Go West, Young Entrepreneur

As you well know, the market in the US for information technology products and services has been in the doldrums for the last 2-3 years.  From my on-going discussions with CIOs, IT managers, and service provider business managers, I feel that the (lack of) spending has bottomed out and will perk up in 4Q03 and significantly more so in 2004, barring egregious international events.  

From a Silicon Valley start-up perspective, this news isn’t as good as it might sound.  There remains a deep-rooted conservatism within the US IT decision-makers.  When the spending spigot gets turned on a little bit, the majority of the released funds will go to established vendors for established product types.  It’s going to be period of replenishment to upgrade and augment the existing infrastructure rather than radically changing it.  Established category leaders such as Cisco, Microsoft, Oracle, EMC, Network Appliances, Veritas, Siebel, etc. will probably do quite well.  As part of the ripple effect of this, their suppliers (semiconductors, software, manufacturing, services, etc.) will probably also do well.  But start-ups who have been sitting on systems products waiting for service providers and large enterprises to start spending again will not benefit directly so much. There may be some exceptions to these broad statements in various discrete market segments.  But in general, I think continued suffering for systems/software start-ups will be the rule.  The only good news for them is they might benefit because the big companies’ stock price will probably go up and they will see the need to refresh their product lines via acquisition.  2004 will be a big M&A year due to the confluence of many start-ups “giving in” and bigger companies agreeing to their (now lowered) price points, using a more inflated currency.

The standard winning formula for the past 30 years or so for an IT start-up company was to assess the US market, build a product that addressed a need within that market, hone and cost reduce the product for that market, establish yourself as the product category leader, and then 1-3 years after introduction in the US, get serious about building out the channel in Europe and then the Far East to expand the market opportunity.  The feeling was that this sequence of timing was right because (a) the US market represents the Big Apple of the IT market – if you can make it there you can make it anywhere - and (b) the needs of the “quaint” European and “backwards” Pac Rim markets always lag the US (except for England and Australia of course, where they speak a somewhat understandable version of the same language).  

This formula is still the built-in bias of all Silicon Valley-based systems start-ups I am aware of (that still exist).  The assumption is although times are tough right now, it’s just a business cycle and things will soon return to normal in the US.  But I actually don’t see the environment getting all that much better very quickly in the US for systems-oriented start-ups.   Over the past few years, enterprises have learned that they can live without the shiniest and brightest new thing, to the point where it is considered job-risking to even suggest differently internally.  It’s going to take awhile for the situation of the past few years to flush out of IT’s collective memory and for people to start taking risks in hopes of big gains again.  Most solutions from start-ups today are carefully picked over and chosen in a tactical way by IT, kind of like a weekend shopper approaches garage sales, where there is curiosity but no real compelling need.

The spending of US carriers and service providers is highly influenced by the policies of the US government.  Right now such policies are oriented towards protecting the existing carriers, even if they don’t invest, which is exactly what they will (not) do until prodded otherwise.  Even when they do spend, their scale drives them to working only with very large established vendors. 

So the low spending and risk avoidance inertia within the US will last for more than just a few years, I think.  More importantly, I believe that the US market may no longer be the sole battleground on which new technology gets tested, vetted, hardened, and where winners and losers are identified.

As I think we all know, many manufacturing, call center, product development, and QA jobs have been moving to exotic places where employee costs are lower – such as India, Russia, mainland China, Taiwan, Korea, Singapore, Kansas, etc.  Just about anywhere other than the Silicon Valley.  This is disturbing, but predictable.  IT education is excellent in those areas and for many aspects of what our industry does, an educated population is the main natural resource required to participate.  Another enabler is a computing and networking infrastructure that allows those knowledge workers to be productive and to interact efficiently with clients throughout the world.  Governments and companies outside of the US have been spending consistently to achieve the necessary infrastructure.   As a result, the percentage of citizens in these countries that are technology users is rapidly increasing.   Pretty soon there will be 10 knowledgeable, discerning, and active users of technology outside of the US for every one within the US.  So much technology has “trickled down” that down is now up.  The center-of-mass of IT spending is shifting to a non-US longitude.  This is not a temporary condition.  It’s a permanent shift in the balance of power. 

Not only that, but in many cases the nature of the infrastructure requirements will be different outside of the US.  Because of initial conditions and the lack of installed base, the fundamental infrastructure in Pac Rim and Mid East countries is different from the US in many basic ways – the amount and usage of copper and fiber, the focus on wireless solutions of various types for services supported in other ways in the US, the rate of adoption and types of non-PC-based clients, and the need to support many services over IP simply due to the lack of a legacy TDM infrastructure.    These users also have been trained to have fundamentally different assumptions about service delivery, billing, security, etc.  As a result, I expect the evolution of these networks to take them further and further away from US norms and therefore drive the need for new products that will either be unique to their needs or will represent the bleeding edge of what will eventually be required in the US.  In other words, there will either be a parallel market established with its own requirements and ever changing product category optimizations, or new products and technologies will get vetted off-shore before coming into the “quaint and backwards” US market.  In either case (and I think the reality will be a mix of these effects), this represents a different game with a different set of rules than we’ve been playing for the past 40 years or so.  US vendors will lose this game if they approach it the way they do today.  The result will be the emergence of more new foreign-based vendors like Huawei, who start to take a big portion of their local (and our off-shore) market share, and then perhaps even become more significant players in the US. 

