Why It's So Hard to Build the Next Silicon Valley

When Brandon Schatz learned in December 2012 that Kansas City, Kansas had become the first city in the nation to get Google Fiber, a superfast Internet service, he started making plans to move his nascent sports photography business there. The day after Christmas, he drove the 165 miles from his home in Springfield, Missouri, to check it out. By February 1, he had settled into his new house. By February 4, he was connected to the network.

That was exactly what officials had wanted. When the area (first Kansas City, Kansas, with Kansas City, Missouri added weeks later) won a challenge to be the first to get Google Fiber, local boosters celebrated, hoping to kickstart an economic renaissance: attracting entrepreneurs, cultivating emerging business districts, and becoming known as a major startup hub.

Four years later, Schatz’s company Sportsphotos.com, which takes photos of amateur sporting events around the country, is growing slowly. He’s taking full advantage of the speedy internet, uploading hundreds of high-resolution photos in minutes from races and other matches. But the business isn’t yet where he wants it to be, and for now Schatz’s main source of income is web development work and renting out rooms in his home on Airbnb. On a recent Sunday, Schatz sat in his home, where he also operates his company, pecking away at a desktop, surrounded by pizza boxes. “I thought we would be huge already,” he said.

Schatz’s disappointment is a tale of misplaced expectations, by both entrepreneurs and city leaders. (The challenges that he and other startup founders face is the subject of the latest episode of the Decrypted podcast; subscribe here on iTunes.) In 2011 the cities’ two mayors called Fiber’s then-future deployment “a once-in-a-lifetime opportunity,” and a way to “spark economic development.” And for Google, which since significantly has pared down support for the project, it was a case of placing too much faith in the ability of its own technology to change lives.

It’s also been hard for the Kansas City area to become the boom town that leaders dreamed of. Some entrepreneurs, like Schatz, were drawn to the city because of the fiber, and some launched businesses. A “startup village” sprang up. But few of the companies really took off, and some frustrated founders ended up decamping to San Francisco, where there was a larger talent pool and greater access to capital. Even the best of intentions and super-speedy internet isn’t enough to create a new Silicon Valley.

Every year after Alphabet Inc.’s Google’s first fiber connections lit up in late 2012, greater Kansas City’s GDP growth has fallen well short of the national average. In 2015, it was just 1.5%, compared to 2.6% for the nation as a whole. Metro regional numbers aren’t yet available for all of 2016, although based on state numbers through the third quarter, both Kansas and Missouri seem to be beating the national average.

“We’re scratching our heads a little bit,” said Jeff Pinkerton of the Mid America Regional Council, a nonprofit that conducts economic research for greater Kansas City. “Why is Kansas City really not taking off, especially with this asset like Google Fiber?”

When Google Comes to Town

Google came to town in 2011. At Wyandotte High School auditorium, on the Kansas side, blue, red, yellow and green spotlights shone on a parade of dignitaries who addressed the audience. Google founder Sergey Brin spoke on a prerecorded video. After the announcement about fiber going into Kansas City, a Google vice president invited the crowd to a barbecue-laden celebration.

Kansas City beat out more than 1,000 other cities for the debut Google fiber project, which aimed to compete against the telecommunications and cable giants that have dominated the market for Internet access. Some analysts believed the ultimate goal was to encourage those competitors to improve their own services and thus the Internet experience overall, which would bolster the environment for Alphabet’s most lucrative business: online search.

Mayors of both cities announced a team of civic leaders to figure out how best to leverage fiber, in entrepreneurship as well as other areas such as education. The group released a plan in 2012 that made recommendations ranging from nurturing technology districts to supporting tax credits for small technology businesses to creating mentor networks.

Despite budget challenges, the state of Kansas has stuck by a preexisting income tax credit of up to $50,000 for angel backers who invest in a young company. Working with a group called Techstars, Kansas City-based Sprint Corp. created an incubator for startups. The Kauffman Foundation, a think tank based in Kansas City, Mo., started a weekly gathering for entrepreneurs.

