Focus on the fittest

Telecommunications Americas, June, 2004 by Ouida Taaffe

There is, supposedly, an inherent balance in the VC market, a bit like the ecological balance seen in nature. Observers argue that not only are VCs and the start-ups they fund part of an ecosystem, it is one that is becoming increasingly complex.

One of the main issues in the market, according to this ecosystem argument, is that the business of telecom operators is, itself, an increasingly complex proposition. If they simply truck capacity from A to B, or even Z, they become utility providers. That, in turn, means keeping margins as fine as a razor and resigning oneself to low growth, which is not an option that--at least if their public statements are to be believed--appeals to many. "We need to innovate quickly, but we don't have sufficient human resources to do that," says Francesco Caio, the CEO of Cable & Wireless, who spoke at the recent European Technology Investment Forum, in London. This need to innovate, Caio explained, is why large carriers like C&W are interested in small start-ups.

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There are, however, VCs who do not see telecom operators as significant innovators. "Some telcos do actively look for new ideas--Telecom Italia, for example. However, there is no great fit between what telcos want and what start-ups can offer. [Wireless] telcos don't need differentiation. They are pipe guys. They need networks that function and a brand," argues Jean Schmitt, a partner at Sofinnova Ventures, a Paris-based VC that focuses on start-ups in the wireless market. "Handset manufacturers, however, are a great way for start-ups to get into business," he adds.

Many wireless operators would strongly disagree that they are just "pipe guys." They certainly spend a great deal of money on trying to mold the individual user experience. Vodafone, for example, has its own portal, Vodafone Live!, that offers users a "Vodafone" look and feel. Schmitt, however, is not convinced that this sort of approach equals differentiation. "There is no real competition between [European] wireless operators. They have done a great job, however, in creating an impression of competition. New handsets [for example] are a way for them to get more traffic on their networks, not a real way of setting themselves apart," says Schmitt.

Other VCs have a less jaundiced view of the operator/start-up relationship. "Now they will go and buy software and systems that start to drive revenue, though that's got to be demonstrable. They are also willing to consider smaller, venture-backed companies," says Martin McNair, a partner at Advent Venture Partners, a London-based VC that manages over [pounds sterling]450 million and is in the preliminary stages of launching a new fund. "They invest and are happy to invest in trials. They do it very gradually. It can take a year. They are also happy to look at revenue models that link sales to the rate of use, to the number of handsets. There aren't very many examples of this, but there are enough within the European operators to signal a change," adds McNair.

However, even if one accepts that telcos, whether fixed or wireless, want to innovate and that they have to turn to other companies to do that, there are still not necessarily rich pickings for start-ups. According to research from Forrester, CIOs and CTOs have cut supply lists by up to 95 percent, with the most serious effects being faced by the smaller vendors. Around 90 percent of CIOs, CTOs and CMOs, in both Europe and the United States, will not consider a deal above $100,000 if the vendor has less than $20 million a year in revenues, Forrester found. It is estimated that over 90 percent of start-ups would fall at this hurdle.

A further difficulty for small companies is that the established vendors "are being very selective in acquiring feature/function to boost their offerings," J. Carl Allen, director of the VC program at Forrester Research, points out. This means that getting a foot in the door through a big vendor--whether through having the business acquired or through finding a partner--is no easy task. The VCs that invest in start-ups need to help them market effectively, Allen believes.

Simple Propositions

VCs are quite pragmatic about what the pressing issues for operators are. Revenue assurance is a recurrent theme, as is making the services that are already in place user-friendly. In selecting good ideas, VCs are also wary of straying too far into the wrong niche--that is the one inhabited by the dominant animal. "Either you get stamped on by the gorilla, because what you are offering is core to their business and they are doing it themselves, or you get picked up," says Martin Cheesman, a partner at Advent Venture Partners

Allen believes that VCs have good prospects if they focus on investing in business intelligence software, business process management and web services, managed security services, financial planning tools, speech applications and storage management software. Of course, within each of these broad headings there are numerous subsets, each of which is linked to its own ecosystem.