From our perspective, this is a very bad scenario.  Our industry runs the risk of become regionalized to North America only. All of our major corporate institutions in the network infrastructure space risk taking on the look and feel of Siemens! 

We can’t stick our heads in the sand and say it won’t happen.  It will if we don’t take appropriate actions.  This isn’t the same as the industrial revolution where the US had an unfair advantage because of our natural resources.  This isn’t the same as the age of the transistor and computer, where we had an edge due to our more advanced higher education and research infrastructure.  The world has caught up when the requisite natural resources to succeed are brains, education, and fast moving bits instead of coal, wood, bauxite, copper, silver, oil, and lots of area for grazing and crops.

What this means, I think, is that we need to embrace the situation and take more of a foreign market focus.  Instead of selling what we can off-shore when we get around to it, in many cases we need to view off-shore markets as the primary initial markets and then expand from there, possibly back into the US market, possibly not.  We need to get this right or we’ll end up with our major IT product vendors sinking to the most embarrassing situation they can possibly be in – lobbying Congress for tariffs against imported IT equipment! If that’s not a symptom that a US industry is on its last legs, I don’t know what is.  

“Getting it right” means much more than defining the product right.  It means understanding how to sell and support that product in every sub-market represented by the global term “off-shore.”  It means understanding who to partner with, who to trust, and who to avoid.  It means figuring out the right company configuration, between US and off-shore assets. 

Whenever I bring up this concept with entrepreneurs a stock response is “Silicon Valley investors don’t like foreign-oriented companies”.  My response to that is “find more creative VCs”.  Dinosaurs die.  Mosquitoes live on. 

I don’t claim to know all the answers to “getting it right.”  I’m learning just like everyone else.  But I’m incented to learn because I think the stakes are very high.  To accelerate the learning curve, I urge entrepreneurs to get help in figuring out the foreign markets.  There are several companies I know of who have been set up to help facilitate US companies in doing business overseas.  Most of these were set up to help under the “old rules” of taking US-oriented products to off-shore markets.  But in some cases their practices have evolved to help companies figure out foreign markets as their primary target.  A few months ago I played golf with Howard Kim, the CEO of Jay-Young Company (www.jay-young.com).  Jay-Young got on my radar screen because they provided very useful services to some of our clients, such as Inkra and Amber Networks.  While playing golf, Howard described his business to me and the services they provide.  They have several people in the US and a couple of dozen or so situated in-country in various major target countries in the Asia-Pacific region.  The combination allows for efficient communication and program execution between the US and Asia-Pacific entities (manufacturers, end customers, service providers, channels partners, etc.).  I know Howard has been very busy because his golf game was not all that sharp.  To help prevent him from having more time to practice, I would encourage almost all entrepreneurs to make a call on Howard (or someone else providing similar services) to see what they have to offer to help hone a strategy that has a large off-shore target market component.  I would also urge entrepreneurs to hone their criteria for VC selection to add more weight to those VCs who have an understanding and influence overseas.  Maybe these are Silicon Valley-based VCs, maybe not. 

The world will be a very different place a decade from now depending on how successful we are in collectively figuring out how to address global market opportunities.  My biggest fear is that our US-centrism will get in our way.   There are risks to “going west,” but even more risk in playing by the old rules when they have changed on US. 

What’s the overall theme of the analysis above? I think its a few things:

1.      Most of the predicted or hoped for NBTs of the past few years are still out there and are happening. But the pace of market development has been and will continue to be slow, which shifts it from a start-up game to a large vendor game, at least from a finished product or systems point of view.

2.      In general, as a start-up, these days it’s better to be an arms dealer (fabless semiconductor, software, services) to the big guys as they fight it out than to compete directly with finished goods products.

3.      There may be exceptions to the above in certain security areas where a combination of more complex features AND scale are needed.  Usually, it’s up to a start-up to take the fresh ideas and adopt the risks associated with progressing technology simultaneously on both those dimensions.  I also might be wrong about storage management software and/or the opportunity for a new server company to blossom. There may also be some other opportunities not mentioned above – like the Next Gen wiring closet switch or Branch Office optimizations.    I have some ideas in those areas but I’m not giving them away for free.  But in general, the exceptions are far less numerous than the rule that big companies and low cost manufacturers rule the day right now.

4.      In many cases, the early and potentially biggest market opportunity may not be in the US in the foreseeable future.  That has tremendous implications for us Silicon Valley types.  More on that next month. 

(volume 6, number 11)