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City Journal Autumn 2006.
Autumn 2006
Table of Contents
New Book From Steven Malanga:
Shakedown: The Continuing Conspiracy Against the American Taxpayer.
The Immigration Solution:
A Better Plan Than Today's

by Steven Malanga, Heather Mac Donald, Victor Davis Hanson
The Immigration Solution.
The New New Left: How American Politics Works Today
by Steven Malanga
The New New Left.
 
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Silicon Alley 2.0
Steven Malanga

Gotham’s digital economy didn’t die after 9/11, and now it’s roaring back.

When the Twin Towers fell, New York’s digital economy, dubbed Silicon Alley, was a major economic casualty. True, the collapse of technology stocks the year before had already deflated Gotham’s tech industries. But the 9/11 attack severely damaged Silicon Alley’s geographic heart, lower Manhattan, transformed over the previous decade into a bustling high-tech district. After 9/11, hundreds of New York tech firms closed up shop; others survived by shrinking dramatically or selling themselves for only a small fraction of their sky-high valuations of the late 1990s. As many as half of New York’s new media jobs vanished.

Nevertheless, Silicon Alley survived: and now—unexpectedly, even improbably—it is reemerging as an economic force in New York. Many of the hundreds of entrepreneurs and thousands of tech-savvy workers who flooded the city during the 1990s stuck around after 9/11, it turns out, and as Internet use becomes almost universal, these industry veterans are back with waves of new start-ups, catering to Internet surfers’ demand for more online tools and interactivity or helping New York’s mainstream industries do business better in the digital age. Their talent has grabbed the attention of industry leaders, who have made New York a key part of their worldwide networks.

“Ten years ago, you could have fit all of the entrepreneurs in New York in a taxicab,” notes Kevin Ryan, cofounder of DoubleClick, one of the city’s first successful Internet firms. “Today New York teems with entrepreneurs. Maybe we’re not as deep as Silicon Valley, but we’re probably ahead of most other places, and that’s the city’s strength.”

As a center of big, Establishment corporations, New York seemed an unlikely player in the tech boom that began in the early 1990s. But as demand exploded for computer software content, a few visionary entrepreneurs came to the city and enlisted its vibrant community of artists, designers, and writers to create that content.

These New Media entrepreneurs launched companies like Voyager, which in 1994 started turning out educational and entertainment CD-ROMs, eventually employing 100 people in its SoHo headquarters. When computer users headed online, New York entrepreneurs followed them. Cable exec Candice Carpenter, for instance, started an Internet site for women, iVillage, staffed with talent from the city’s publishing world. New York’s mainstream media firms revved up their own digital divisions; by 1999, the New York Times employed 300 in its online department. And as big media digitized, more New Media firms sprang up to help, including DoubleClick, whose innovative software organized Web advertising. Excited investors poured billions into these start-ups, and Silicon Alley hiring soared, reaching around 140,000 people by 2000, PricewaterhouseCoopers estimated.

A gold-rush frenzy ensued, fueling unwise deals, such as the $10 million that venture funds sank into Manhattan game firm Interactive Imaginations, started by a 24-year-old whose previous entrepreneurial experience was running a dog-food delivery service. The company quickly burned through its cash without producing a viable business. After the tech bubble burst in 2000, financing for such speculative ventures evaporated, leaving Silicon Alley reeling even before the terrorists struck.

Even so, many tech entrepreneurs who came to the city during the nineties didn’t just pack up and go when the good times ended. They fought to save their companies, downsizing and refocusing them more successfully than many have realized. New York’s 15 largest independent Internet firms before the crash, DoubleClick and iVillage among them, all survived the downturn, though shrunk or merged.

Gotham’s big media firms also kept Silicon Alley alive. They ratcheted down their Internet ambitions after 9/11, of course; the New York Times, for instance, canceled a public offering of its New Media division. But as they watched the Internet become ever more popular, drawing away readers and ads, they invested in or acquired some of the city’s top New Media firms. In two noteworthy post-9/11 deals, NBC bought iVillage—by 2005, it had expanded into an online community of some 19 million (mostly female) users—for $600 million, while the Times shelled out $410 million for the Manhattan-based search engine About.com.

Thanks in part to such investments, Silicon Alley stopped hemorrhaging employment by late 2004. Though it is hard to get an accurate figure of New Media jobs, since government surveys place some workers in more traditional employment categories, City Journal estimates that the industry shrank in New York by 30 to 50 percent during the post-9/11 recession, leaving a still-substantial 80,000 to 100,000 digital jobs, generating up to $8 billion in annual salaries.

