Investment strategies for non-US VCs
This post is inspired by comments that I’ve been receiving over the past year on a post about the past and future of the Silicon Wadi (Israel) and a recent discussion of a few colleagues on the venture capital community.
Before I dive into the details let me give the bottom-line for non-US VCs and entrepreneurs: You can’t develop and take a product to market, being far away from the market and the eco-system. (with a few exceptions I will mention later on). Find and nurture your own competitive advantage.
With you permission, I’d like to start by examining a number of sectors.
Online Consume – Silicon Valley – The source of tweets and dittos
Having lived in the Silicon Valley and abroad, one can’t imagine how different the market looks like in and outside of the Silicon Valley. Let me highlight the difference in two aspects:
– Consumers – Ever wondered who are the people that order limousine services through their iPhone wherever they go (Uber), pay with their smartphone (Square), share their credit card purchase history online (Blippy) or share what they plan to do rather than what they are currently doing (Ditto) – Most likely these are the ones sitting at coffee shops at University Ave., work around Mission or Market st. in San Francisco or Shoreline in Mountain View. They are in most cases the early adopters and in some case the only adopters. It can be most challenging to understand this audience while living in Berlin or Paris or even by visiting San Francisco for a week. Look at the following two graphs and tell me which startup is likely to better understand Twitter or iPhone users and develop a service to address their needs.
Figure 1: Twitter users by geography
Figure 2: iPhone & iPod distribution by geography
– Eco-system – Over the last week I’ve attended events by Guy Kawasaki – Apple evangelist and founder of Garage Technology Ventures, Konstantin Guericke – LinkedIn Co-Founder, Jack Dorsey – Twitter’s co-founder, a launch party by an exciting new social travel startup (Gogobot) and a lecture by serial entrepreneur Steve Blank. Apple’s iPad 2 launch, the crunch awards in other events also happened recently in San Francisco. This eco-system, that keeps introducing you to new ideas, technologies and opportunities, as well as experienced entrepreneurs that share their experience and are happy to talk to others, is key to understanding the market and developing future successful online products and services.
Many years ago Porter claimed that geography with many competitors is not favorable. Not any more – Where there is competition there is knowledge. There is the reason why many media companies are located in Los Angeles, many gaming studios are located in Korea and North Europe and many internet companies are located in the bay area – The ecosystem.
Even startups that started in other places within the US like FourSquare (NYC), Facebook (Boston) and GroupOn (Chicago), moved to the bay area early on.
Having said that, a few exceptions do come in mind. Let me mention a couple of them: Dapper , acquired by Yahoo , FraudSciences, acquired by eBay , CityDeal, acquired by GroupOn and Qype / Xing , the European competitors or Yelp/LinkedIn. All these examples (and others) are classified into two exceptions:
– Strong IP – Both Dapper and FraudSciences developed a technology and an Intellectual Property that was most valuable to the acquiring company. Think about the complex algorithm required to identify an online fraud and how valuable such an algorithm is to Ebay/Paypal. What about Go-to-market ? Well that’s why they were sold to Yahoo and eBay, offering remarkable returns to their investors and entrepreneurs.
– Local orientation – CityDeal, XING and Qype were based on business models that had a strong domestic element: need to partner with local businesses (cityDeal) or an entry barrier that was based on gathered local information (Qype) or the understanding of local culture.
A third exception worth mentioning – China: The market is China and so big and culturally different that companies like Baidu, QQ, Alibaba and CTrip were able to emerge.
To recap, if you are an entrepreneur starting an online consumer company or a non-US based VC focused on online consumer, unless there is a significant IP, a domestic component to the venture or you are based in a large domestic market like China – The liability is huge.
Enterprise Software / cloud computing – A centralized distribution and M&A activity
Generally speaking the enterprise software sector holds similar characteristics to online consumer, with the main difference being that the domestic enterprise market in many countries is big enough to reach a certain mass. But then again, companies that wish to reach worldwide markets need to either develop their own distribution channels (how many companies were able to do that in the last few years ? maybe SaaS will change that as it offers new distribution channels and customer acquisition economics) or use the established distribution channels or HP, IBM, SAP, NetApp and others (through acquisition or alliance).
In summary, while the needs of enterprises around the world are somewhat similar, getting to mass market requires tapping into the large distributors, either through partnerships, joint ventures or acquisitions. A venture with a strong IP stands a good chance of getting acquired by Computer Associates, SalesForce, Microsoft, Taleo and others. The focus on cloud will certainly push forward investments in this sector on the one hand but reduces dramatically the barriers on the other hand. If I were a non-US VC I would be very selective on investments in this sector.
Enterprise Hardware and networking – Enterprise hardware and networking is different than enterprise software by the fact that Intellectual Property (IP) plays a more significant role. The long research life cycle is a big barrier that enables small companies to innovate and build products that are harder to replicate and easier to acquire. Getting to market – again, requires established distribution channels (Cisco, IBM, Dell). Tandberg (Norway) and P-Cube (Israel), acquired by Cisco, are good examples of small companies that developed such a valuable IP. Having said that, today most of the established enterprise HW companies are based in the US and many of their acquisitions are of US based companies (HP’s acquisition history, Cisco’s acquisition history)
Telecom – Help my service provider re-invent himself
I’ve separated the telecom sector from the networking sector for one good reason: The telecom market is relatively small and consolidated with a few hundred of operators around the world. Given that, it is somewhat easier to reach the market. If each account manager leads five accounts on average, with 20-30 account managers a company can have a good coverage of the market to drive sales. Historically, the sector offered a good opportunity from exit through acquisition – Cisco, Juniper, Ericsson, Nokia and others, unable to innovate in all the sectors they were operating in, used to acquire some of the promising technologies at significant investments. Native Networks , acquired by Alcatel and Chromatis , acquired by Lucent, are good examples.
