A Conversation on Innovation

Here is something which we hear repeated often -

It costs 50-60M to fund a fabless semiconductor startup which means that there are very few opportunities to fund a semi startup.

I am sure the numbers have  some element of truth to them.  I asked the following question internally of my team -

Let’s say all the IP blocks were ready to go, and high quality verification IP were available for all interfaces, how much would it cost to build a fully-verified design for a chip with moderate complexity – ARM core, multiport DDR controller, PCIe controller, and mutiple channels of flash controller?

The estimate was in low single digit engineer-years.  Say, with a fully loaded cost of 250K/yr, that is less than a million dollars!  Here are some other costs -

• Development of differentiating IP
• IP acquisition cost, backend services (1-3M)
• Mask cost (say 500K for 90nm, < 1M for 65)

If you add up all the costs, you can get a chip delivered with say core IP development cost plus another 3-4M.

Now, where does the $50M number come from? I am assuming this number represents a VC’s expectation on amount of investment that would need to be made to take a product from initial design through volume production. There are a lot of costs which a startup would need to incur which are not listed above -

• Overhead – finance, management, sales, etc
• Course correction – it is very seldom that the original plan does not need to be adjusted to respond to a market condition.
• Reference design – this often carries a huge software development investment and can be a  big expense if marketing needs a working prototype for tradeshows and customer engagements. You can often lose an entire generation of a chip while the reference design is being built.
• Pace of market development – As Paul Mclellan posted recently, startups are often too early to the market, not too late. Semis can be perishable commodity. Process shrink, change in interfaces, etc  could mean that a chip that does not ship in volume right away might not ship at all before the next generation is delivered. That means all the mask cost, NRE, bringup cost, is all wasted.

I believe an investment model can and should emerge which addresses some of these anomalies -

• Need to make sure that a larger portion of investment and management focus goes into the “core”.  Some sort of investment sharing along the lines of what Paul Slaby calls semi-fabless semiconductor model could be an interesting answer.
• “Staged” investment where the component with longer shelf life (i.e., differentiating IP)  is invested with different financial risk-reward profile than the silicon itself. Former would mitigate technology risk, latter needs to be all about managing market risk. Most investments in fabless semis don’t work that way today.
• Just like we all accept 50 million dollar silicon cost as the final truth, here’s another: software development costs are skyrocketing.  In order to make the sale, semis are expected to provide reference designs which include full software implementations.  Semiconductor business success is all about shipping in volume because of the high NRE. The top-100 OEMs consume 70% of all semiconductors.  A lot of these OEMs don’t even use the software from the semis but develop their own software as their differentiators. So, all that initial software investment by the semis is a) often  impossible to monetize, and b) doesn’t even get used beyond tradeshows and sales demos. Needless to say, in a financially constrained environment, something needs to change.

I believe if we get creative about the current fabless investment model, not every semiconductor oppourtunity needs to be a billion dollar opportunity before it can attract meaningful investment.

In my opinion, the central innovation which lead to this big growth engine in Silicon Valley was economic — the unique access to capital. For someone like me who started his life in a different part of the world, the notion that you could walk to your neighborhood bank and get access to millions of dollars with no collateral is crazy. Often, all that you had was a good idea.

And, for the last thirty years, the smart people at Kleiner and others were able to create an asset class which provided sustainable capital for further technological innovation. Of course, it was sustainable because the investment model provided returns commensurate with the risks it took in providing capital with no collateral and mostly in exchange for equity stakes.

In other places where free markets are essentially operating but the capital is available only to a few, oligapolies result which has a consequence that fewer people participated in the upside of wealth creation and the innovation engine didn’t have the same effectiveness because  engineers were not spending time thinking of ways to create the next Google.

In my simplistic view of the world, this is how venture investment works -

• Identify a discontiuity to invest in.
• Exit is a “home run” if the investment leads to creation of a core platform in the new market.
• Equally importantly, there are exit opportunities through acquisitions. Acquirer is often the creator of the platform which looks to augment growth through acquisition. Capital is relatively cheap in the hyper-growth phase.

Here is something I had written in the summer talking in a bit more detail how investment needs to take the platform into account.

In the current climate, venture money has more or less moved on from electronics to the next discontinuity. Today it is alternative energy. To a smaller scale, in the EDA industry, reasonable investment had gone into ESL in the hopes that it would provide the next discontinuity.

• from a macro-level, can we afford to wait in the silicon valley to wait for the new discontinuities to become large enough to provide next level of job growth?
• what about electronics and all the people who are finding themselves unemployed in the midst of the careers?

My core belief is that a new investment model is needed to provide the fuel for innovation in the post hyper-growth phase. Of course, you can’t force a context of innovation, perhaps unless it is done with government money and it doesn’t need to be self-sustainable.  Is there is a need for further innovation in electronics which can then lead to job creation in Silicon Valley?

At least from my perspective, it is unclear if we have a blueprint for recovery from the current crisis in the silicon valley. For the most part, the crisis I am referring to is the high unemployment in the experienced technology work force.

My experience goes back to arriving in the valley in 1991 in the midst of a deep recession. At least from a job perspective and for most of my acquaintances, the employment market has never been bad. Even when the bubble burst, the biggest impact was that a few startups disappeared, but then people landed jobs in larger companies, and life moved on.

Times are different. I never thought I would hear so many stories of sheer desperation from technologists in the midst of their careers when they have been looking for jobs for 6 to 12 months and there is absolutely nothing.

What happens next? Since the recession might be technically over, are we to just wait for a few more months for the next cycle to begin when jobs will come roaring back and we will be back to the days when recruiters would be offered a new car for placing a new employee?

We all hear that innovation would once again be the key to recovery. In the limited world of the electronics food chain, is it possible that the innovation we are seeking calls for us to re-visit the economics of  innovation itself rather than to discover the next big idea? I am hoping to explore that with friends and colleagues to which this place and this industry has given so much.

Large companies tend to create net negative jobs in aggregates, so the job creation engine has to come from small businesses. It would be great to see some specific data on where the job recovery has come from in the past recoveries in the silicon valley, but I am going to assume that  most jobs are created in yrs 1 though 5 through investment money and then  years 6 through 10 by those outlier companies which become the next Google and become a big job creation engine. Yrs 10 onwards, maybe a company’s contribution becomes net negative as it acquires other companies and sheds jobs to realize cost synergies. Again, all this really needs to be tested against real data.

In the context of job creation, here is my simplistic view of the world -

• Keep the innovation engine going to create jobs in the early phases
• Look to the big outlier successes in the middle phase
• Job creation by mature company would mostly be a discussion about the lightning rod topics of tax policies, impact of offshoring, etc

… more on these topics in the next blog …