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Hoov's Musings (volume 3, number 12) |
The
Return of the Starship Enterprise
Mark Hoover,
President, Acuitive, Inc.
As I’m sure most of you know, for the past three
or four years the networking business has been all about the Service
Provider industry. Large
Service Providers have merged and consolidated, claiming that
bigness and critical mass is the success formula of the day.
New small and focused Service Providers have been spawned,
creating a rich new vocabulary of terms (Competitive LECs, Managed
Service Providers, Security Service Providers, IDCs/Colos, Hosters,
Network Service Providers, Storage Service Providers, Application
Service Providers, Application Infrastructure Providers, Portals,
Content Aggregators, Distributed Content Distribution Providers, and
my personal favorite – Service Provider Service Providers), each
of whom claim that the old guard doesn’t “get it” and that
focus and nimble flexibility are the keys to success.
For the most part, service providers of all types have been
richly financed by either private or public money to give them the
capital they need to put their infrastructure in place and market
their services. The general philosophy has been “if they build it,
they (paying customers) will come – in droves.”
Much of that money has flowed to the networking
infrastructure product companies, who have aggressively positioned
themselves as suppliers to the service provider community.
Large established vendors have worked hard to build and
acquire product lines relevant to the Service Providers, and to
point out that fact to Wall Street.
Hordes of start-up companies have been launched to address
one area or another of the Service Provider community; optical
transmission products, optical cross-connects, optical service
managers, MAN solutions of different sorts, optical components for
those products, Internet Traffic Management products, sophisticated
edge routers, bigger and badder routers, broadband access servers,
network-based services devices, IADs, and network management and
semiconductor companies looking to address the needs of all of these
product categories.
The capitalization of the product companies,
especially start-ups, has been even more pronounced than that of the
Service Provider companies. Money
gushing into venture capitalist funds has been re-directed into such
companies at an astounding pace.
In 1999 and the first half of 2000, companies who were
developing a product with no real world market validation and a
dozen competitors building similar products were pulling down $100M
financing round at valuations that make one wonder whether going
public would ever be a good idea, because the open markets (both
financial and customer) might not “vote” as positively as the
private capital market. But
people don’t give venture capital funds money to have it sit in a
money market account, so as the money flowed into them, more and
more companies have been launched on less and less of a solid
foundation.
The paragraphs above describe the formation of a
bubble, and as we have seen in the past few months, the bubble has
started to burst, as a domino effect of economic reality has been
initiated. As far as I can tell, reality struck first with the ISP/NSP
community. Their
problem is that they really haven’t been able to define and
deliver a set of value-added services that people are willing to pay
for. Most people look
to ISPs simply for transport. Even worse, if the ISP/NSPs do find an interesting new
service to deliver, competition generally drives the pricing down
quickly because it is difficult in these times for them to create a
technological or marketing barrier-to-entry.
As soon as someone discovers the whiff of an idea that may be
sale-able, all existing ISPs jump on it (and the VC community may
spawn dozens more quickly just to try to capitalize on the idea).
Soon, everyone is back to equality – and trying to win
business by dropping prices. You’ve
got to have a lot of money in the bank to win a war of
attrition like that, and few relatively new companies do, in spite
of record private financing.
So – the ISPs and NSPs experience revenue
shortages, which makes it difficult for them to pay their bills. This in turn hurts the systems vendor community both directly
and indirectly. They
lose revenue from the ISPs, but also from other Service Providers
that may be part of the ISPs overall ecology for delivering
broadband services – like the CLECs and ILECs acting as broadband
access brokers, who experience revenue shortages due to the slowness
of their ISP/NSP customers bill paying. As the systems vendors experience a slowdown, this in turn
impacts their suppliers – optical, semiconductor, and software
component suppliers – and the domino effect continues.
The effect of the above situation has already been
felt big time in the public markets.
Don’t be fooled, the hammering of Nasdaq in the September
through December time frame had almost nothing to do with uncertain
political transitions and dimpled chads.
It all had to do with unreasonable futures projections across
the board for all computing and networking related technology
stocks, returning to sanity in a time-concentrated manner.
There may have been a small overshoot in that return to
sanity, but not a huge one. Most
technology stocks seems pretty reasonably valued to me right now.
Now, Acuitive doesn’t spend a lot of time working
with companies in the public sector, we focus most of our time and
energy on start-up companies. What
is the impact of all of the carnage in the public sector on young
and middle-aged start-up companies?
I think there are two main impacts.
One is a greater selectivity by the financial community in
terms of who gets launched and who gets on-going funding.
This means fewer companies with vague and unvalidated
product/market strategies, fewer companies with green and incomplete
management teams, and fewer clusters of companies chasing the same
(real or imagined) market. The
rate of failure of existing start-ups - those launched in the last
18 months or so - is about to dramatically increase, as they
discover that cash flow is not a God-given right but something that
needs to be earned over and over again, and the community you earn
it from is going to be much more miserly in the near future.
This is not a doomsday scenario at all.
This is just a return to how start-up life used to be and
should be – a return to the survival of the fittest that makes
much stronger companies out of the ones that pass through the
hurdles and survive.
The second potential impact I see is a return of
focus on the enterprise market.
This market has been largely ignored by the systems start-up
community over the past few years because it seemed like the Service
Provider market had much more growth potential, more opportunity for
innovation, and fewer entrenched vendors.
Not that the enterprise customers have cared that much.
They had that little Y2K thing to occupy their minds for a
couple of years and have generally viewed the slowdown of new
technologies offered to them as a welcome relief.
But the venture capital community is a funny
animal. They are quick
to solve perceived problems that they helped to create.