Unfortunately, the last couple of years haven’t been too good for telecom operators and the fierce competition led to a focus on cost & price reduction, leading to a market consolidation (Nokia-Siemens, Alcatel-Lucent and Nortel’s bankruptcy) and minimizing opportunities for innovation. The opportunity for US and non-US startups is in helping service providers re-invent themselves, by enabling new business models and new sources of revenues.
Gaming – Increasing number of M&As in general and cross-border M&As in particular
The industry is still at its infant stages but four pieces of information emerge:
– There has been numerous M&As in recent years and I expect more this year. In 2010 we’ve seen 50 transactions aggregating $1.2B in disclosed value (21% increased over 2009). Note that 14 of these transactions were cross-border transactions.
Future M&As will be driven by three types of acquirers: The free to play platforms (e.g Tencent), traditional gaming companies (e.g Activision, EA) and media companies (e.g Disney, News Corp.).
– Distribution barriers online and on mobile are lower than those of packaged goods. Moreover, traditional gaming companies like Electronic Arts & Activision are looking for next generation gaming companies while pushing aggressively towards online/multi channel Gaming as a Service (MC-GaaS).
– Asia (Korea,China), North Europe and the US emerge as the center of gravity. The gaming market in China is currently the biggest market. According to ThinkEquity, the ARPU in China is 5-6 bigger than that in the US and South Korea enjoys that trend to a large extent on both the demand and the supply side.
– Recent exits for gaming startups were at the x7 on revenues, driven by ability to scale at a rapid pace.
Given that, I see numerous opportunities for non-US VCs and entrepreneurs in this sector, with the only disclaimer that one still needs to be where the market is. Different cultures adopt different flavors and business models: mobile gaming, social gaming, XBOX and other specific purpose device games etc (though multi-channel GaaS is emerging to as the most promising trend) . The result – across the globe innovation.
Clean-tech – Regulation drives Europe and Asia ahead
Maybe the greatest and most promising opportunity for non-US investors and VCs for a couple of reasons:
– Innovation – Unlike the telecom market, the cleantech market nurtures innovation. Competition is still based on innovation rather than just price.
– Market – Europe and Asia are far ahead of the US in terms of pro-cleantech regulation. Germany, Italy and China, for example, are producing significant amounts of their energy with Solar, Wind and other alternative energy sources. The US – only 0.5GW of the total 140GW energy produced in the US is produced through solar – 0.5%.
– Big upside – online consumer and enterprise markets are dominated by a small number of companies. The clean-tech industry is still at its infant stages and offers a room of new dominant players. On a national level, countries that will be lead the way towards oil independency, will boost their economy and gain a long term competitive advantage.
It is important to note that many clean-tech (especially power generation related) investments are capital intensive and the investment cycle challenges the traditional VC business models. Many of these investments will require tens or hundreds of Millions of initial investments and will turn profitable over 10-20 years, calling for either intensive syndication or new types of funds.
In summary, the market for alternative energy is not in the US. Regulation doesn’t foster innovation and the transition for a country as big as the US is going to be slow. Governments in Denmark, Germany, Israel and Italy offer a great test bed and local support to kick alternative energy related ventures.
Summary – local eco-system as an investment strategy
To summarize, the preferred location for a startup should be with close proximity to its market. It is difficult for entrepreneurs and investors to understand consumer needs remotely and more importantly – understand their purchasing behavior. Non-US VCs and entrepreneurs should leverage their competitive advantages: talented engineers that can develop algorithms or superior hardware , software/online services that require domestic partnership or localization and the emergence of eco-systems for new industries outside of the US.
My perspective: I’m a former intra-entrepreneur and a current entrepreneur, a consultant to a number of startups and VCs in the Silicon Valley. I majored in Entrepreneurship while at the Stanford Graduate school of Business (Sloan Program) and I’m deeply involved in the entrepreneurship and VC community here in the Silicon Valley. Having said all of that, I’d love to hear your comments and perspective.
Shani's Business Review (SBR) 
As a cleantech startup based in Taipei (Greater China), I can tell you we’re having a hell of a time with the startup ecosystem over here. There seems to be nothing happening for entrepreneurship apart from what the IT and Mobile world are doing. To such a point, in fact, that we’re working on launching the first monthly meetings for Cleantech in Taipei. We essentially have to create our own ecosystem to keep on.
This is a shame, because the market opportunities are truly ripe for the taking, and the ecosystem of manufacturers and OEMs is splendid.
Edouard,
Thanks for the reply.
As you noted the market opportunities in Greater China (and more broadly in Asia & Europe) are big.
The challenges in these areas have to do with the structure of the ecosystem and the mindset of the investors. Just today i had a discussion with a friend who has an incubator in Taipei. I heard a similar feedback. Europe faces similar challenges, given the risk averse nature of investors there. I’m wondering if strategic investors might be an interesting source to tap into.
Best, Shani