Welcome to the New Silicon Valley

He walked the stage, stopped at the end, and paused. A slight grin on his face. You could tell he was about to say something clever. Or, at the very least, something he thought was clever. He was going to put a charge in the conference audience, most of which were idly sifting through email.

"And of course, we can't all sell our companies for $320,000 per device sold."

He then paused for the slight audience reaction that followed.

The conference attendee sitting next to me glanced up from his email and let out a hyena-like cackle, clearly satisfied with the jab. Then he went back to typing. He had more email to catch up on, I suppose.

The speaker, an executive from Cisco (CSCO 0.37%), had just taken a dig at Nest. It's a company famous for its "learning thermostats." Google (GOOG 1.25%) (GOOGL 1.27%) bought Nest for $3.2 billion earlier this year, an eye-popping price for a company founded in just 2010 that only had two products. His comment implied – an incorrect – astronomical sum Google was paying for how many devices Nest had sold.

I realized that no one here was rooting for Nest. At least, not anyone I met.

They weren't from the New Silicon Valley.

Nest, the newest entrant in an old market

I was in my second day at last month's conference called Connections put on by Parks & Associates. It's billed as "The Premier Connected Home Conference" and was held in San Francisco.

It was far from the first time there that I'd witnessed someone roll their eyes, shake their head in astonishment, or scoff at the mention of Nest. The reason was simple: Nest had stolen the industry spotlight.

The media loves the story of Nest. It's a company that builds connected home products, and was founded by the man known as the father of Apple's (AAPL 0.64%) iPod. Its products are sleek and free of buttons while most existing home thermostats, well, suck.

Perhaps just as importantly, Nest targets selling a benefit as much as a product. The company targets not just saving money from its learning thermostats, but also helping the environment. Nest's monthly energy reports sent to its buyers don't even lead with their own home's energy savings; instead the amount of energy all Nest thermostats have saved globally since their October 2011 launch is featured prominently.

Nest has an astounding amount of buzz; in fact, searches for the company recently passed the term "home security." Nest may be a serious player in a trend like 'The Internet of Things,' but its search popularity surpasses even that much-hyped trend.

Yet, in the opinion of the established "smart home" industry – both the old guard of Silicon Valley and companies outside the Valley -- Nest was just one small entrant in a market that didn't need inventing. Nest wasn't creating some vision of a new, better, connected home, it was merely a small fish in a home products pond that is already very big, and getting larger.

After the conference ended for the day, I planted myself at a standing table and chatted with a banker focused on mergers & acquisitions in the space. I asked him about Nest and got the now predictable eye roll.

A woman stopped by the table to chat about The Motley Fool, noticing the unconventional company name on my conference lanyard. She'd been working at an industry trade publication that focused on home automation for the past 20 years.

The past 20 years! This wasn't some fly-by-night industry. Nest may have captured the imagination of the media, but the connected home was far from a new idea. It is decades old!

The next battleground

Take ADT (NYSE: ADT) for example. It's the current leader in home security and pulled in $3.4 billion worth of sales in the past 12 months. It has 6.5 million residential customers representing 25% market share in the United States. It has a vast sales network, and heavily promotes its Pulse app to handle full home automation services like remote security, video monitoring, lighting and thermostat control.

In a highly profitable industry, ADT is the gold standard.

Then there are established hardware players like Honeywell (HON 0.30%). Its home products like thermometers and HVAC systems sit in its "Automation and Controls Solutions" business, which brought in $16.6 billion last year. Philips has impressed with its connected Hue light bulbs. General Electric (GE 8.28%) has its own line of smart appliances.

There are some very large and well-established companies competing for future smart home riches.

Yet, Google didn't shell out billions for any of the existing industry players. Rather than buy ADT to acquire its 6.5 million customers and 25% market share, it'd rather start over from scratch. It'd rather build its own vision of what the connected home would be by placing a bold $3 billion bet on Nest.

Google didn't want the baggage; it wanted a fresh start. There's already a thriving and profitable model for addressing home security and home automation, but Google wants nothing to do with that decades-old, reliably profitable model of thousands of local salesmen. ADT employs 17,000, Nest employs less than 500.