An area straddling State Line Road, the border, became the first neighborhood that Google wired for fiber, and a community of founders sprang up. The district, which had zoning laws that made it easier to run a business from home, became known as Startup Village. That’s where Schatz, the owner of Sportsphotos.com, moved into a rental house.

It was an online video about the Kansas City experiment that drew him. He realized that Google Fiber could be the key to his nascent business: Batches of photos that took 40 to 50 hours to upload would be done in less than one. “It’s a little nerdy, to see this video and be all kinds of inspired,” says Schatz, 34, a boyish looking former U.S. army sergeant whose tours of duty included Bosnia. “But I was inspired.”

Yet in practice, a dazzling Internet connection didn’t mean much for some businesses. Mike Farmer operated his startup, Leap, a search engine, out of a Startup Village house for a while. “What do you do with gigabit speed that makes the experience more relevant?” he recalls asking his team. They goofed around with ideas, such as having search results take the form of several high-definition Netflix movies streaming at the same time. Given that most users wouldn’t have gigabit Internet, Leap never did find the right scenario. Farmer wound down the business last year.

“The true power of Google fiber is exposure,” says Matthew Marcus, executive director of the Kansas City Startup Foundation and co-leader of the Startup Village, referring to the publicity the technology brought to the city’s startup community. “The fact is, it’s really difficult to consume one gigabit of speed.”

Some startups have contended with the lack of access to a big talent pool. Tech companies in Silicon Valley, Waterloo, Canada, and New York City, tend to hire from nearby universities with strong software-engineering programs. The schools with the strongest engineering schools in the region are more than two hours away from Kansas City, though.Funding has also been a problem in Kansas City. Entrepreneurs lamented that local investors looked for the type of traction that would merit tens of millions of dollars from Silicon Valley venture firms. But if businesses achieve that, Midwestern venture firms invest just single-digit millions. Lack of access to capital contributed to the departure of two promising Kansas City startups, bond marketplace Neighborly and green-homebuilder Acre, which both moved most operations to Silicon Valley.

“There are plenty of angels that will write $50,000 checks, but there’s not that much bridge,” says Sandy Kemper, chief executive officer of Fairway, Kansas-based C2FO, a working-capital finance company he founded in 2008. Kemper turned to big investors outside Kansas City, including San Francisco’s Mithril Capital and Singapore’s Temasek Holdings, for most of his backing. In his hometown, “there is a finer filter, and maybe a little bit higher hurdle.”

One advantage cited by many local entrepreneurs, low costs, can actually backfire. “It might be a misplaced sense of comfort,” says Ajay Royan, the general partner at Mithril Capital who invested in C2FO. He believes the best entrepreneurs work with an intensity driven by the reality of global competition—a reality too easily lost sight of in a low-pressure, low-cost environment. “If you get comfortable with the fact that things seem to be going well in Kansas City,” he says, and don’t think beyond it, “that’s bad.”

C2FO is one many other entrepreneurs hope will eventually list on a public market and raise hundreds of millions of dollars, with a valuation north of a billion. It has already raised $99 million and is used by some of the world’s biggest companies, including Acer, Costco, BNSF Railway, and Pfizer. That type of public offering, more than anything, would truly foster entrepreneurship in Kansas City, entrepreneurs say. It would show existing investors the upside of investing more than a few thousand dollars in startups, along with creating a class of richly rewarded early employees who would in turn likely become investors in other startups—or founders of their own.

Lance LeMay, a venture capitalist at Kansas City, Missouri-based Open Air Equity Partners who invested in Kemper’s and Farmer’s companies, said boosting the venture-backed startup ecosystem in Kansas City won’t even take that much. “More than a billion-dollar exit, you need lots of successful exits,” he said. “You don’t need a home run. You need lots of doubles.”

