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As printed in Waters, November 2002The Next Big ThingWhat do venture capitalists see as the future of IT? Here’s a hint:
it’s the same thing that has already been IT’s hot item for
years. What’s the NEXT BIG THING? The conventional wisdom is that venture capitalists are unceasingly searching for the answer to this question. Not this year! At least most VCs who invest in information technology aren’t. Reading the papers, and looking at the stock prices of IT bellwethers such as Sun, Siebel, SAP and Oracle, it might seem that this is because venture capitalists are not investing in anything involving IT. This is definitely not the case. In the second quarter of 2002, according to PWC’s MoneyTree survey, venture capitalists invested $1.75 billion in IT-related companies, 30 percent of all the venture capital invested in this period. While this is down about 80 percent from the highs of 2000, it’s still a lot of money. Software was the biggest area of new IT investment, with about $1.1 billion, followed by IT services, which is often software delivered in a different form, and after that computer hardware and peripherals. Where is all this money going? Like Noah’s ark, venture capitalists seem to be investing in a couple of just-about-everythings, provided that it can be sold to the enterprise. Enterprise Resource Planning (ERP), logistics, financials and relationship management solutions of every kind are still being funded. Of course, some species have gone extinct, like desktop applications for the PC and new computer “boxes.” No one wants to do the test market for the next extension to MS Office, and technologies to replace silicon-based computing are far off in the future. Those few hardware plays that are being funded generally involve networking. With the IPO window walled up, most of the capital went to existing companies rather than start-ups. It’s estimated that for every dollar invested in new ventures, six is being invested in follow-ons. In the current environment, only those companies with sales traction (or truly charismatic CEOs) are receiving this additional capital. Post-bubble, such CEOs are in much shorter supply. OK, you may be saying, this is all very well, but what new technologies are hot? This is no longer a particularly relevant question for venture capitalists. What was hot mattered when you could go from start-up to IPO in eighteen months. If your Sand Hill Road neighbor’s online exchange for overripe lemons was selling on NASDAQ for 100 times next year’s projected revenues, then rushing to create a watermelon exchange to take public had a certain short-term logic. Without a hot new-issue market, different rules apply. It’s back to basics for venture capitalists. Today, what matters most is whether a business can be created that can grow and be self-sustaining without a tremendous investment of capital. This puts the focus on what IT customers are buying today and the new venture’s business model, not what nifty stories involving technology can be sold. So what new software applications are enterprise IT customers buying? The short answer is as little as possible, and what’s left falls into two categories. The first is only what is absolutely necessary to keep IT operations up and running and secure. New companies with security solutions for protection against viruses, crypto-terrorists and just plain thieves are plentiful, and many are being funded. All are proud that the CIA, DOD or NSA has bought their product. Unfortunately, sometimes they’re too close to being their only customers. But there is a real problem here needing a better solution. The second category getting past the IT approval process is a purchase with a very high ROI and almost instantaneous payback. It’s strictly “SHOW ME THE MONEY!” and tomorrow is not soon enough. This is bad news for vendors of big-ticket software solutions with lengthy integration schedules. In the bubble years, many venture capitalists weren’t interested in software solutions that sold for less than a million dollars; the opposite is true today. It’s also bad news for new, relatively unproven technology. Everybody agrees that “the network will be the computer,” but the number of venture capitalists willing to back vendors of general-purpose peer-to-peer computer systems probably equals the number of CIOs willing to bet their jobs by rapidly deploying this technology today. Rapid ROI is often most easily achieved by better utilizing the IT assets already deployed. This is good news for providers of tracking, testing, monitoring and management solutions. There has been a significant inflow of venture capital to companies in these areas. The tightness of funds has not been all bad. Indeed it’s created some new opportunities in hard-hit industries, such as securities. Even the larger firms there are finding they no longer have the resources to develop every necessary software application in-house, or the luxury of losing money on some in-house processing activities. Outside service providers that can perform these functions more cheaply, quickly and often with higher quality by using technology and/or offshore locations are attracting customers and venture capital. An emphasis on robust business models has led many venture capitalists to take a new look at services. VCs like these businesses’ recurring revenues and high switching costs. If the technology/software component is high enough, scalability is a manageable issue. My firm, Milestone Ventures, has made three investments this year. All closely fit this model, and we are looking at more. Electronic data capture for clinical drug trials and back-office processing—with daily valuations—for hedge funds are examples. By this time, you may be getting a little exasperated at the VC community. Surely, some venture capitalists are looking past the present to the future. If so, what are they looking at? What is the NEXT BIG THING in IT? Like in the commercial….shhhh, don’t tell anyone, but…. It’s the same as it was the last time. It’s the Internet! It’s likely to be the BIG THING in IT for the rest of this decade. The use of the Internet and related technologies, such as wireless, to streamline and enhance business processes both within the firm and with its partners and customers is just in its infancy. The enabling technologies that begin to realize the Internet’s potential, such as XML and Web services, are just coming online. Plenty more will need to be developed. As computing and storage resources transcend firewalls, security problems will grow. As the computing environment becomes more complex, management systems will need to be more autonomic. Information storage and retrieval from disparate systems and among firms and persons with varying levels of trust and authorized access will challenge current technologies unable to help us find the information we want on our own PC. In short, there will be no lack of problems and, hence, opportunities. So, as we assess the management and underlying technology base of prospective investments today, we are doing so with an eye to how they will be able to help meet the coming challenges of the second wave of the Internet era, the NEXT BIG THING. ---
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