It wanted to forge its own new way of approaching the market. To do so, it was willing to spend billions on an unproven company, and would be willing to lose billions more as it funded Nest to make an impact.

In part because of that decision, smart, connected homes have become the latest battleground technology in the New Silicon Valley.

A new, more arrogant Silicon Valley

Since venture capitalists and computer firms began pouring in during the 1970s, Silicon Valley has been about technological upheaval. While the Valley was left battered and bruised during the fallout of the first Dot-com crash, it has come roaring back across the past decade with a new identity.

The identity was shaped by some of the greatest business success stories this country has ever seen, such as Facebook (META 2.98%) ushering in social networking at a scale that connected the whole planet. Google using "don't be evil" as its corporate mantra while it grew to become one of the world's most powerful companies. Apple bringing mobile phones – an enormous market that had been largely free of Silicon Valley's influence – to its knees on its way to becoming the world's most valuable company. 

The first Dot-com bubble was rooted in establishing the Internet, the New Silicon Valley is about technology conquering the world. It's global. It's swift. It's relentless in targeting new industries.

Technology, after conquering mobile and putting a computer in everyone's pocket, was expanding to take on any industry it felt was not bettering the Earth. It was looking established, profitable industries in the eye and threatening to wring out their bloated models, to disrupt their comfortable, fat profit margins.

Windows from Microsoft is increasingly irrelevant. From a monopoly a decade ago, when you factor in smartphones and tablets, less than 20% of computers now run on Microsoft software. No self-respecting start-up would use Oracle's expensive systems when salesforce.com offers cheaper cloud-based alternatives. Even IBM finds itself falling behind in the cloud computing battle.

Cheaper, easier: say goodbye to your profit margin, old world

My time at Connections was a face-to-face encounter with an industry confronted by the New Silicon Valley. Home security and automation products have generated tens of billions of dollars in operating profits, but the New Silicon Valley was now telling them their business was being disrupted.

It wasn't just Nest either. Dropcam was raising nearly $50 million to offer low-cost security cameras; on Friday Google bought it for $550 million. Apple recently unveiled its new Home Kit framework, which provides a management system for a whole range of automated home products. Hundreds of millions is going to start-ups in the field.

All the new Valley solutions remove the need for expensive professionally installed systems. They are -- by and large -- cheaper and easier to use. If they charge a monthly fee, it was a fraction of what incumbents like ADT or AT&T charged.

The threats to the existing industry were obvious, but the incumbents went to great lengths to dismiss the newer entrants attracting buzz. Their attitude was that of a parent, letting a kid run himself out screaming for attention, while they handled the real responsibilities of the industry.

The battle against the new Silicon Valley

The dismissal of the New Silicon Valley is far more reaching than my time spent at Connections, however.

At its most extreme, the New Silicon Valley is critiqued as industry-members acting as missionaries of a new religion of technology. Google the term "cult of disruption" and you'll find nearly a million results.

The belief that other entrenched industries are somehow inherently evil, and only an industry like technology can use its disruptive holy water to make the world a better place is something that has not surprisingly united targeted industries. If you were a cab driver, would you like Uber's CEO's characterization of cabs as "evil?" No one wants to root for the brash upstart, especially when their approach is both loud and at times arrogant.

It's why conference attendees scoffed at Nest. They had been building the ingredients of the smart home for decades, yet Nest designs one sleekly designed product, espouses a product to better the world, sells a few hundred thousand devices, and suddenly the media marginalizes an industry selling hundreds of millions of home products a year. Suddenly, they are the roadblocks to Nest bettering the world.

HBO's newest show, Silicon Valley, relentlessly lampoons New Silicon Valley's White Knight mentality and incomprehensible start-up jargon.

It has become HBO's newest hit show.

Yet, the biggest blow against the New Silicon Valley came last week, when The New Yorker ran a cover story called "The Disruption Machine." The article targeted the messianic tone of the New Silicon Valley by sub-titling the article "What the gospel of innovation gets wrong." The article essentially argued that Silicon Valley's hallowed theory of disruption is wrong, and that examples of disruption from the seminal book on the subject – The Innovators Dilemma – weren't even accurate. Companies being "disrupted" in the book, originally published in 1997, turned out to be wildly successful.

