Institute of Directors > Director Magazine

Director Magazine

February, 2002

SECTION: Vol. 55, No. 7; Pg. 31-34; ISSN: 00123242; CODEN: DRTRDV

B&H-ACC-NO: 107366005

DOC-REF-NO: DRT-2072-17

LENGTH: 1588 words

HEADLINE: Working on sunshine

HEADNOTE:

Known for a culture of sun, surf and software, California has outshone other US states for years. But with a recession at the gates, has the golden state lost its lustre? Tim Phillips reports

ABSTRACT:

California has been attracting business people in search of a fortune for more than 150 years. And while the US edges into a recession, Californians are accustomed to their state's economy bouncing back quickly. Its combination of entrepreneurial activity and short-term economic downturns means that setting up an office in California is less expensive for 2002. An economic slowdown should not remove the fundamental incentive to open a US office: the world's largest companies are on a company's doorstep, whether it wants to sell to them, make joint developments with them, borrow their money or steal their staff. If high-tech and biotech is concentrated in northern California, the southern half of the state is given over to two very different businesses: entertainment and aerospace.

BODY:

ITS GROSS DOMESTIC PRODUCT is larger than that of China, France, Canada and Brazil combined. If it were a nation, its economy would be only slightly smaller than that of the UK or Germany. But should we treat California, with a population of 34.5 million, as a country in its own right?

Absolutely, says James Sinclair, a Los Angeles-based Briton and president and chief technology officer of Global Network Security Services (GNSS), which provides hi-tech security products for large companies, especially in the entertainment business. "Even Hollywood's like a country in its own right," he says. "You do fine here, if they can understand a word you say."

In California, saying that the UK and the US are divided by a common language is no joke, says Bill Pugsley, the managing director of software company, Perwill.

"We may speak a similar language," says Pugsley, "but the nuances and business methods are so different as to make it easier to operate in France by comparison."

Regardless of the difficulties, California has been attracting business people in search of a fortune for more than 150 years. And while the US edges into a recession, Californians are accustomed to their state's economy bouncing back quickly. In the late 1980s, the end of the cold war and its effect on the defence and aerospace industries, as well as a succession of major earthquakes, caused what California state's department of finance admits was a "far deeper and much longer recession" than anywhere else in the US. Yet by the middle of 1990s, the state was re-emerging, leading the worldwide technology and entertainment boom.

Downs and ups

So any snapshot of California's economy shows a mass of conflicting signals. New business incorporations for the first nine months of 2001 were down around eight per cent from the past year. Unemployment, at 5.4 per cent, is significantly higher than the national average. House prices in Santa Clara the heart of Silicon Valley dropped by the six per cent in one month this summer. Yet "The Valley" is still where two out of every five dollars of venture capital funding in the US is spent. The internet may not be as hot as it was, but California is the heart of the mobile telecoms industry (the area around San Diego is now known as "Telecom Valley"). It is also the home of 2,500 biotechnology companies, employing 212,700 employees a boom industry that already employs more workers than either aerospace (150,000 employees) or food processing (183,000 employees).

This combination of entrepreneurial activity and short-term economic downturns means that setting up an office in California is less expensive for 2002, says Sinclair.

"We do business with the Fortune 500 companies, and it works out much cheaper to have an office out here if you want to do that," he says. "Look at units that were on the market for between $11,000 and $13,000 per month six months ago - and the realtors wouldn't budge on the price - whereas now they will do you a deal for between $4,000 and $5,000. There's also a plethora of software engineers out here - in the market's current state, skilled people are relatively cheap." An economic slowdown shouldn't remove the fundamental incentive to open a US office: the world's largest companies are on your doorstep, whether you want to sell to them, make joint developments with them, borrow their money or steal their staff.

Star dusters

California's Office of Economic Research (OER) estimates that computer hardware shipments from the state are worth $33bn a year - almost one third of the US total - and 25 per cent of the US's hardware employees are based in the state. Although many are employed by large companies such as Apple, Sun Microsystems, Cisco or HewlettPackard, the OER states that "most manufacturers are the less well known firms employing fewer than 20 workers."

This clustering of technology firms came about because US venture capital firms were investing only in businesses that were local to their own offices and those offices were in Silicon Valley. The high-tech industry's culture of partnership also meant that it was easier to do business with an office in San Jose than one in Staines. That same effect accounts for the high-tech cluster of software businesses in California, also worth $33bn. In 1998, the OER's latest available year for statistics, the county of Santa Clara had a $10)bn software development business with an annual payroll of $l2bn, and San Jose was the city with the highest average salary in the US. Five of the top 10 software companies in the world are based within a few miles of each other, the largest being Oracle Corp, in Redwood Shores.

