Milestone Matters -
Summer 2003 Newsletter
“A digital telephone call is information technology.
MP3 players are information technology.
Finding Nemo is information technology.
Cell-phone infrastructure and wireless technology are
information technology.
Now, what part of that is saturated?”
Andrew Grove, Chairman, Intel Corp., commenting in
BusinessWeek, August 25, 2003 on alleged IT saturation
Editor's
Corner
Dear
Friends, Investors and Associates:
In the SPRING Newsletter, I wrote that the
specter of uncertainty engendered by the Iraqi conflict had
evaporated with the ousting of the Hussein regime and that this was
hugely positive news for the world and the US business community.
I believe we are continuing to march in a positive direction
with the formation of the Interim Governing Council and the
continuing efforts to crush the remaining dissidents and to rebuild
the civil order. The
coming months will determine whether we continue toward a peaceful
transition or events spin out of control.
This is a political rather than a military challenge.
The brutal calculus of international politics and its
handmaidens - media focus and public opinion - will not be swayed by
the current periodic spate of killings of US personnel, tragic
though they are. But
sharp and sustained escalation would greatly complicate US hopes for
regime metamorphosis to something approximating a Western democracy.
My perception is that US policy will work with time---indeed
is working---but it will not be a smooth road.
The twin challenge of the Israeli/Palestinian
conflict is also now being fully engaged by all parties and it
appears that the world feels better in so far as energy is being
expended on complex diplomatic choreography rather than on killing.
Of course we have been down this hopeful road many times only
to meet with disappointment and more bloodshed, so the attitude of
most observers is made up of various ingredients: hopeful, watchful,
skeptical.
This is the larger optimistic, but tenuous
context, within which the US business community is operating. We are
increasingly encouraged by what we see.
The NASDAQ has risen 25% since the beginning of 2003 and this
trend has, at long last, stirred the IPO pulse.
Although wags have pronounced the IPO market,
"dead", the facts are otherwise.
There were actually 10 Initial Public Offerings in the first
half of the year and they enjoyed an average gain of 36% through
July 1, 2003. Probably,
among other factors, this high average gain reflects the fact that
these IPOs were conservatively (cheaply) priced by the bankers
and/or in this difficult market, only the highest quality candidates
were deemed eligible in the first instance.
(The exact opposite process from that which governed IPOs
which were sold during the bubble).
Admittedly, most recent offerings were for financial services
firms and very few for IT companies, but one has to start somewhere,
though the road back is likely to be long and slow for IT.
As to the gloom and doom year of 2002, the VC
business did not evaporate, but continues to decline to below the
snow line from the glorious and treacherous peaks of 2000.
During 2002, 2,368 companies raised $24.7 billion from 2,000
investors. Of
importance from MVP's standpoint, 281 companies located in the
states of New York, New Jersey and Pennsylvania, raised $2.5
billion. This year,
through June 2003, venture firms invested approximately $7.5 billion
in 866 companies of which 541 were within the IT sector.
Our NY metro IT focus continues to make good
sense. Last year,
almost 70% of companies financed were located in the major
metropolitan areas of San Francisco, Boston, Washington, D.C. and
New York. The
"connectivity space" including telecommunications, semi
conductors, networking products, broadband and wireless attracted
the most capital - 39%.
As to day-to-day MVP activities, we are quite
pleased in that we feel all five of our portfolio companies have -
by several objective measures - become more valuable since the time
of our investments in each. With
respect to the flow of investment opportunities, despite some quiet
incoming deal months, we have always been fully engaged in assessing
about a dozen opportunities, which is ideal.
This allows us to scrutinize each opportunity carefully.
Because of a number of variables beyond our control, it is
always difficult to forecast the precise timing of financings but we
believe that we will add two companies to our portfolio within the
current quarter.
My partners and I always welcome hearing from
you. We look forward to
seeing you and reporting in person on Milestone's progress at our
annual meeting on October 1st, 2003.
Yours truly,
Edwin A. Goodman
General Partner
Milestone
II Portfolio News
Knovel,
a provider of online technical reference information to the applied
science and engineering community, announced that 18 new customers
joined the Knovel Service in June.
Knovel expects the same number of new customers in July from
corporate, academe and government accounts worldwide.
Forty of the “Fortune 500” companies are now Knovel
customers. Knovel’s
renewal rate continues to run at 100%!
For the past two years, every single corporate, academe, and
government Knovel customer has renewed their subscription.
Additionally,
Glen Pagan recently joined the firm as VP of sales.
Mr. Pagan now manages Knovel’s sales, support and training
activities.
Octagon
Research Solutions, a
provider of regulatory and clinical information management software
and services to the life sciences industry, recently appointed Alex
Hase as vice president of sales.
Octagon also
recently launched its ViewPoint software solution.
ViewPoint allows project managers to monitor and control
every aspect of the complex regulatory submission development
process through automated workflow management, unobtrusive metric
collection, scenario modeling, issue tracking and flexible task
assignment.
In addition, Jim
Walker, President and CEO, has been nominated for the Enterprise
Awards CEO Under 40 Award. The
2003 Enterprise Awards are presented by the Eastern Technology
Council in partnership with PricewaterhouseCoopers LLP. The
prestigious awards recognize achievements in the technology and the
life sciences industries.
The
SME Market: Revisited
A few years ago, we
hated the idea of investing in software or service companies that
sell into the small to medium sized business (SME) market.
Today, to our own great surprise, we are willing to look at
SME deals seriously. What
changed?
