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The Triumph of Silicon Alley
No one predicted it; few perceived it: but in just four years, the New Media industry has emerged as New York’s most powerful job engine.
Summer 2000

From modest beginnings only five or six years ago, when observers viewed Silicon Alley companies as a relatively insignificant and perhaps ephemeral sideshow in the New York economy, the New Media industry has now clearly emerged as one of the city's most important engines of growth. Between 1995 and the end of last year, employment in the industry shot up over 500 percent, from some 27,000 to about 138,000 people, according to a recent PricewaterhouseCoopers survey. That means that the New Media industry is now a bigger New York employer than the construction, legal-services, banking, and apparel businesses, among other important city industries. It is Silicon Alley, not Wall Street, the study demonstrates, that has driven Gotham's private sector hiring in the last two years.

The new industry's growth has sparked big changes in other parts of the city's economy. In the last two years, job gains among Internet companies have helped to reshape whole neighborhoods, as Silicon Alley companies have snapped up cheap office space in areas that other New York businesses traditionally ignored. And well-funded Internet companies have prompted the city's law firms, accountants, even restaurants and caterers, to alter the way they do business in order to win new high-tech clients.

Silicon Alley Job Growth.

It's understandable that experts were slow to perceive the magnitude of the upheaval taking place under their feet. Government data make it hard to measure Internet company growth, and the industry's volatility, with highly visible company failures, gives an impression of impermanence. But it is now certain that the online revolution is here to stay, even if the specifics are still being worked out. As a key part of that revolution, businesses have increasingly been using the Internet as a way to operate more efficiently and to reach customers more effectively. New York, long one of the world's centers of business-to-business expertise, has used this traditional strength to claim a prominent place in the Internet world.

Where the New Media industry goes from here is crucial to the city's future. If the city is to keep growing, it can only do so with a powerful contribution from digital businesses—meaning that policy makers need to think hard, and fast, about encouraging a climate in which this new industry can continue to prosper.

Few would have predicted such dynamism during Silicon Alley's earliest days. Back in 1995, when just over a third of American households owned personal computers and only 13 percent of those households used the Internet or online services, a new industry sprang up to supply PC owners with computer games and interactive learning programs on CD-ROMs. New York's first New Media companies set up shop here to draw on the city's rich pool of artists, writers, graphic designers, and storytellers to produce those CD-ROMs.

The City's New Job Engine.

Typical were Chelsea-based Music Pen, which produced award-winning entertainment and educational CD-ROMs in partnership with Microsoft and Scholastic, and Voyager, based in SoHo, which pumped out CD-ROMs with titles like Multimedia Beethoven and Poetry in Motion. By 1994, Voyager was a $12 million company employing more than 100 people. Typical too was Wanderlust Interactive, which created interactive games for kids. Founder Catherine Winchester, seeing that content was becoming the key to her industry, sold her Hong Kong-based software company to move to talent-rich New York in 1994. With her industry experience, then rare, she quickly attracted venture capital and in March 1996 went public in one of the city's first digital offerings, raising $6.2 million.

The city's publishing companies, owners of plenty of content to offer computer users, rushed into this market too, boosting the new industry further. Random House, Simon & Schuster, Time Warner, and HarperCollins all began interactive divisions that churned out electronic versions of popular books and CD-ROMs based on other media properties, like Star Trek: The Next Generation Interactive Technical Manual.

But the CD-ROM era was fleeting. By the end of 1996, technical leaps allowed computers to send and receive ever-greater amounts of data over ordinary phone lines. Soon, PC users found much to fascinate them on the Internet, and their interest in buying CD-ROMs quickly waned. Wanderlust's first major product bombed during the Christmas season of 1996, and the company eventually filed for bankruptcy. Voyager had to start cutting workers in the spring of 1997, and it too eventually disappeared. The city's biggest publishers all exited the business or dramatically scaled back their commitments.

A few pioneers also boldly staked out the Internet during that period. Jim Butterworth, a Lehman Brothers investment banker, raised $4 million to start Netcast Communications, which aimed to broadcast radio programs over the Internet. In 1996, David Rose, a scion of one of the city's real-estate families, raised more than $4 million in venture capital to found AirMedia, which planned to use a new technology to deliver information to personal computers from the Internet. Both these early Internet players folded without ever producing significant revenues.