Disruption is at the core of the New Silicon Valley, it's the lifeblood of its ambitions; the theory that explains why high-technology companies can conquer multi-billion dollar industries like the smart home market.

While The New Yorker piece will likely be read by fewer people than your average BuzzFeed article about cats playing with toys, it became the source a rallying cry for Silicon Valley's elite to defend disruption on – where else? -- Twitter.

Missing the mark

While The New Yorkers' article led to impassioned defenses of disruption from some of Silicon Valley's most influential figures, the most interesting aspect of the article isn't putting disruption on trial. Instead, it's a useful conversation-starter to talk about what disruption really is, what kind of effect Silicon Valley's most ambitious firms will have as they pursue new industries.

The reality of disrupting existing industries falls somewhere between wide-eyed 25-year-old entrepreneurs speaking of disruption's awesome powers in hushed tones and The New Yorkers' view of disruption as a broken theory.

Overall, disruption is a model based on hindsight. It's a generally useful way of understanding why seemingly entrenched companies fall. It's far from perfect, and far from always being predictive. While Disruption has become the battle cry of the New Silicon Valley – and the name of TechCrunch's annual start-up event – the truth is it's often painfully slow.

As an example, let's put some figures behind one of the great technology disruption stories of our time: Amazon (AMZN 1.30%) battling bricks-and-mortar retail. There is ample evidence Amazon has begun chipping away at many retailers, Best Buy being a prime example.

Yet, since Amazon's founding in 1994 it has produced a total of just $2.2 billion in profits. Over 20 years, its revenues have grown by $74.4 billion.

Over that same time frame, the world's largest retailer – Wal-Mart – has booked $192.4 billion in profits. Its revenues have grown by $408.4 billion. That leaves Wal-Mart with 87X the profits and over 5X the sales growth of Amazon.

If this is what disruption looks like, count me in on being disrupted.

The author of The Innovator's Dilemma, Clayton Christensen, noted how drawn out disruption can be in a recent interview with BusinessWeek. He noted "disruption doesn't happen overnight," while explaining how it took over 52 years for the nation's 316 department stores to be cut down to less than 10.

The problem here is that when disruption became the rallying cry for the New Silicon Valley, the term "disruption" became turbo-charged to fit the Valley's own ideas of what it should mean. The billions of dollars flowing into Silicon Valley start-ups, the press following each new idea, all benefited from the idea that disruption was something more immediately powerful, more world-changing, than the sometimes dull academic roots the term came from.

The New Silicon Valley – Results may be slower than expected

So, if disruption is often less glamorous and slower-moving than advertised, does that mean ADT and its peers in the old guard of the smart home are safe?

Not quite. Let's look at another industry in the throes of disruption from the New Silicon Valley: the cab industry. It's an industry that shows the New Silicon Valley at its most ruthless, efficient point, but also the challenges in living up to expectations it has created.

Cab-killer Uber recently raised $1.2 billion at an $18.2 billion valuation, among the highest ever for a venture-backed company. Uber being valued at more than $18 billion is already higher than the entire United States cab market ($11 billion). Globally, that market is larger, possibly as high as $100 billion.

Uber captures anywhere from roughly 5% to 27% of fares coordinated in its app from a mix of taxis, private cars, and luxury "black cars." Running the numbers, their capturing the vast spoils of the cab industry is already priced in as a start-up company. The funding round of Uber implies it has already won the cab market and has larger opportunities ahead.

Cabs are a business with little historical effect from the furnace that is free-market competition. Startup ride-sharing competitor Lyft recently cut prices by 20%. How many times have you ever seen cab fares go down?

Yet, the competition is inherently unfair. Uber now has a billion-dollar war chest. Lyft doesn't yet take any commissions for rides booked on its app. In both cases – and among a number of other funded companies in the field – cabs are seen as a land grab. The time to make money isn't now; instead all companies are looking to build out user bases, with an eye to vast future opportunities.