Before answering
that question, let's examine why we originally found the SME market
so loathsome. In our
heart of hearts, we felt small business owners were: (a) too cheap
(b) technology averse (c) too shortsighted to examine ROI rationally
and (d) ultimately too difficult to close.
If you could get
over those showstoppers, you had to satisfy yourself that you could
acquire an SME customer at a reasonable cost.
But when we did the math, the customer acquisition cost
appeared too high relative to the customer's lifetime value, net of
installation and support costs.
You could quickly rule out a professional direct sales force
because of the low price point of the products relative to a
salesman's expense. This
left you with telesales or indirect channels.
Telesales has
worked fairly well for companies selling to larger enterprises in
certain areas, such as system management tools (think Computer
Associates), where the buyer is sophisticated and more
self-sufficient with respect to pre-sales engineering, installation
and support. Our
experience however, told us that smaller businesses often needed
more education and hand holding throughout the pre- and post-sale
process than a telesales team can provide. This conclusion drove us to consider the indirect reseller
channel, which I know from personal experience can be painfully slow
and frustrating to ramp up.
Lastly, and I am
guilty of using the following rhetorical question on many occasions,
how many software or technology-enabled service companies have been
remarkably successful selling to SME's?
The answer is always, "You can probably count them on
two hands: Microsoft, Intuit, Dell, Nextel, Great Plains, Symantec
(ACT! and Norton) and ADP."
You shouldn't even count Microsoft given its monopoly status,
and Intuit and Dell really gained visibility and traction as
consumer products initially.
Given that
devastating analysis, why are we reconsidering an area we have
traditionally eschewed? The
first reason is that our normal sweet spot, the large enterprise
market, has been equally unappealing for a variety of reasons, which
has forced us to rethink our long cherished assumptions.
With the exception of outsourced technology-enabled service
companies (all of our portfolio companies, to date, fall into this
category), early stage software companies have found the Fortune 500
very unfriendly the last several years: anemic IT budgets; endless
sales cycles; constant restructuring in the ranks of the decision
makers; vendor rationalization i.e. an increasing preference to buy
from fewer and larger vendors; and so on.
Of course, this is
a big change from what we saw in the late 90's, when large companies
spent aggressively on IT. Small companies on the other hand, remained as frugal as ever
(remember what a flop Onvia was?).
This is the first clue to our renewed respect for the SME
market. Small business
owners didn't buy during the bubble because they didn't see the
value. They didn't want
the distraction. They
didn't want their staff to get sucked up in endless integration
projects of questionable value.
They didn't want to spend $4 of services for every $1 of
software they purchased. They
didn't get romanced by buzzwords like CRM and EAI.
They didn't want technology for technology's sake.
They actually wanted the stuff to work…out of the box.
In short, small business owners aren't bad technology
customers; they turned out to be smart technology customers!
If we accept this
insight, that SME's are smart and not dumb when it comes to
technology, we need to determine if anything has changed in the last
few years which makes the prospect of selling software or services
to SMEs more tenable. It
turns out there have been several important changes worth
considering. First, the
ubiquity of broadband and the participation by an increasing
percentage of small businesses, makes possible the delivery of thin
client, hosted solutions. After
three years of improvements, we are now seeing technology companies
with mature and elegant thin client software applications that
really work and deliver value (i.e. salesforce.com).
Because the
solutions are hosted, an early stage software company doesn't have
the expense or worry of how the system will work on 14 flavors of
Windows or how it will react in numerous network environments.
Similarly, the hassle and expense of installing and
supporting shrink-wrapped software goes away.
Software bugs can be identified, fixed and deployed for every
customer in weeks. In
short, the total cost of ownership for the customer becomes more
reasonable and the economics of the software development cycle
become, if not advantageous, then at least neutral to the technology
vendor.
Another trend in
favor of technology companies selling to SMEs is the open source
movement. By adopting
an open source operating system, programming language and database,
price points for the SME can come down but margins for the
technology vendor can be maintained.
We still have to
address the biggest problem. How
do you sell to these guys profitably?
This remains a big challenge and we by no means claim to have
cracked the code. Direct
sales a la ADP is still tough, but not impossible.
You need several things going for you: a
"crackerjack" sales and marketing team and process; an
indisputable payback; remarkable ease of use; preferably, a
significant recurring revenue component; a costly and painful
business problem that is hard to solve otherwise; and a pitch that
can be delivered effectively in less than 15 minutes.
While employing a
direct sales model is possible, telesales and indirect channels are
more probable. Once
again, the proliferation of broadband opens up new possibilities.
Telesales people can perform remote Webex demonstrations,
which shorten the sales cycle considerably.
Also, setting up an indirect channel or franchise model
becomes much easier with a hosted product because the reseller
doesn't have to worry as much about training its technical staff,
which frees it up to focus on selling out of the gate.
Finally, lead generation through Google and email marketing
has been a boon to technology companies selling to SMEs.
While we have only
one portfolio company in the SME space (ExpertPlan),
we are seeing interesting companies with demonstrable traction.
An area we particularly find appealing is automatic vehicle
location (AVL) for small fleet owners.
IBM also recognizes the increasing importance of SMEs; since
2001, they have invested $500 million pursuing this market.
Our budget is a little smaller, but we are increasingly
optimistic we will complete a few more investments in the SME area.
---Todd T. Pietri, General Partner
Milestone
Venture Partners
Investing
in early Stage Enterprise Information Technology Companies in the New York
Metropolitan
Area
551 Madison Avenue, 7th
Floor, New York, NY 10022 V: [212] 223 7400 F: [212] 223 0315
www.milestonevp.com
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