Business Forum: Why Minnesota Won't Catch Up in Software -- and why it won't matter

By Isaac Cheifetz
Published April 2, 2001

I was having dinner with a Minnesota-based venture capitalist in Uptown Minneapolis last month. He complained that there are only a handful of software companies of national stature based in Minnesota, driving him and other VCs to invest the bulk of their funds on either coast.

While Minnesota has hundreds of software companies, there are only a handful that are market leaders nationally. Why is this so, given the technical and business excellence here?

Minnesota historically was a major center for computer vendors. Of the nine top computer companies in 1980 (IBM, Sperry, Burroughs, Control Data, Honeywell, DEC, Harris, HP and Cray), four had headquarters in Minnesota, and IBM had a key plant in Rochester.

Minnesota is an unusually vibrant business center, with nearly 40 Fortune 1000 companies based here. That's about twice as many Fortune 1000 companies per capita as the national average.

Minnesota's economy is not limited to large companies. It has a continuing track record of successful start-ups in a variety of industries, particularly medical devices and manufacturing, and a robust investment community (a Fortune magazine article on the topic several years ago was headlined "MoneyApolis"). It has a world-class research university, a key factor in the growth of regional technology centers.

Some reasons for the state of the Minnesota software industry are historical, others perhaps cultural. Historically, Minnesota's mainframe computer companies, with their proprietary architectures and high profit margins, did not flourish in the PC age, when even supercomputers became commodities. Moreover, the mainframe companies were focused primarily on hardware -- "Big Iron" -- rather than software.

Software as Commodity

Entrepreneurs who left those companies to start software companies had few software "home runs" to compare themselves to. Contrast this to Silicon Valley, where a software entrepreneur would have Fortune 1000 software companies such as Oracle or Peoplesoft as benchmarks for success and return on investment.

Culturally, the very stability of the Midwestern business ethic may be a hindrance to pure high-tech companies. Northern California and Texas, two major software development clusters, are notable for their "boom or bust" cultures. Winning big, with brash style, is the goal. Failing big, also with brash style, is respected in Silicon Valley and Texas, and considered no cause for shame.

In contrast, Minnesota's business culture esteems growing businesses that are profitable market leaders. Its investing mentality is similarly an incremental one, valuing singles and doubles as much as home runs. Additionally, the imbalanced lifestyle that Silicon Valley start-ups often require, with their 100-hour work weeks, generally is disdained here and required only as a last resort.

This trend also manifests itself in the impact of economic downturns. In 1990, after the 1987 stock market crash, the S&L crisis and the end of the Cold War, New York, Boston, Texas and California were hit hard, with employment rates and real estate prices sharply receding.

Minnesota, with its balanced economy not dependent on any one industry, suffered only a mild economic slowdown, sidestepping the more intense downturn of regions heavily reliant (and speculating) on finance, defense, energy and technology.

Can Minnesota catch up in the software industry? Even if it can, it shouldn't try.

The software industry no longer is where the action is. A wave of commodification has swept across the computer industry the past 10 years, first hitting hardware, now challenging software vendors.

In hardware, only Dell (arguably more of a supply-chain innovator than a computer company), Compaq, Sun, HP and IBM are relatively healthy. Investors would be hesitant to invest in a new computer company, however innovative the technology. No new computer company has launched to profitability in more than 15 years.

Leverage Local Strengths

Similarly, in software, a handful of dominant companies (Microsoft, Oracle, Computer Associates) make the overwhelming majority of profits, and the bulk of the industry loses money. This imbalance in software-vendor profitability has grown during the past five years but was masked by the dot-com era's high market capitalizations.

So "catching up" in software is no more desirable than "catching up" in hardware -- it has evolved into a commodity niche with low margins. What does matter in the present global economy, with the Internet innovating and disrupting every industry, is solving business problems using the new technologies, and delivering these services on Web-based platforms.

And that's the good news. Minnesota is unusually well-positioned to play a key role in the next stage of the Digital Economy, as the workflow of entire industries moves to the Internet. The concentration of blue-chip companies, the expertise in corporate IT and outsourcing, and the culture of long-term profitability all will be competitive advantages as e-commerce matures from an adolescent to young adult.

Partnerships between industry and education and technology clusters should focus on local strengths: industries such as health care, agriculture and retail, and IT disciplines such as data storage, decision support and enterprise application integration.