This week, I partnered with a fellow Midwesterner (though a bit more Midwest than I am) and startup operator Lea Boreland to take a quantitative look at innovation and the Midwest.
This was a really fun piece to work on. I grew up in Kentucky, but now live in Los Angeles. I miss Kentucky deeply – and I remember driving by the Ford plant most days, or going on field trips where we would pass quarry after quarry. (In fact, you can feel the tremors from a nearby drilling at my childhood home).
We wanted to write a piece to highlight the potential of the Midwest – and give it a voice in the conversation about Silicon Valley and tech.
Lea and I will show that since WW2, the Midwest has stagnated in comparison to the West, but there’s massive potential to reorient the applied industrial knowledge of the region toward 21st century trades like software development and machine learning. We only need to develop the risk capital ecosystem to take advantage of this potential.
I. The Midwest was once the home of industry in America.
In 1850, textiles were the most important part of the American economy, representing 1/5th of the U.S. Industrial Production Index, followed by Transport Equipment and Machinery, and shifting into chemical and fuel products gradually over time.
During this time, the Midwest became the a hub of industry due to its proximity to natural resources (ex., fertile soil, heavy metals) and water access. The upper Midwest specialized in mining and pineries, while the lower central states became the nation’s breadbasket. The former capacity can be traced back to Precambrian lava flows, while the latter can be owed to ancient glaciers producing rivers (ex. The Mississippi River Basin, the Great Lakes) and favorable soils (see clay loam and alfisols on the chart below).
Thanks to these ancient geologic happenings, the Midwest had both stuff to be processed and a means to transport it…at just the time when we were developing the technology to process and move stuff at scale. The region took this advantage and ran with it, leading US technological exploration into the early 20th century: Chicago was the nation’s first railroad center, and Detroit was, of course, the capital of the automobile industry. Meanwhile, at this time, the West coast was just beginning to be populated.
II. The Midwest is now underperforming the rest of the country.
Here’s the thing: when you build anything, you acquire technical debt. You forfeit optionality. The Midwest was built around manufacturing and industry, and then a new, higher yield technology came around: the semiconductor. While traditional manufacturing has been gradually replaced, automated, and/or outsourced, the tabula-rasa West Coast has been able to, from nothing, deploy the infrastructure to capture and grow the market for new technology.
This growth can be traced back not to a geologic source but a intentional, if serendipitous, policy choice: Stanford University hired Fred Terman as its president, and Terman—who saw war-era innovations firsthand while working for the DoD— created the physical place (the Stanford Industrial Park) that would link public innovations with corporate America in the postwar years.
Since then, the West coast has taken off, while the Midwest has barely gotten a hand hold onto the new tech based economy. Data on major public companies helps us visualize this shift. In the year 2020, CA is home to 550 publicly held companies, whereas Kentucky (where I am from) is home to only 13:
The returns from these public companies have also varied dramatically by region. The South and the Midwest have clearly lagged behind the West and the Northeast over the past five years, but the South has outperformed on a 20Y basis (due to oil and gas). The Midwest tells an interesting story in this graph: one of potential. One of the rules of investing is to find companies that have great potential and are trading at a low multiple – the Midwest clearly has room to the upside:
Finally, we can look at the impact of the industrial shift on employment. The graph below shows the unemployment rate by state since 1976. You can see the evolution in unemployment shift from the coasts to the middle of the country overtime, representing a gradual migration of human capital from the Midwest, to the Northeast and the West, as traditional industrial sectors decline and tech grows.
III. As a result of this slow start to the tech boom, very little VC funding is making its way to the Midwest….But there is a ton of potential to reorient the applied industrial knowledge from the Midwest’s heyday toward high-tech pursuits.
This graph, created in November 2020, shows the Top 100 YC Companies by Location (United States only). It segments the firms by headquarters – the West (CA, WA primarily), the Northeast, the Midwest, and the South. Out of the 85 companies listed, only 3 are headquartered in the Midwest/South, 3 in the Northeast, and 2 in Utah, which we considered to be a hybrid West-South.