As Silicon Alley struggled, a remarkable new Web world arose, attracting millions of users and revolutionizing the way Americans entertain themselves, shop, and do business. In the five years since 9/11, Internet usage in the U.S. has doubled, with many of the newest users flocking to so-called Web 2.0 sites: those that welcome user participation or interaction, or that enable people from around the country—indeed, around the world—to find and join networks of those with similar interests.

No enterprise better captures the participatory Web 2.0 spirit than the raucous teen- and young-adult-oriented online meeting place MySpace.com, which Wired magazine vividly describes as the “biggest [online] mall-cum-nightclub-cum-7-Eleven parking lot ever created.” Users provide MySpace’s content, fashioning their own personal online portraits, filled with selections of favorite music and intimate photos, and often including blogs that chronicle their relationships, struggles in school, parent problems, and so on. Virtually unknown to the over-40 set, the Los Angeles–based firm has expanded with blinding speed since its 2003 launch, attracting some 20 million users a day, including many young artists and musicians who’ve used the site to distribute their work directly to fans—without corporate intermediaries. A vocalist in the Hollywood Undead band, which has no recording contract, exulted to the New York Times last year about the group’s MySpace page: “We have 60,000 people who listen to it every day.”

Those kind of eye-popping reports prompted Rupert Murdoch’s New York–headquartered News Corp to plunk down $580 million last year to buy the site, seeing it as a herald of the Web’s democratized future—and a way to promote the corporation’s television shows, movies, newspapers, and other content to tens of millions of young people. Wall Street predicts that the site may be worth $15 billion in three years—not an unreasonable estimate, considering that Google just bought the video-sharing site YouTube for $1.65 billion.

Such monster deals have set off a race to create profitable Web 2.0 businesses—a knotty challenge, given the user-driven nature of this new cyberworld. Gotham’s sizable cadre of experienced, tech-smart businessmen and workers give New York a powerful advantage in this race. Web 2.0 companies don’t need to be in the city, of course; technologically, they could be anywhere. But a key lesson of the nineties is that Web entrepreneurs like being around others in their industry, and they’ve tended to cluster—or “agglomerate,” in economist-speak—in a few metro regions. New York benefited from such an agglomeration in the nineties. Now, the digital community that remained in Gotham is clustering again into a Silicon Alley 2.0, with veterans of some of the nineties’ most visible firms introducing an array of second-generation New Media enterprises.

For example, several former senior executives of Sixdegrees.com—founded in 1997 as one of the first firms to tap the Web’s power to connect people, and sold three years later for $125 million—have recently launched start-ups in New York. One of the most promising is Fotolog—the MySpace of photo buffs. Debuted in 2002 by Adam Seifer, formerly Sixdegrees.com’s chief operating officer, Fotolog initially consisted of families and friends sharing photos online. But the spread of cell-phone cameras changed it into a visual group blog, so to speak, with people taking snapshots of their daily lives and uploading them, creating a giant online photo journal. By September 2006, Fotolog—taking advantage of technological advances that marry wireless phones to the Web—boasted around 4.6 million registered users, posting nearly 200,000 photos daily to their personal webpages on the site or to hundreds of searchable Fotolog-hosted groups such as Coolcars and Tattooland.

Lately, Seifer’s firm, which generates revenue by selling online ads and charging members for service enhancements, has hired away top-level talent from Liz Claiborne and Time Warner to bolster the site, which BusinessWeek named one of the “best of the web.” Says Seifer: “People ask us all the time why we didn’t move to Silicon Valley when this business took off, and I say, because in New York you are not just dealing with technogeeks; you can tap into an experienced community of executives.”

One such executive, Sixdegrees.com cofounder and former investment banker Andrew Wein- reich, has founded Istandfor.com, a Manhattan company that extends the Web 2.0 emphasis on social networking to politics. Clients such as Newark mayor Cory Booker and New York attorney general and gubernatorial candidate Eliot Spitzer have already hired the firm, which manages blogs for would-be officeholders, enlists online endorsements for them, and organizes supporters into online communities (Artists for Spitzer, for instance). “The common thread in these businesses is that they use technology to bring people together,” says Weinreich.