The same regulations that fostered the cab industry were pulled away so rapidly; it's not surprising cabs were deeply pressured. It has been an industry simply unprepared for rapid change. An ideal candidate for the kind of disruption the New Silicon Valley drools over.

But, the next opportunity cited by many for the cab industry is logistics, operated by companies like UPS and FedEx. These are companies that – unlike the cab industry – have spent years cutting their teeth in fierce competition and won't be such easy targets. Uber proponents will note the global logistics industry is a $4 trillion industry, and they could do well by serving a portion currently underserved like fast, local delivery.

They might do very well, but we saw how slowly Amazon has had to chip away at its own trillion-dollar industry, retail. Attacking such a competitive market is often a long slog. One that has a far longer timeframe than the holding period of most Silicon Valley venture funds.

Cheap money and exponential growth

The basic premise of Clay Christensen's disruptive innovation is that incumbents are unable to properly compete with new threats, because doing so would compromise their existing sales and profits.

Today, a couple key areas are driving the conversation on disruption. First is the exponential effect of technology across the past 20 years. The second is how "cheap" money is itself. Both are playing a huge part in the looming battle over the smart home.

Let's first look at exponential technology increases across the past 20 years. In 1994, the average computer cost roughly $2,300. Today, smartphones can be had for as low as $50. The result is that the worldwide market for technology services has moved from hundreds of millions of people to several billion. If you have a technology idea, it can be sold to a far larger market.

At the same time, advances in networking, broadband infrastructure, and the declining cost of servers has enabled cloud computing. That has had the same effect on building companies that cheap smartphones had on more people owning technology.

Think about a messaging service like WhatsApp. Between April and August 2012, it went from handling 2 billion to 10 billion messages per day. In the late 1990s, building the technology infrastructure to handle such a change would have required tens of millions of dollars in servers and new employees to manage the startling growth. Today, it merely requires capital from a VC and requesting more space from their cloud-computing operator. We're in a vastly different world than the Dot-com Bubble.

Later in my trip to Silicon Valley, I met with a company named Orange Chef. It started by making plastic bags to protect iPad screens while cooking. Later, its small team of three people decided to make a decidedly ambitious cooking pad that connected to an iPad app. Venture capitalists told them the product would take 18 months to design, manufacture, and secure retail placement. They finished the product in six months, without venture financing, and secured an exclusive retail deal with Williams-Sonoma.

Think for a moment about the smart home space. Companies like Nest and Dropbox launched with modest sums of venture capital, and sleek hardware in relatively high volume. The software services, their apps, and all infrastructure could be housed cheaply in the cloud. Thanks to the growth of the smartphone industry, all the processing and sensors inside the devices had become much cheaper. Startups are no longer limited to apps or websites, they can make hardware as well.

The shelves of Home Depot are suddenly as open to a Nest as they are to a company like Honeywell.

Thank Ben Bernanke

The second trend of "cheap money" may be even more important.

In the venture space, low interest rates have left large institutions scrambling for returns. If you're a pension with a targeted return of 8% a year, yet the government debt that might be half their portfolio is yielding less than 3%, if you want to increase your returns you need to increase your risk. That means investing more directly in smaller, privately held companies.

Silicon Valley venture firms didn't headline the latest round of funding that gave a billion dollars to Uber, but instead staid Wall Street institutions like BlackRock, Wellington Management, and Fidelity led the round.

Cheap money is pouring in from Wall Street. The recently departed Fed Chairman Ben Bernanke could claim another title: chief disruptor of the United States. The Fed's decision to keep money cheap is helping fuel the boom in disruption. 

Aside from start-ups, the situation also affects how larger technology companies operate.

Consider ADT and Google. Low interest rates have led ADT to load up its balance sheet with debt. In the past year, the company has repurchased $1.7 billion worth of its own shares. Today, the company has $4.4 billion in net debt, against $349 million in profits and $3.4 billion in sales.

By contrast, Google has $62.3 billion in sales, sees profits of $13 billion, and has $51 billion in net cash. There are few calls for Google to return its cash to shareholders or take on huge amounts of debt. Investors in growing technology companies like Google want money to go toward growth rather than returned to them.