Despite these failures, the industry kept growing in New York, because even as the focus shifted to the Internet, one thing remained the same: content was crucial—and the city had shown, back with the CD-ROM makers, that it could provide it. Entrepreneurs rushed to design Internet services based in New York.

Candice Carpenter, who had launched the home shopping network Q2 for Barry Diller's QVC, started iVillage to cultivate an online audience of women. Hiring journalists from the New York-based fashion and health magazines, as well as producers from the New York-headquartered TV networks, the company rolled out a series of sites offering advice on beauty, diet, fitness, health, and so on. A persuasive money-raiser, Carpenter garnered $67 million through several rounds of venture-capital financing before eventually taking the company public last year.

Silicon Alley Payroll.

In 1996, Fernando Espuelas, an AT&T marketing executive who was not yet 30, founded StarMedia Network in Connecticut to create Internet services for Spanish and Portuguese speakers in Latin America and U.S. markets with large Latino populations such as New York and Florida. AT&T co-workers, says Uruguayan-born Espuelas, "thought I was out of my mind"—a frequent experience of New Media entrepreneurs back then. Espuelas and co-founder Jack Chen quickly saw the importance of Manhattan and moved the company there. "New York City has a wealth of human capital, supplying us with multinational and culturally diverse employees," Espuelas says. "Our close proximity to Wall Street enables us to tap into the pulse of the financial community." Targeting a virtually ignored niche, StarMedia garnered $80 million in venture capital from the likes of Henry Kravis and Chase Capital Partners.

Crucial to Silicon Alley's growth were investors willing to pour money into New York-area companies even as some of the earliest investments in the marketplace evaporated. In the early 1990s, venture-capital investments in local technology companies could be counted in the tens of millions of dollars. But by 1996, West Coast VCs experienced in technology investments started noticing all the activity and ideas emanating from New York, and they began placing their bets. They were used to the idea that to score big in new technology companies you had to make many investments, knowing that only a very few will succeed. Steel-nerved investors from around the nation put about $185 million into Gotham's tech companies in 1997 and another $287 million in 1998.

The sudden availability of money helped to create a class of technology entrepreneur not previously common in New York. "The entrepreneurship virus has hit New York in the last five years," says venture capitalist Brian Horey, co-founder of the New York New Media Association, Silicon Alley's trade group. "Venture capitalists used to have to teach people in New York how to be entrepreneurs, but not anymore."

The real turning point came toward the end of 1998. After a series of highly successful public offerings of West Coast Internet firms, Wall Street turned toward the Internet industry in its own backyard. In the fall of 1998, Manhattan-based EarthWeb went public in a highly touted offer that shot up more than threefold in one day. Soon after, theglobe.com followed with its own glossy offering, and the IPO gold rush was on in New York.

In 1999, 41 New York-area Internet companies (37 of them within the city) went public, raising $3.5 billion—more than all New York companies of every type had been able to raise in the IPO market in any other year except 1998. The venture capital market also exploded. New York-area Internet companies, mostly within the city limits, raised about $1.6 billion ($2.5 billion, if you count Internet-related companies) from venture capitalists in 1999, according to PricewaterhouseCoopers. In the fourth quarter alone, technology companies accounted for 70 percent of all the money invested by venture capitalists in the region. Adding in several hundred million dollars in other types of financing, including convertible bond offerings and private deals from so-called angel investors, local New Media companies raised a total north of $6 billion in 1999.

The cash has spurred an unprecedented hiring frenzy. Just consider the remarkable growth of DoubleClick, now one of the city's biggest New Media employers. In 1995, Kevin O'Connor was helping to run an Atlanta software company when he became convinced that online advertising would have a big future on the Internet. He and his partners spent eight months working on software to help organize advertising online. Then he journeyed to New York—the nation's advertising industry capital and, he believed, the future center of advertising online—and founded DoubleClick in January 1996.