Bio-boost

While computer hardware and software businesses have felt the effect of the spending slowdown, the nascent biotechnology business has been one of the few to receive a boost of venture capital spending. "Despite the current worldwide economic uncertainty, one sector that has remained incredibly strong is biotechnology. If anything, we've seen biotech companies pick up momentum during this past year" says Jeffrey Gersick, managing director of CTTCA (Europe, Middle East and Africa). The companies in the area have a combined revenue of $20bn, which is hardly surprising: biotech was invented in the University of California, where the first research was carried out in 1973. Today, 80,000 people work in biotech in the Bay area alone.

If high-tech and biotech is concentrated in northern California, the southern half of the state is given over to two very different businesses: entertainment and aerospace. Boeing has 12 manufacturing sites in California, while Northrop Grumman Lockheed and Hughes Electronics are headquartered in the state. The emerging recession has affected the aerospace industry. For these firms, the current economic climate is reminiscent of the recession of the early 1990s when military spending declined sharply. For suppliers, the economic slowdown is even more painful, as manufacturers' cutbacks mean fewer suppliers and lower margins.

Southern discomfort

Hollywood is also finding tougher competition, with foreign film studios eager to use their cheaper wage structures to grasp business. The proximity of Silicon Valley has also created a new hybrid business of technology and entertainment in multimedia - be it computer animation, cable television or internet production.

Another potential pitfall for businesses wanting to establish an office in California is the State's labyrinthine tax system, which allows the state to tax your office based on your company's entire worldwide income, no matter how small the local office is. "There's federal income tax and also income tax at the state level," says Scott Grugle, a senior manager on the US tax desk at Ernst & Young. "Then there are other taxes based on your gross receipts, which aren't large but impose a large overhead in time preparing the documents," he continues. He advises six months of tax planning before opening an office if you are going to avoid the disadvantages.

Costly karma

And while earthquakes are a constant threat, so too are "brownouts". California cannot produce all the electricity it needs. For a state which can't function without power, this is worse than embarrassing - it can be catastrophic for businesses if the current conservation measures in place are insufficient.

And although wages may have fallen in the technology industries, employing them isn't necessarily easy. "The high-tech boom has created a here-today, gone-tomorrow attitude to employment", says an executive with British firm of consultants who runs her company's San Francisco office. Previously managing director of a UK marketing company, she moved out to California in 2000 to set up its US outpost. She explains, "Employment laws are totally different - you can pretty much hire and fire at will, and employees can leave without any notice. You have to work even harder at keeping them happy."

At GNSS, Sinclair has discovered that the downturn in the job market has eased the stress of retaining staff. On the other hand, he warns Brits not to judge by appearances: it's the job that someone does, not their accent or look, that matters.

"Moving out here isn't hard. But your Rolodex is the most important thing you can possess. Business works on phone calls and referrals from mutual friends. Most of the entertainment district wears beachwear. If you go to a restaurant here and see someone in a suit talking to someone in beachwear, then the guy in the suit is no doubt pitching for the other guy's business. In the UK, the guy in the beachwear is his son."

GRAPHIC: IMAGE TABLE, FACTS & FIGURES; IMAGE PHOTOGRAPH; IMAGE PHOTOGRAPH, The right signs: despite recessionary trends, California is still proving popular for venture capital funding; IMAGE PHOTOGRAPH, Roll out the barrels: the state's wine industry is still in its infancy in international terms, but exports to the UK are rising

SIDEBAR:

NAPA VALLEY

GRAPE EXPECTATIONS Californians are rarely accused of not marketing their products well enough. The state that gave fast food and movies to the world has one growth industry that surprisingly remains largely undiscovered: wine.

Nine out of 10 bottles of wine produced in the US comes from the state's 850 wineries, many of which are Although small compared to the technology sector, according to the US department of commerce, California's wine exports were worth $560m in 2000. A combination of an ideal climate, a ready supply of manual labour, and the public taste for "New World" wine should ensure that California's wine business has a rosy future.

If some of the winemakers like Mondavi, Gallo and Beringer are well-known globally - several publiclyowned - many more are still small-scale family operations that operate primarily in the domestic market.

"California has had more growth in its imports in the last year than any other country. Whereas in the UK we're drinking five per cent more wine, the amount of Californian wine we are drinking has grown by 27 per cent," says John McLaren, the UK representative of the California Wine Institute. Of those 850 wineries, only 300 of them are represented at all in the UK.

We're now beginning to see a few British wine importers specialising in California wines, McLaren says, and while the wineries of France, Spain Italy or Australia are much better known, California's small estates are still literally in undiscovered country. But McLaren doesn't think they will stay that way.

"The wine trade is becoming more efficient, and its marketing will improve and in a business that is notoriously poor at innovating the way it markets itself, Californians are better than most," he says.

LOAD-DATE: February 26, 2002