Disrupt or Co-operate

An allegation that has been levelled at European entrepreneurs is that they lack ambition. This is ostensibly a significant contributing factor that has led to the lack of globally significant technology companies developing in Europe.

We are facing one of the components of this with one of our companies at the moment which in broad terms lines up as follows:

1. We have developed a technology product that has the potential to significantly enhance the efficiency of a large services industry
2. The services industry has historically been slow to adopt new technologies
3. We are a technology product company and hence our natural instinct is to focus on selling software product

Conventional wisdom suggests it is much easier to sell our technology to the existing services companies and improve their efficiency. But because of the culture of these organisations this won’t be easy.

The alternative, and this comes back to the point about ambition, is to take on the service market segments, one by one, and disrupt the entire market with a next generation services business with a significant technology edge.

Clearly it’s important to understand how fundamental the technology is to the underlying services business. But I’m interested in investor’s & entrepreneurs instincts and experiences on this front – do you lean towards driving efficiency in the market or disrupting the entire industry?

Opportunities in machine learning

I continue to be intrigued by the potential that machine learning can contribute to internet offerings and human effectiveness in a broader sense. Clearly this isn’t idle thought as we’ve invested in this theme more than once. As we are all starved of time just keeping lines of communication open who has time to consistently process high volumes of data and drive improved insights & understanding.

The deeper the insights the more potentially valuable the technology. In the UK are we resourcing up for a world where data scientists will be increasingly valuable. On the surface these are roles that would appear to be hit by science funding constraints, which would be a shame. Behavioural learning frontiers need to continually be challenged; if globally we continue to push geographic boundaries and are making significant discoveries (http://bit.ly/TWIDeS) this should not be beyond us!

We are consistently looking to see how machine learning can be more broadly applied within technologies in the development of new markets and the disruption of existing ones.

Business software – yesterday, today & tomorrow

“The most important, and indeed the truly unique, contribution of management in the 20th Century was the fifty-fold increase in the productivity of the MANUAL WORKER in manufacturing. The most important contribution management needs to make in the 21st Century is similarly to increase the productivity of KNOWLEDGE WORK and the KNOWLEDGE WORKER.”

Peter Drucker

Yesterday’s business software focused on capturing data and reporting it upwards.

Today’s business software captures knowledge, data, sentiment and actions and plays it back, predominately upwards, but also sideways and downwards in an organization. It does it in real time and is cognizant of relationships beyond the organizational chart.

We are interested in tomorrow’s business software that will continue to evolve beyond what today’s software offers in striving for improvements in knowledge worker effectiveness.

What does all this Tech IPO madness mean?

Its turbulent times for IPO’s for technology stocks as companies with robust business models like Workday and LinkedIn gain ground and those with flaky, transient business models come under scrutiny from the hardened analyst community.

Whilst some canaries are now calling the implosion of Zynga (another 100 layoffs yesterday) the beginning of the end of the technology “bubble” – this feels like too broad a generalisation. What seems to be happening is that the broader market divide in valuation multiple between the stocks everyone wants to own and the rest is finding its way to Silicon Valley. Until now it has been tough to find the courage to short technology stocks but the current stock price disintegrations ( Zynga & Groupon to name the obvious) is only going to give the bears more confidence, so we can expect this differential in performance to continue.

Business model aside, another key element to maintaining stock price performance is the companies’ innovation engine. Whilst innovation is alive, optimistic investors have something to hang on to and shorts struggle to settle and build positions.

The key to innovation culture is the management team and its ability to attract & support talent.

In investing in private companies we always retain a primary focus on the balance and effectiveness of the team. But do public markets attribute enough value to quality of management? We need to remember that technology companies operate in fast moving markets and only great management can adapt to these twists and turns; good products can’t adapt by themselves.

A bit off-topic, but Yahoo looks like an interesting company in this respect. It’s rapidly building the right culture and team and with a few positive surprises this company could soon become a must-own (we don’t invest in the public markets).

So we are not overly concerned about what we see in the IPO market; however it does help to focus the mind on two key elements of a successful business that are not ephemeral; quality, cohesive management teams and products that breed deep commitment from clients and hence resilient revenues in all economic climates.