Two more New York New Media veterans, former DoubleClick CEO Kevin Ryan and the company’s ex–chief technology officer Dwight Merriman, have launched an innovative business that capitalizes on a key Web 2.0 feature: user contributions in the style of Wikipedia, the online encyclopedia written and edited entirely by readers. Ryan and Merriman’s ShopWiki offers online buying guides for everything from women’s clothing to electronic games, all written and updated by consumers themselves. It also features an advanced search engine that “crawls” around the Web gathering product information from more than 120,000 online stores, rather than relying on the stores to send the info, as with most online shopping services. The new firm is one of nearly a dozen that DoubleClick vets have started.

Old Silicon Alley hands have also helped transform blogging into a potentially lucrative e-publishing business. As everyone knows, blogs began in the 1990s as simple online journals, but lately have evolved into elaborate forums of commentary and debate on politics and culture, engaging millions of participants and readers, in true Web 2.0 fashion. While attending a New York Knicks game in Madison Square Garden in early 2003, Jason McCabe Calacanis, who covered the 1990s dot.com industry as founder of the Silicon Alley Reporter, and Brian Alvey, Web designer for TV Guide and other publications, decided to come up with a way to capitalize on this extraordinary Web traffic. Their idea: sign up some of the Web’s top bloggers, many of whom made little or no money from their citizen journalism, and aggregate their writing into a powerful network that could sell advertising.

Weblogs, Inc., as the duo named their start-up, eventually enrolled about 90 bloggers, with Peter Rojas, whose hugely popular Engadget blog surveys new technology, heading the list. Weblogs, Inc. provided the bloggers with the technology and ad support needed to convert their passion, and readers’ attention, into steady income. With costs negligible—after all, e-publishing requires no printing presses, paper, or expensive distribution systems—Weblogs, Inc. rocketed to profitability in just 12 months. In late 2005, the partners sold the firm to AOL for $25 million, joining the Internet giant as executive experts on the Web 2.0 world.

Another New York journalist, Nick Denton, founded a similarly successful federation of blogs, Gawker Media. The company targets upscale Internet users with sites like Gawker, which dishes dirt on New York’s celebrity and media culture; Wonkette, which chronicles the intersection of politics and fame in Washington, D.C.; and Defamer, a Hollywood celebrity blog. By early 2006, the company’s blogs boasted a whopping 2 million page views a day and about $2 million annually in advertising sales. The success of Weblogs, Inc. and Gawker Media has encouraged a growing number of high-profile bloggers, including lefty pundit Arianna Huffington, whose West Coast–based Huffington Post has become a liberal must-read, to set up New York ad operations to cash in on their heavy Web traffic. After all, part of Weblogs’ and Gawker’s secret is their New York location, close to the nation’s leading ad agencies and some of its big advertisers.

A slightly different species of Silicon Alley firm has sprung up to take advantage of the lightning growth of Internet advertising. Among the sharpest is Right Media, launched by Michael Walrath, one more former DoubleClick executive. With advertisers now funneling $15 billion a year into Internet advertising, Right Media’s online market, enabling buyers and sellers of Web ads to do business with maximum efficiency, fills an urgent need. With its market already attracting around 11,000 participants, the company—financed by more than $50 million, including a big chunk from Yahoo—has grown to employ nearly 100 people in New York.

A second thriving enabler of online ads is Manhattan-based Massive Inc., whose founder, Mitch Davis, began pondering in 2002 how to capitalize on the skyrocketing popularity of online video games, especially the so-called massive multiplayer games, in which thousands of online participants interact with one another, forming armies to storm cyberspace castles, for example. With millions playing these online games, Massive’s sophisticated software, inserting ads into the games’ ever-changing environments, is a marketer’s godsend. In online video racing, for instance, animated billboards hawk products as virtual cars zoom around the virtual tracks.

Impressed by Massive’s software—and by the big-league advertisers like Coca-Cola and Intel who’ve paid massively to use it—Microsoft plunked down a reported $400 million last year to buy the company, which will stay in New York. “Traditional advertisers are under ever more pressure to put more of their money into online advertising, and anyone that can help them figure out how to do that is a good investment these days,” says James Robinson IV, founder of RRE Ventures, a venture capital firm that invested in Massive.

Silicon Alley has prospered by helping other New York companies get up to twenty-first-century speed. GPShopper, for example, founded by Alex Muller, an engineer who worked in Israel’s technology industry, takes advantage of the city’s abundance of retailers. Using the latest search-engine technology, Muller’s service lets consumers scan nearby stores for products—and have that information zipped right to their cell phones. The service represents one way that brick-and-mortar retailers can compete with online buying. “We are essentially a technology-based marketing company that helps drive consumers into stores, and New York is the center of the marketing world,” says Muller. “New York is where many of the people we want to partner with are headquartered.”