ADT's capital efficiency is a sound way to run a business – assuming your competitors are playing on a level playing field. In the case of ADT, they aren't. While cheap money encourages a company like ADT to load up on debt – reducing its ability to handle risk and new competitive threats – that same cheap money only encourages companies like Google to take more risks.

That leaves a competitor like Google free to spend billions competing for a targeted market like smart homes. Google has no focus on what the returns on the capital its spending on a market like smart homes will be in the next five years, merely that there is a huge opportunity for profits down the road. Even if Google ramps spending in the space, earnings weakness in tech companies is more often forgiven than not if revenue growth is strong.

ADT doesn't have such luxuries. On Jan. 30, the company issued earnings that disappointed investors. Three days later, its stock had fallen 24%. The company has to be very focused on hitting expectations and providing consistency.

Google and its smart home peers don't need to necessarily "kill ADT" by any means either, merely decreasing its sales by 15% could destabilize its dividend payment and make its debt load increasingly burdensome. Their model runs in direct contradiction to the stability ADT prefers.

The next iPhone moment?

I walked out of the Connections conference and stared across the Bay. It was a gorgeous day, the California sun moderated by an ocean breeze. It felt like how a movie tries to make you feel.

Maybe the New Silicon Valley could fix that -- Facebook had just invested $2 billion in a virtual reality company.

I thought, "maybe it's the weather." When you're in a place this nice, everything feels better. The possibilities look endless when you're cruising down a California coastal highway.

I couldn't stop thinking about the conference. The interplay between an established industry making billions of dollars, and the upstarts from Silicon Valley offering sleeker, cheaper, and better products.

My mind kept drifting back to 2007 and another industry: mobile. That year, the iPhone was announced into an industry that collectively shrugged its shoulders. Microsoft CEO Steve Ballmer said, "there is no chance the iPhone is going to get significant market share." Research in Motion CEO Jim Balsillie dismissed the iPhone for its lack of a keyboard.

At the time, 1.3 billion mobile phones were already sold a year. By Apple's own admission, it wanted just 1% of the market. It was just a small fish in a growing pond.

Yet, it introduced a new paradigm. It was an Earth-shattering moment -- Apple had shifted the power from carriers. Its phone had no AT&T logo on it, no pre-installed apps. The market was especially ripe for disruption because no one liked the existing products, phones were built to serve the carriers rather than delight customers. Add to that the fact many customers were on contracts where they could upgrade their phones every two years, and this was a market ripe for rapid disruption.

My time at the conference, the dismissal of Nest, and the new group of products felt so familiar. Was this connected home conference a repeat, just shifted to a new market, of what happened in 2007?

Like phones, no one loves products like thermostats and other devices in their home. Yet, we spend thousands decorating and beautifying our houses. It makes sense that people would rapidly adopt products that are not only technically superior, but also look better. This market isn't technology making a blind leap into a new market, and it actually reinforces existing strategies. This isn't the kind of disruption that takes decades, in fact, it's the kind that's potentially very rapid.

Google has informed the SEC it may sell ads on devices like thermostats. It has spent nearly $4 billion buying smart home companies in the past six months. Apple still makes the vast majority of its profits from the iPhone, so wouldn't making the iPhone the remote control to your home only strengthen the grip of the products on people's lives? Both companies have tens of billions in cash ready to win the battle, and will relentlessly pursue their own paths to control.

Wouldn't you rather have the remote control to your home and life built by Apple than ADT? Disruption as a model for the future isn't always a perfect predictor, but it does seem like the ingredients are in place for this market. 

The New Silicon Valley may be brash, it may be arrogant, but in the case of the smart home, it looked to continue its winning streak. 

The conference ended; a colleague and I could head back from the center of the world's change to the world's area most resistant to change: Washington D.C., where our offices were located.

He asked me, "So, do you think Nest or any of these companies are going to disrupt what's going on in the connected home."

"Probably," I muttered, as I reserved an Uber on its iPhone app. Cabs, well, they just suck.