The top quadrant represents YC firms that are in the West, across all batches and industry. There is some crossover from two firms located in Lehi Utah, Podium and Weave. Zapier is in Tulsa, Oklahoma, which is considered the South by some, the Midwest by others. EquipmentShare is in Columbia, MO, and ShipBob is in Chicago, IL.
This pattern repeats into the W20 YCombinator class, which included 117 companies headquartered in the United States. 99 of these are based on the West Coast, 98 of which are in California and 1 in Washington. 18 companies represent the rest of the country, with 10 located in New York, NY, 3 in Massachusetts, 2 in Texas, and one each in Michigan, Chicago, and Pennsylvania.
There is clearly a lot of funding going towards companies located on the West Coast – and that makes sense, because a lot of companies build on the West Coast, However, the Midwest has a plethora of untapped knowledge, both in tech and in manufacturing. A few key opportunities:
- Connecting tech and traditional manufacturing: “Hardtech innovation” will come from the minds that gave us the previous Industrial Revolutions – but in a different space. It will be focused on smart manufacturing, IoT, smart homes, and connected devices. The applied industrial knowledge used to build automobiles are like those needed to build robotics, devices, energy tech, medical devices, and much more, as Katie Pyzyk highlighted in her recent piece.
- Midwestern cities are “maker cities.” The knowledge of production processes and advanced tech here should not be discounted.
- Agriculture and Energy: The Midwest is also known for agriculture. This knowledge transfers well into bioactives and other ag-engineering opportunities, as well as work in hydrogen and electrical vehicles.
- River access: The Ohio River connects most of the Midwest and South. It actually served as a point of economic prosperity when steamboats and barges were how products were shipped around the states. Now, there is an opportunity to harness both its physical power—as the University of Cincinnati is already doing.
- Universities: The Ohio State University, University of Michigan, Notre Dame, are just some of the higher education institutions in the area that are well-established research hubs. Another undervalued aspect of the area? The students are great too. Human capital from tiny towns and underserved areas needs to be tapped into.
IV. VC can and should play a huge role in this.
Public projects like the Tennessee Valley Authority and the Research Triangle in Raleigh-Durham all catalyzed their respective regions. There is a big opportunity for private dollars to come in and do similar work elsewhere in the region. There are so many companies changing the world in cities like Cincinnati, Louisville, Ann Arbor, and Memphis. These cities are economic anchors to the rest of the country and provide promising potential for growth.
If we can grow them, this would also add resilience to the economy as a whole. According to the work of David Castells-Quintana and Vicente Royuela in “Agglomeration, Inequality, and Economic Growth”, it’s actually more beneficial to have a network of small economies than a series of concentrated cities:
“A more balanced urban system, in which small and medium-sized cities play a fundamental role in the mobilization of local assets to exploit local synergies, seems to be a better strategy than intense urban concentration.”
We are seeing the fallout from urban concentration now—expensive homes, high cost of living, etc. Smaller cities can exist simultaneously with larger cities to boost the growth of the entire nation. A cohesive national economy that spans across the entire country would begin to chip away at so many of the problems the United States faces as a nation.
Venture capital has the opportunity to go into smaller cities and build from there, as Andrew Yang has done with Venture for America. The Bay Area may always be an anchor for startups, but there is opportunity to invest in traditional industries that are rapidly changing, such as manufacturing, agriculture, oil, and gas.
The ecosystem will continue to grow, as applied knowledge catalyzes new ideas. The Midwest is the most undervalued asset in America, and the scope of opportunity is massive.
Some companies and careers in Energy Tech, as curated by Lea:
Companies and Careers in Energy Tech
- Tennessee Valley Authority, a publicly owned development corporation
- NextMV, a Midwest based logistics startup
- Nimbus, an Ann Arbor based urban mobility company
- Rivian, a Michigan-based EV startup
- EquipmentShare, a Missouri based industrial equipment rental service
- Censys, an Ann Arbor based cybersecurity startup
- ShipBob, a Chicago-based e-commerce fulfillment service
- M25, a Midwest-focused venture capital firm