This morning, Dan Saffer shared on Twitter that Smart Design SF is shutting down. Earlier this month, Adaptive Path surprised pretty much everyone who cares by announcing they were being acquired by Capital One. So what’s going on?

I don’t know the rationale for Smart’s decision, but in talking to friends, and trying to make sense of what’s happening, it appears there are two opposing forces that San Francisco design firms have had trouble reacting to.

The first is the growth of well-paid in-house design teams at money-hoarding tech companies and well-funded startups. I first saw this about 10 years ago, when Adaptive Path lost a candidate to Google because they offered what we thought was an insane salary. A few years later, Facebook and Twitter followed suit, and now every tech company is offering designers 50-100% more in salary than what design agencies can swing. In the past, agencies could say, “Yes, but we respect and value design in the way that in-house companies don’t, and you’ll get to work on a range of things, instead of just one thing over and over.” That doesn’t hold true anymore, and most of the interesting design work is emerging in-house, and designers want to be where the action is. And get paid better to boot.

Here comes the counterintuitive bit. If design is in such demand (and jobs pages at every company suggests it is), why aren’t agencies just charging more, and using those higher billings to pay their designers more, and thus be competitive? That’s how markets work, right?

Well, not quite. What’s actually happening, according to friends at agencies, is that client’s willingness to buy design from agencies is decreasing, and project budgets have been shrinking. And the prevailing theory is that this is happening because companies are building in-house teams, and that’s where their ‘design budgets’ are going. Whereas in the past, a company might spend 20% of a design budget internally and 80% externally, that’s now swapped.

Another way to put it, as companies have gotten smarter about design, and recognized it’s a competency they need internally (something which Adaptive Path promoted in our book), they’ve become less comfortable outsourcing it.

So, San Francisco design agencies are often billing less than before, yet the talent market is able to earn more than before. This is a quandary.

It’s telling that Smart Design seems to be otherwise financially healthy — last month they opened an office in London. Their main offices is in New York. It just seems like they’ve thrown in the towel in SF, and from what I can see — I don’t blame them.