At first the company went almost unnoticed. Advertising on the Internet was minuscule in 1996 and difficult to track. But as technological advances drew more people online, DoubleClick flourished. Its online network became one of the industry standards, allowing advertisers to place their ads, with only a single transaction, on more than 100 websites. DoubleClick also developed a series of smaller networks composed of sites about specific subjects—entertainment, say, or technology—for advertisers who wanted to target their message on the web.

Silicon Alley Revenues.

The strategy helped advertisers make sense out of the cacophony of the Internet, and DoubleClick rapidly attracted attention and investments. It grew from 13 employees in March 1996 to 171 at the close of 1997, when it registered for a public offering. Since the IPO, the company's growth has accelerated and has recently reached the rate of two new employees a day, a job-creation phenomenon unusual in New York for half a century. DoubleClick closed out 1999 with more than 1,300 employees and a spanking new headquarters on the West Side.

Other companies grew just as fast. Agency.com, founded in 1995, employed 220 people in September 1998, 670 a year later, and more than 1,000 by the time it went public late in 1999. StarMedia more than doubled its ranks from 400 workers when it registered to go public in the middle of 1999 to 900 workers at the beginning of this year. As these businesses have expanded rapidly, they have moved their hiring beyond technical workers into support areas, building up sales and marketing forces, accounting staffs, and other departments that provide jobs for New Yorkers without advanced computer skills. For instance, InterWorld employs about 325 people in New York, but only 120 are in software development. DoubleClick has about 280 people in software development locally, but hundreds more in support jobs. Traditional businesses have been hiring New Media workers rapidly, too. The New York Times Company now employs more than 300 people just devoted to its online efforts.

The buoyant public markets also prompted many traditional businesses to spin off their web operations, providing a window into the job growth that was occurring. Barnes & Noble established its web operation in early 1997, and by the time the company announced it was spinning it off, in March 1999, the unit employed 700 people. DLJdirect, the Manhattan-based online operation of the Donaldson Lufkin and Jenrette investment bank, employed only 140 people at the end of 1995 and 374 by the close of 1998. But last year it more than doubled its workforce to 865 people.

Despite these impressive job numbers, doubts arose about whether New York was really emerging as a New Media leader or was simply riding the wake of a national trend. In late 1998, Federal Reserve Bank of New York economists concluded that, while the industry was significantly fueling the local economy, it was premature to call the city a center of the digital age yet. The computer-services jobs category, as defined by the federal government, has a much bigger impact on Silicon Valley's economy than on New York's, the study noted. But computer services alone is a poor proxy for New Media, the economists acknowledged, because so many Internet companies are not classified as computer businesses, and further analysis might raise the city's industry ranking.

Total Investment in New York New Media.

A study by the city comptroller's office, taking a longer view, reached a different conclusion. From 1992, when the city's digital-age economy began to emerge, until mid-1999, computer-services jobs in New York increased nearly threefold, to more than 43,000—double the national growth rate. By dramatic contrast, in the previous seven years, computer-services jobs grew at a slower rate in the city than throughout the rest of the country. The numbers suggest that the formation of the New Media industry in the early 1990s helped turn New York from a laggard in the technology field into a national leader.

But as the New York Fed's economists had cautioned, computer-services employment alone doesn't tell the story. The federal government's Standard Industrial Classifications system for counting jobs by industry is obsolete and is now being replaced. The system has no way of classifying some of the newest Internet companies. Instead of being counted as technology firms, many have been grouped under more traditional industry classifications. DoubleClick, for instance, bears an SIC code as an advertising company, and all of its 1,300 jobs are counted as advertising jobs. HotJobs.com is classified as a staffing business, and Jupiter Communications as a research and consulting company. But what really ties all these businesses together is the Internet.

Classifying digital companies in these ways has given a distorted view of the city's economic revival through the late 1990s, making it look like the old, familiar scenario of increased Wall Street employment, supplemented by expansion in the consumer industries and rapid growth in business-services jobs. But nothing in the old model of the city's economy can account for the unprecedented employment growth of 1998 and 1999, when the city added more than 175,000 jobs—even though Wall Street hiring slowed. Investment firms added just 13,000 jobs in the city in two years. Even considering the vast earnings power of Wall Street—which, economists say, produces two jobs in other New York industries for every one that Wall Street itself creates—the securities industry probably accounted for only about a fifth of the city's new employment since 1998.

