhere. Boston's Route 128 specializes in software and computer services businesses fueled by brainpower from local universities, such as the Massachusetts Institute of Technology. In contrast, the D.C. area's tech scene is built on the telecom and Net businesses. Indeed, while Silicon Valley ranks first among U.S. high-tech regions based on revenues and number of companies, the D.C. area tops the list for high-tech services, such as telecom and Internet access, according to a recent report from the Milken Institute think tank.

What has made the Washington tech scene so vibrant, though, is that the second-generation startups are moving well beyond the region's traditional government roots. Former MCI execs are running new companies, including long-distance player Primus Telecommunications Group Inc. (PRTL) and Pathnet Inc., a wholesale telecom carrier. AOLers are striking out on their own: Robert J. Smith, founder of AOL's Digital Cities service, is now CEO of D.C.-based E2ENet.com Inc., which plans to build portals for industries. Even startups such as Ciena Corp. in Linthicum, Md., a maker of optical networking equipment, are producing entrepreneurs. Ciena founder David R. Huber has started Corvis Corp., a Columbia (Md.) company that will make optical routers.

What's more, executives of the region's successful companies are plowing their profits back into new startups. Mario Morino, the retired vice-chairman of software maker Legent Corp., which was acquired by Computer Associates International in 1995, helped found the Capital Investors Group last year, a $5 million venture fund whose supporters include AOL's Case and MCI WorldCom Vice-Chairman John W. Sidgmore. One of the first beneficiaries: Arlington-based Cyveillance, which scours the Web for nefarious activities that might hurt its clients (page 170).

LOYALTY. As in the Bay Area, the combination of money and skilled workers acts like a magnet to attract even more resources to the area. The Silicon Valley venture firm Draper Fisher Jurvetson just opened a Reston (Va.) office. Kleiner Perkins scouts out deals in the area regularly and invested $10 million in Corvis. Top Valley law firm Cooley Godward LLP also has set up shop in Reston, while premier tech law firm Wilson, Sonsoni, Goodrich & Rosati, headquartered in Palo Alto, Calif., is looking for office space.

Australian Phillip H.J. Merrick says he could have started his business-to-business software company, webMethods Inc., anywhere in the world but chose Fairfax, Va. The reason: He thinks the Washington area has better resources for entrepreneurs than anywhere else, including Silicon Valley, where he thinks workers are too disloyal. ''People from Washington don't go job-hopping every 18 months,'' he says.

All the action in the Swamp is attracting deep-pocketed acquirers looking for cutting-edge technology. In June, Texas Instruments Inc. (TXN) announced it would acquire Telogy Networks Inc., a Germantown (Md.) maker of Internet voice software, for $435 million. In April, Sweden's Ericsson (ERICY) spent $450 million for Torrent Networking Technologies Corp in Silver Spring, Md., which makes high-speed routers. And last year, Lucent Technologies Inc. (LU) paid a cool $1 billion for Yurie Systems Inc. in Landover, Md. Yurie makes equipment that compresses voice, video, and data to zip them speedily over networks. Yet Silicon Swamp comes up short on a few counts. Despite the influx of new money, venture-capital funding still lags. According to PriceWaterhouseCoopers' MoneyTree Survey, the D.C. area snagged only 5.6% of the $14.2 billion in venture funding invested in the U.S. last year. That puts it third behind Silicon Valley, with 32% of the investments, and New England, with 15.3%. But as financiers discover the area's potential, that gap could narrow. ''This is the best-kept secret in the country,'' says Frank A. Adams, CEO of Grotech Capital Group, a Timonium (Md.) venture-capital firm.

And the intellectual ferment in the Swamp is nowhere close to Silicon Valley's bubbling cauldron, in part because the area lacks a world-class technology research university. ''There's never going to be another Valley,'' cautions Morino. But the region's self-appointed impresario is trying. Morino founded the Potomac Knowledgeway and the Morino Institute to introduce budding entrepreneurs to established execs.

Here's the upshot of Silicon Swamp: Enterprising techies are pumping new life into Washington's once-dreary, bureaucracy-obsessed culture. The region now has a pulse and some sizzle to supplant government-issue gray. And for a change, some folks in Washington's swamplands are actually creating wealth--instead of siphoning it from hapless taxpayers.

By Catherine Yang, with Amy Borrus and Susan B. Garland, in Washington Information Technology

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