The Death of Network Innovation (1)

The North American telecom business has entered an innovation crisis that has nothing to do with the current macroeconomic meltdown.

Back in prehistory, which is to say in the decades prior to AT&T’s divestiture in 1984, investment in network technology was a clubby affair, led by a handful of national and international telecom giants: AT&T’s Bell Labs, Northern Telecom’s Bell Northern Research, British Telecom’s Martelsham laboratories, and so forth. Nearly any communications device you can point to – from a cellphone to a communications satellite – depends on innovation that started in those laboratories, Bell Labs chief among them. The Labs alone employed over 22,000 at the time of the Bell breakup.

The Labs’ famed Holmdel headquarters was sold to a real estate developer two years ago, with plans to convert it into a hotel and mall – the consequence of a rapid decline that began with divestiture, reached its apotheosis in the tech implosion of 2000, and was finally interred with the purchase of Lucent by Alcatel in 2006. The labs continue to exist as an ALU unit – but the resemblance with their former identity is in name alone. (I know that’s not the corporate line, but not one of my Bell Labs alumni friends would dispute it).

The disappearance of Bell Labs (and the concomitant decline of its counterparts) needn’t have signaled a death knell to telecommunications innovation (even though it did kill one of the primary engines for basic physics research in America). In the period leading up to and following its demise, an even more important engine for applied research was coming into being: the venture capital model for enterprise creation.

The venture-backed model for fostering new enterprise originated with innovative risk-takers like Arthur Rock (who was the first investor in Intel) and George Doriot (the first backer of Digital Equipment Corporation) in the 1960s and 1970s.

These and other wildly successful growth stories like Apple (also a Rock investment), Cisco, and Lotus Development attracted ever increasing capital to the hundreds of partnerships that sprang up to channel fresh investment dollars into startups. By 1995 annual US venture investment had reached nearly $8 billion (by way of comparison, Bell Labs’ budget in its last pre-divestiture year was about $2 billion; fifteen years later as a Lucent subsidiary funding remained flat or in decline).

And of course nothing guarantees cataclysmic failure more fully than the pandemic spread of a good idea. In 1999, the total VC cash put to work reached $54 billion; and at the height of the madness in 2000, $105 billion dollars were put to work. We all know what came next.

What I find most interesting about the bubble and subsequent implosion, however, is not the spectacular runup and cliff – it’s the resiliency of the venture model after the implosion, contrasted with the unceasing decline of investment in network technology, even following the recovery of technology investment overall.

While total venture investment dropped by nearly 75% in the three years following 2000, by 2004 it was on a growth path again, and in the next three years had come close to resuming its pre-bust expansion rate.

(I compiled the data for these charts from the MoneyTree reports published by PricewaterhouseCoopers and the National Venture Capital Association)

By contrast, investment in network technology has yet to reach bottom. There is virtually no new enterprise creation in the sector, and the drip feed of capital that continues to flow is serving mainly as life support for survivors of telecom’s nuclear winter.

There are lots of interesting sub-stories within these numbers – the rise of life sciences and more recently, green technologies, as investment targets – but that’s a story for another blog post. The critical message here is that the two engines that drove telecommunications technology innovation in the last half century have melted down, and there is no credible replacement for them on the horizon.

In the next post, I’ll look at the reasons why network tech investment has failed to recover along with the rest of the tech sector.