The March PricewaterhouseCoopers study, which tracks down jobs at Internet companies—despite the government data's inadequacies—and comes up with a total of 138,000 New Media jobs in the city, gives irrefutable proof of Silicon Alley's newfound heft. But jobs are not the only measure of the industry's growth. Last year, the Citizens Budget Commission found that New York had more registered domain names—electronic addresses on the Internet—than any other city in the country, including San Francisco and Los Angeles, indicating the large volume of Gotham's online activity. New York has also emerged as one of the foremost cities for incubating Internet businesses, as measured by the number of local businesses able to make it to the public markets. Last year, 37 New York Internet companies went public, compared with 19 New Media IPOs in the Boston/Route 128 corridor and 23 in the entire state of Texas, reputedly a hot location for technology companies. Those companies were scattered among cities like Houston, Dallas, and Austin, as well as in the suburbs.

Even comparing New York with Silicon Valley is eye-opening. In 1999, 127 Internet companies went public in California, a truly impressive number. But those companies were mostly spread across the state's suburban landscape: only 16 were in San Francisco proper, and another 13 in nearby San Jose. These numbers suggest an unusual, if not unique, position for New York in the digital revolution. In other hot areas, the growth is largely coming in the suburbs, with some spillover into nearby cities; in New York, the New Media revolution is more of an urban affair, with a spillover into the suburbs.

Why? Much of the industry's growth in New York has sprung from the desire of New Media businesses to be close to one another and to their customers, from Wall Street to Madison Avenue. Despite the virtual nature of the product these businesses produce, their way of operating has been remarkably similar to that of other service businesses such as law firms or ad agencies—lots of face-to-face meetings and intense client contacts. "If you are 45 minutes from your clients in this industry, you get the business. If you are three hours away, you don't," says William Schrader, chief executive of PSINet, the Virginia-headquartered Internet provider that has already opened one office in New York and is planning a second, bigger facility.

This dynamism is reshaping the city's commercial real-estate landscape. A study of office leasing in New York last year by the RealtyIQ real-estate research organization found that technology companies—led by Internet firms—took out leases on 3.8 million square feet of space during 1999. That made technology businesses the second-biggest renters of new office space last year, behind only financial companies. More significant, perhaps, is the trend. Other major industries in the city—including Wall Street—leased less new space in 1999 than the previous year. But technology firms more than tripled the space they took. Tech firms account for the entire gain in the city's commercial real-estate market in 1999.

The dot.com expansion has been a boon to struggling areas of the city. Since late 1995, when the city and state offered incentives to lure New Media companies to downtown Manhattan, office vacancy rates in the old financial district have declined to 8.9 percent from over 20 percent. The average price per square foot of space there has increased 40 percent, to nearly $35 a square foot. Areas like SoHo and TriBeCa, among the first neighborhoods to attract New Media firms, now boast office vacancy rates around 5 percent. Today, Internet firms are eyeing areas once considered unsuitable for offices. In 1999, for example, DoubleClick leased 150,000 square feet on West 33rd Street and 11th Avenue for its new headquarters. At the beginning of this year, Global Crossing took more than 200,000 square feet at 11th Avenue between 46th and 47th Streets for a website maintenance and hosting facility.

Many of the city's traditional service businesses—from law firms, accountants, and personnel agencies to restaurants and hotels—have expanded to serve Silicon Alley. Sometimes, the battle over the new business has been fierce. Several major San Francisco law firms experienced in technology companies—including Brobeck Phleger & Harrison, Morrison & Foerster, and Orrick Herrington & Sutcliffe—were quick to recognize Silicon Alley's potential and to open Manhattan offices. Brobeck Phleger has served as the counsel on some of the most important public offerings of local Internet companies, including DoubleClick and Multex.com. In response to the San Francisco invasion, top New York law firms such as Proskauer Rose and Kaye Scholer Fierman Hays & Handler have created their own technology practices. One result of this face-off was a ferocious salary war between New York and San Francisco firms earlier this year that drove up wages for a first-year associate in the city to $135,000 a year.