In the years that Kansas City has been trying to make the most out of Fiber, Google has been doing the same. In early days, company executives talked it up, with executive chairman Eric Schmidt telling conference goers in late 2012 that of all the company’s current innovations, including self-driving cars, it was Google’s “most compelling on many levels,” something that “changes your life.” Shortly afterward, it started announcing more cities for the project, beginning with Austin, Texas, and Provo, Utah. In 2013, the company recruited Craig Barratt, a wireless chip industry veteran, to lead the group that included Fiber. In 2015, when Google became Alphabet, Barratt was given the title of CEO. Over time, Google Fiber announced it would expand into 21 cities.

But just as Kansas City might have overestimated the asset Google Fiber could become, Google overestimated Fiber’s impact, and its expansion plans deflated. Barratt left in October 2016, surprising many employees. The same day, the unit announced it was stalling expansion plans in eight cities and cutting 9 percent of its staff. This month, Alphabet hired Barratt’s replacement, broadband executive Gregory McCray, and further slimmed Fiber, shifting hundreds of its employees over to Google’s core Internet business.

Fiber, Where Art Thou?

Fiber is now in only nine locations, including Atlanta and Orange County, Calif. Other Bets, the part of Alphabet that Google Fiber belongs to, reported losses of $3.58 billion last year on revenue of $809 million. It also contributed to Other Bets’ $1.39 billion in capital expenditures.

A number of factors lay behind Fiber’s strategic shift. Former employees said a chief reason was the discrepancy between the desires of Google’s co-founders to expand the service and make it faster and the demanding costs of providing it. Cable incumbents moved aggressively, introducing similar high-speed services at low prices. Unexpected political hurdles emerged. In Louisville, Kentucky, for instance, AT&T and Charter Communications sued Google Fiber over a wonky utility-bill regulation.

“Google invested in Fiber during a time when it was willing to make lots of big investments with uncertain or long-term returns, but over the last couple of years Google has become a different place,” says Jan Dawson, chief analyst at Jackdaw Research. “It doesn’t necessarily make sense for Alphabet to continue to invest in it as heavily at this point.”

Schatz recently changed his business model. Instead of getting amateur athletes to pay for the photos, they download them for free, with sponsorship fees providing his revenue. Having observed the reluctance of local investors to back companies that lack strong income, he is working to build relationships with big sports retailers and fitness companies that could sponsor the blanket photography of the events he shoots.

The race-photography business alone is worth $20 to $50 million annually a year on sponsorships, he calculates; add in other amateur sports and expanded marketing initiatives and it could be exponentially more. But for now, he’s capturing just a tiny portion; revenue last year doubled but was still under $100,000, he says. This year, he hopes to keep growing and achieve profitability.

He knows developing ties to potential sponsors would be much easier in a city like New York or Los Angeles, but he believes he can pull it off from the heartland.

Sometimes, he thinks back to advice a venture capitalist gave him a few years ago, to drop everything else and focus only on his business. The laid-back atmosphere in Kansas City made it easier to put that advice aside, he says.

“It probably would have been good to have extra pressure,” he says now. Still, he says perks such as a community of fellow entrepreneurs make him happy he stayed put.

Meanwhile, some of the original startup supporters in Startup Village have sold their real estate to non-entrepreneurs.

After Google Fiber came to town, Brad Feld, a venture capitalist at Boulder, Colo.-based Foundry Group bought a bungalow in Startup Village for use, gratis, by a promising young company. For a time, Leap’s Farmer housed interns there. Today, a start-up engineer lives in the house. On a recent visit, a layer of dark fuzz and grime obscured floors. A vacuum cleaner stood at the far end of the main room, plugged in but apparently unused. A side room lacked furniture, but did sport a large pile of clothing flung in its center. A skittish cat bolted across the kitchen.

Three doors down the street, Schatz has decided to launch an intense search for financial backers. An early port of call: Silicon Valley.

—With Mark Bergen