Venture caught in a rut?

I’ve been a bit heads-down for some time & it’s taken a thought-provoking manifesto from FoundersFund to force me to take a step back. Its true, there are so many behaviours that encourage “group-think”; from the casual conversation piece “what are you looking at right now” to the clustering of investment strategy around popular themes that give fund investors (false) comfort– there are unparalleled pressures on investors to pursue increasingly narrow mandates.

Equally for entrepreneurs there is the temptation to go where they know momentum is good – private sale website anyone – because they know that this is where consumer interest is currently piqued and that investors will happily open their cheque books in response to compelling month-on-month growth. I question whether micro-innovation will build the powerhouse companies of tomorrow. Whilst I appreciate Chris Anderson’s view that good ideas generally stem from existing ones, I suspect there is the danger that too many of today’s new business propositions are not innovating on enough fronts simultaneously to become the seriously valuable and distinctive businesses we aspire to build for the future.

Are we currently going through a phase of venture investing in marginal innovation, supported by incremental improvements where those increments are already proven elsewhere. This helps today’s nervous LP’s get comfortable with risking their capital in a sector with poor track record, but ultimately that sense may prove illusory. Given the difficulties managers experience in getting to critical mass, this investment strategy is a completely logical reaction but this capital is not taking real venture risks and so can’t expect its returns.

This may be where family offices and investors with non-institutional sources of capital come into their own. Ultimately outrageous returns are available to those that look beyond the obvious; who consider that to build standout businesses over 5-10 years takes a perspective that may well not be popular today. What they need, though, are entrepreneurs that dare to be bold

Startups on the racetrack

I’ve been thinking  about driving a Caterham 7 as an analogy for running a startup:

It has a very high power to weight ratio with rear wheel drive

It’s quicker over short distances than most racing cars

It’s most effective when travelling in a straight line with aggressive acceleration

It loses most of its effectiveness if you try to turn at any kind of speed and can easily spin out of control and crash

When the next corner arrives you need to slow down steadily, concentrate, turn tightly and get the car pointing in the direction you need to go next as quickly as possible ie. get the back (product) out

Then put your foot flat

Easter Hunt: where is the profitability?

An area that is often lamented by European entrepreneurs is the conservative approach that their target investors take to achieving profitability relative to their American counterparts. Whilst I don’t dispute a difference in attitude and appetite for risk, if you read some of the underlying thinking behind these investment theses and think through the logic behind investing in Fred Wilson’s “large networks of connected users”, I don’t believe American professional investors are discarding the importance of commercial success to the extent we may believe, rather they have changed their metrics. Anecdotally it is also interesting to hear that companies like Facebook were actually profitable at a very early stage which is probably a departure from conventional thinking.

The first implicit assumption that our US contemparies have become comfortable making is distinguishing bottom line profitability from unit economic profitability. It’s clear to me that the value of an Internet/software company should derive predominately from its ability to grow extremely rapidly (accompanied by potential to sustain/accelerate this), closely followed by the underlying unit economic profitability and its future prospects. That being the case “Net Profit” is no longer as relevant a measure of value in a startup or even developed Internet/software business, but financial guidelines are still needed to help steer the business.  Bessemer’s 6 C’s of cloud finance do a good job of this (http://www.bvp.com/cloud).

It’s not just the software markets that are being disrupted, it’s the way these companies are being valued too.

Take the large networks of connected users. By 2001 it was clear that Google had stumbled upon a way of effectively monetising an internet service that drew in the attention of millions of users. That monetisation has clearly been spectacularly successful. Is it really so difficult to believe that Facebook, Twitter et.al will be able to capitalise on user engagement to achieve significant commercial benefit?

The ability of US investors across the spectrum to appreciate and adopt a shift in valuation metrics, from investors in Salesforce at 10X revenues to start-up investors, creates the funding eco-system that is necessary to provide these companies with an unfair advantage in financing their quest to capture global markets.

That unfortunately is where we Europeans come unstuck. Much as we’d like to build the global Internet and software companies of tomorrow, unless those that advise the larger providers of capital this side of the Atlantic wake up, early stage investors in Europe have little option but to raise growth capital in the US (and hence start to migrate West) or sell early.