Of course, as more city businesses come to depend on revenues from the digital world, the local economy's vulnerability to a downturn in the industry grows. And as the gyrations of the Nasdaq this spring have demonstrated, the industry is extremely volatile. Some of the first-generation local Internet firms to go public are still burning cash rapidly and are nowhere near profitability. A number have seen their shares plummet, suggesting that some may be unable to go back to the market for secondary offerings. Investors have abandoned, in particular, website designers and online retailers. Some observers predict that as many as three-quarters of these companies might have to go out of business or sell out to traditional media companies.

Signs of trouble are everywhere. The founders of the globe.com have already been pushed aside for new management. Barron's recently placed EarthWeb on its list of Internet firms in danger of running out of cash, although EarthWeb disputes that notion. The board of iVillage recently hired a new chief executive amid reports of shareholder dissatisfaction with founder Candice Carpenter. E-commerce firms like iTurf and Fashionmall.com have seen their share prices plunge as their losses widen and competition grows from well-funded traditional retailers going online.

A significant stock-market downturn would slow the explosive growth of the biggest publicly held New Media companies in New York and depress hiring throughout the industry. An extended market downturn would hit two of New York's key industries hard, cutting into Wall Street's profits, while depriving digital companies of the capital they need to keep expanding. The next recession in the city may be a result of such a one-two punch.

But beyond the stock-market headlines, there's also much to suggest that the great digital revolution isn't simply going to go away and that it will remain an important shaper of the local economy.

While some of the city's New Media companies use up their financing in a race to grab market share online, many others are quietly turning profits. More than half of area New Media businesses surveyed by PricewaterhouseCoopers were in the black in 1998. More than two-thirds of that group said it took them two years or less from their founding to begin earning money. "There are more than 8,500 New Media companies in this region that are not publicly held, and they have been growing and becoming profitable," says venture capitalist Brian Horey. "Even if we have a fairly lethargic public market, the industry will do just fine."

The city's long-term prospects are also promising, because most experts believe that the business-to-business sector of New Media continues to have the greatest growth and profit potential, and New York's traditional strength and expertise in this sector have proved triumphantly transferable to the Internet world. In familiar New York fashion, companies such as InterWorld, which makes software that runs electronic retailing sites, and DoubleClick, with its ad network, prosper by helping other businesses work more effectively, as do firms like Arbinet and e-STEEL, which run electronic trading sites that businesses use to find the best prices on goods and services. InterWorld projects that the digital business-to-business market will grow fivefold in the next four years, and InterWorld president Jeremy Davis expects his own workforce to grow by 75 people, to a total of 400 jobs by year-end. "We hire a lot of programmers from the banking and financial industries, because they are used to creating mission-critical, bullet-proof software," Davis says. "This is a talent pool that is here in New York."

In addition to attracting fledgling New Media firms that see the opportunity to serve New York's many important traditional industries, Gotham has also drawn in established, well-funded technology companies from elsewhere, who have come here to be near their major Wall Street and Fortune 500 clients. The PricewaterhouseCoopers survey found that 20 percent of New York's New Media operations are units of companies founded or headquartered elsewhere but relocated here. That's up from 12 percent in 1997.

One indication of where the city's New Media economy is going is the recent decision by PSINet to open a huge web-hosting facility here that will employ 300 people. Virginia-based PSINet is a $500 million Internet provider that serves big corporate clients. Despite the wonders of the virtual world, PSINet decided that it needed several Internet facilities in the New York region to service its Wall Street and corporate customers. The company has zeroed in on Long Island City for its first facility. It expects competitors to open four or five similar centers in the region.

These and other trends bode well for the new economy's continued growth in New York. But the city faces several important challenges to keep the new jobs coming.

So far, Manhattan accounts for most of the growth, with five times as many New Media companies as the other four boroughs combined. But with Manhattan getting prohibitively pricey for start-ups, city officials should clear the way for the next generation of digital entrepreneurs to go to boroughs where commercial space is cheap and plentiful.