As in the nineties, Wall Street offers tech entrepreneurs a world of opportunity. YellowJacket Software, for example, a California firm, developed an online system allowing traders to analyze transactions in the highly specialized but rapidly growing field of weather derivatives. These financial instruments allow companies to hedge against weather-related losses: a utility firm, say, can buy a contract that will pay them if they lose revenues because of a warm winter. YellowJacket has moved to Manhattan to be closer to the city’s financial world as it tries to strike it rich in what is now a $12 billion slice of the derivatives market.

Moving to Manhattan to take advantage not so much of its special market opportunities as of its tech talent pool are two Internet colossi, Google and Yahoo. Google recently moved from five floors in a Broadway tower to 300,000 square feet on Eighth Avenue, where it can accommodate up to 1,000 employees. Its New York outpost opened in 2000 with an ad office but expanded three years ago to house R & D teams. Gotham is now the company’s second-largest location, trailing only its Sunnyvale, California, headquarters. “We are impressed with the quality of talent in this area and continue to expand,” says Craig Nevill-Manning, Google’s New York research director. Yahoo opened an East Coast research center in Manhattan late last year, headed by a former Bell Labs scientist.

All this excitement has investors ready to finance a new generation of tech firms. The New York metro area has become the third-biggest market for venture capital in the nation, outpaced only by Silicon Valley and greater Boston. Even more important, perhaps, a crucial component of the digital economy—venture capitalists willing to finance start-ups—has emerged in the city. They have joined together in New York Angels, a consortium of nearly 70 investors, each agreeing to put up at least $50,000 a year for local high-tech start-ups. “We get maybe 400 businesses a year looking for funding,” says chairman David Rose, a scion of New York’s Rose real-estate family and an early investor in local technology firms. “There’s a lot of pent-up demand.”

But these new investors are cautious, tending to back entrepreneurs with proven track records. That wariness has helped give the new Silicon Alley a less freewheeling spirit than during the 1990s, when blue jeans were the norm and firms often splurged their venture capital or IPO money on lavish launch parties and fancy offices before turning a profit. At a recent off-the-record meeting of New York Angels, all but one of the 40 or so investors attending wore ties, and the three entrepreneurs pitching for dollars were likewise buttoned-down. Each company founder emphasized his business experience and how much of his own money had already gone into his venture, and each outlined a realistic road to profitability.

With capital tighter and entrepreneurs paying close attention to spending, Silicon Alley’s revival has yet to produce the kind of ripples through New York’s broader economy that occurred during the late 1990s, when the tech boom drove gains in everything from commercial real estate to corporate party planning.

The lack of that kind of economic buzz is a reminder that Silicon Alley’s revival is fragile—so much so that it could still founder in New York’s tough-on-entrepreneurs climate, with its high costs, entangling regulations, and job-killing taxes. Compounding these problems, Gotham has shuttered nineties programs that helped tech firms find cheap space and grow throughout the city, deeming them pointless after the post-9/11 meltdown, when few proved interested in taking advantage of them. Thus, New York’s incentive programs now favor manufacturing businesses and local neighborhood development, suggesting to would-be tech entrepreneurs that the city would rather cling to its shrinking old-economy industries than develop new digital ones.

If New York officials want to encourage Silicon Alley’s continued revival, they must focus on what would make the city more welcoming to entrepreneurs. Foremost would be rolling back the city’s most destructive taxes, especially the nearly $2 billion property-tax hike of 2003. With Manhattan businesses now paying around $15 per square foot in taxes on office leases, compared with just $3 in nearby Jersey City, tenants like Citigroup are again moving jobs out of the city; tech companies, as they begin to prosper and add jobs, might follow. The city should also end surcharges on its steep personal income taxes, which fall disproportionately on budding businesses, since many organize themselves as Subchapter S corporations, taxed at personal income-tax rates. And it should renew incentive plans that allow landlords to offer attractive rents to tech firms that want to locate in the city’s underused office districts.

If the first version of Silicon Alley—the first cutting-edge industry to emerge in New York in decades—bloomed unexpectedly amid the doldrums of the early 1990s, Silicon Alley’s rebirth after the devastation of 9/11 has been no less unlikely. Despite all the blows Gotham has suffered—including self-inflicted ones—the city still has a golden opportunity to capitalize on all the ambition and money and expertise at work in its digital economy. New York’s future prosperity may depend on it.

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More by Steven Malanga:
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