As they view the glut of start-ups in the Service Provider
space, and as they see the market for their products pushing out and
slimming down, they are first to contemplate a “shift right” and
return the focus back to the enterprise.
Many times, just in the last two months, I have observed
entrepreneurial teams pitch to VCs whose reaction is, “very
interesting, but we don’t think there is a market in the (service
provider) space you are targeting – can we think of a way to spin
this as an enterprise play?”
The deer-in-headlight look that occurs as a response is quite
humorous to observe. The dynamic here is that it takes entrepreneurs a long time
to develop and validate a strategy, so the ideas for most of them
became rooted six months or so ago when anything to do with service
providers was considered hotter than hot, and then after a lot of
work they get in front of a VC, who just yesterday decided that the
enterprise is now hot.
But, as with most VC behavior I have observed which
is often mistakenly and derisively referred to as “herd
mentality,” there is a lot of wisdom at work here.
The Service Provider market truly is over served even under
the best of scenarios and massively so if their fortunes slip.
The enterprise market, however, is just there. It always has been and always will be. The enterprises are the ones trying to run profitable
chemical, insurance, manufacturing, medical, and other types of
companies, who may benefit from leveraging state-of-the-art
computing and networking technology, but whose fortunes do not
absolutely depend on it. In a sense, even the Service Provider market is just a subset
of the enterprise market, since it is the enterprises (and
indirectly – their customers) that pay for most Service Provider
services.
Almost all of the modern generation blue-chip
technology companies – e.g. Cisco, EMC, Intel, Microsoft, and Sun
became blue chip because of a focus on the enterprise.
For each of them, forays into the Service Provider space is a
relatively new aspect of their strategy (with varying results).
So if you are a VC and you want to launch a company with
potential grand slam potential, why not launch an
enterprise-oriented company?
Well, the reason is, there are plenty of hurdles in
that sector as well, which is one of the reasons why most investment
diverted from that space and to the (previously perceived) wide open
and dynamic Service Provider market in the first place.
Note that the few emerging companies who have been focused on
this space in recent years haven’t been highly successful. Ironically, most of the ones I am aware of are spending most
of their time figuring how to morph into a service provider-oriented
company.
The thing is, enterprises are conservative, both in
terms of taking technology risks as well as vendor risks. As a result, the enterprise market likes to choose single
vendor winners who become the trusted gorilla in their particular
space, such as Cisco in networking or EMC in storage, or Sun in
workstations. It takes
a lot to displace or end run these well-established vendors, who
often supply services, training, people, and other
relationship-sealing values as well as product. To be successful in the enterprise space, a vendor needs to
create something that is hugely compelling, massively discontinuous,
and underestimated by the existing vendor community. Anything less than that can usually be delayed, deflected,
vilified, un-interoperated with, or otherwise defended by the
incumbent gorilla until either the potential market opportunity goes
away or the gorilla acquires a filler for that hole in their product
line. For instance,
start-ups marketing bigger/better/faster versions of existing
product categories do generally succeed in large enterprises.
Unless the goal is be acquired by the gorilla, after causing
them some (mosquito-bite level) pain.
Completely new product categories that represent a new way of
thinking can succeed here and when they do, the rewards are huge.
It is in this battlefield where IBM lost it to DEC, who lost
it to Wintel; this is also where routing and Cisco displaced
circuit-switched data, SNA, and private lines, and where the
adoption of client/server and star-wired LANs launched Novell,
SynOptics, Cabletron, and 3COM.
All of these technologies were discontinuous and compelling
and therefore opened the door for a new generation of vendors into
the enterprise space.
I should mention that there are really three
enterprise markets. It
is in the highly visible high end as discussed above, gorillas are
made and ultimately relationships matter more than technology.
The dynamics in the mid-tier, and small business segments are
quite different. Small
business tends not to embrace new technology quickly so the winners
there tend not to be start-ups – they tend to be established
businesses with a broad channel and low-cost manufacturing
capability.
But the mid-tier often can be addressed by start-up
companies because the mid-tier companies, while name brand-aware,
don’t usually have the kind of deeply rooted relationship with
their vendors that large enterprises have.
Instead, their equivalent is a relationship with a VAR or
Systems Integrator. If
a start-up can establish a relationship with such channel partners,
they may be able to penetrate the mid-tier and at the same time
start to establish their brand, without showing up on the
gorilla’s radar screen for a while.
Bigger/better/faster can often succeed in this segment
because the VARS are constantly looking for ways to differentiate
themselves and they may have been locked out of relationships with
the gorillas in the particular product space.
They are willing partners just as long as they don’t have
to take on the burden of market education and “whole product”
creation that usually accompanies a discontinuous innovation.
I would point to Extreme Networks and Foundry as examples of
successful companies who exploited the mid-tier as a Cisco
end-around strategy for Layer 3 switches in the early phases of each
company’s development.
So my advice for start-up companies today who may
be assessing becoming enterprise-oriented is to first identify whom
the gorillas in their projected space are.
Then very honestly determine whether your idea is a
discontinuous innovation or more of the bigger/better/faster variety
(be careful because people tend to think of their ideas as
discontinuous even when they are not). If the idea is discontinuous and compelling – go for broke
and target the large enterprises.
Also read everything that Geoff Moore has ever written.
You have a chance of creating a legendary new company.
If your idea is more in the bigger/better/faster
category, examine carefully a mid-tier strategy for initial market
focus, combined with a breakout plan later into other market
segments.
However, if your idea just doesn’t make sense for
an enterprise strategy, and a VC tells you that’s the way to go,
tell them to take a hike. There
is still plenty of capital out there and companies are always best
served matching their technology to the most suited prospective
customer than they are chasing the financial community’s
strategy-of-the-moment.
(volume
3,
number 12)
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Hoov's Musings |
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