As a start, city hall recently offered $2.5 million to landlords in eight newly designated high-tech districts—seven outside of Manhattan and one in Harlem—to help market their buildings as homes for tech companies. But the program offers no other inducements to entice the landlords to invest up to $50 a square foot—or $25 million for a 500,000-square-foot building—to do the necessary upgrading and rewiring. City Council speaker Peter Vallone and others have reasonably suggested that, to encourage developers to make the speculative leap, the city should offer tax incentives similar to those of the 1994 downtown revival plan that helped lure New Media firms to lower Manhattan (in an ideal world these tax cuts would extend to the entire city). As part of this program, the city is also thinking of threading high-speed telecommunications cables to the outer boroughs through a disused water-main system. More ambitious, but much more problematic, is Senator Charles Schumer's plan to see if public/private partnerships could develop large-scale technology projects outside of Manhattan.

As the city looks to keep the new economy growing, it should follow through on promises it has made to change the extremely frustrating way its tax code treats many of these businesses once they become profitable. One target of the industry is the city's commercial rent tax, the only levy on rents in the nation. Under its new lease, for instance, DoubleClick must pay about $2.8 million in rent tax over the next 15 years. The Giuliani administration has eliminated the CRT everywhere in the city except Manhattan's main business districts and has committed the city to end the CRT for Manhattan companies, too, in fiscal year 2003, when Giuliani will no longer be mayor. It will be important for the next mayor to follow through on Giuliani's plan.

Similarly, the city will have to change the way it treats small, private companies that organize as unincorporated businesses or as Subchapter S corporations. A Subchapter S corporation pays its profits as dividends to its owners, and the profits are then taxed as part of the owner's personal income. Because the city doesn't recognize this form of ownership, Subchapter S corporations are effectively taxed twice in New York: their owners must pay the city's personal income tax on company profits, and the company must pay the corporate tax on profits, too. Small New Media companies just starting to register profits hate these taxes—enough to make them consider leaving town. The Giuliani administration's preliminary budget for fiscal 2001 proposed recognizing Subchapter S corporations and increasing the tax credit it offers to owners of unincorporated businesses, but it later withdrew the proposals—a mistake that needs rectifying.

The city's New Media industry has also complained long and loud that the city's primary phone company, Bell Atlantic, has been slow to bring new services and technologies to New York and is responsible for a severe shortage of the telecommunications capacity vital to digital businesses. For example, in other cities, the company began offering DSL service—which allows users to access the Internet at much faster speeds than using traditional phone service—in 1996. In New York, the service wasn't operational throughout the city until after the turn of the millennium. Public officials need to do more to open this marketplace to competition.

Alternate phone companies have tried entering the market, and they have made some headway in signing up large clients and rewiring big office buildings. But competitors have charged that Bell Atlantic, which still controls the basic telecom infrastructure in the city, has been slow to process orders to switch customers to them and has charged too high a rate for competitors to rent Bell Atlantic's existing lines. Under pressure from the FCC, Bell Atlantic cut its rental rates this spring by over 80 percent for other carriers that want to offer DSL service in New York. New Media industry leaders have been pressuring public entities—such as the often slow-moving state Public Service Commission—to take more actions like this, and a 1999 report by the New York City Comptroller's office backs them up.

When New York's current economic expansion began so tentatively in 1994, economists wondered how the city could possibly recover the more than 300,000 jobs it had lost in the devastating recession of the previous four years. No new job engine loomed on the horizon, and business leaders doubted that Wall Street alone could provide the necessary vigor. Then, virtually out of nowhere, New Media materialized, recognized only during the last year as something much bigger than an evanescent fad. With the strong boost it got from digital companies, New York has added more than 300,000 jobs in the last five years, boosting its total to 3.6 million jobs, the same level as 1988, the employment peak of the eighties (though still 200,000 jobs below the city's 1969 historical job high). After years of watching the rest of the nation boom, Gotham has suddenly emerged at the forefront of one of the hottest trends in the nation's economy. It is a startling turnabout—to be cherished and nurtured.

Research for this article was supported by the Brunie Fund for New York Journalism.

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