The coffee shops of Mayfair

Web2.0 and venture capital

We ran a cracking event on Web2.0 on 18th November. Here are the notes:

 

 

My Introduction

 

What

 

My definition is that web2.0 is a collection of new technologies which are offered over the web which make possible a new set of products, services and business models.

That is pretty broad.

Tim O’Reilly goes into far more detail and comes up with 7 core competencies that define a 2.0.

The important thing, I think, is that there is unquestionably disruption.

Given this disruption, given the confusion and pace of change there is opportunity And there is innovation. And where there is opportunity and innovation there is, inevitably, venture capital.

 

Why now

 

Two reasons why; technical and cultural.

 

1) Technical innovations are enabling this market.

According to Neilsen/Netratings today over 60% of US homes have broadband connections. In six months times this is expected to be around 75%.

Bandwidth is no longer a problem for many web based services, and will become less of a barrier as time goes on.

2) Not only are the pipes bigger but there are more of them. There is now a ubiquity of access to IP networks from Starbucks to tiny mobile phones in your daughter's pocket. Internet protocol is everywhere.

3) We also have a brace of more granular technical enablers (many of which have been around for while) which are today being exploited to do new things:

• RSS news feed pushing user generated content,

• Ajax

  pushing web software & mashups,
• P2P lowering distribution costs
• Open-source & LAMP is pushing entrepreneurs to deliver value beyond commodity software.

 

Culturally

 

Another way to answer the question "Why now"is to look at what has gone before. The first wave of dotcom companies have been useful for a number of reasons.

These companies have experimented with hundreds of different business models. This means that today, both large corporates and entrepreneurs have a much better understanding of what the value chain is, and where they can sit within it.

We also have today an educated user-base. The dot coms spent lots to time and money promoting to both consumers and businesses. This has lead to the mass adoption of the web.

This brings us to the question of

 

Who?

 

My nephew is an internet power user. He is twelve years old. I have seen him concurrently listening to podcasts, watching web video and sending IMs all whilst copying his homework from the web.

My father thinks that the internet is what you get when you look at the MSN homepage.

Both search for, compare and buy products over the web. Both users are valuable.

 

When?

 

So, when does this new wave of technology collide with this hungry base of users?

 

It is happening now.

 

The evidence can be seen in current web economics:

1) Web advertising market share is predicted to be 6.9% in 2007 up from 1.2% in 2000 and at the expense of TV and press. (According to stats from Zenith Optimedia)

http://www.businessweek.com/magazine/content/05_47/b3960075.htm

 

2) The long tail of consumer demand is real. The web is one big low-cost route to market. This is why we have Bob Young: the founder of Red Hat software; leaving Red Hat and to set up Lulu, a long-tail publishing technology business.

 

3) Finally many entrepreneurs I talk to are telling me they no longer want, no longer need venture capital

Entrepreneurs are today launching web-businesses that have:

• a very low initial capital cost,

• a zero cost of customer acquisition,

• which are cash flow positive from day one or two

This means that VC money is a nice to have rather than a must have.

Yet these businesses are still very high growth.

 

How much?

 

Does the size of the market justify Venture Capital investment?

 

The analyst groups are still feeling their way around sizing this market. A better way of justifying an investment decision is to look at exits and ask: Do they justify VC investment?

 

The short answer is yes.

 

There are some very healthy early signs of web 2.0 exits.

MySpace. ($580mn Newscorp.)

ITV (£140mn Friends Re-United 28 times earnings).

 

Finally there’s also a business called Skype: one the best things to ever happen to European Venture Capital.

 

Skype was classic web2.0: using the ubiquity of IP, broadband, adding some clever technology into the mix and leveraging these to do something new.

Selected web based businesses are clearly making money. The challenge for VCs is to answer which ones?

 

 

John Battelle

Chairman of Federated Media publishing, Founder of Wired and industry Standard, Author of “The Search”.

 

Version 1.0 was very long on vision. Between 1995 & 2000 there was more funding and public funding than the market was ready for. Today the market is now ready for Web 2.0. Why?

1) Large amounts of money dedicated to research and development.

2) Much more opportunities and profits now, than in the late 90s.

3) In the early 90s, many believed the war was over who owned the window into the web, but the value lies in what is in the window and service and application that each user chooses to use.

 

The rise of platform sites e.g. Google, Amazon, Yahoo, eBay. They guys let other people build their business for them.

 

General principles of web 2.0?

 

1) Web is a platform where you can access web services, which are not controlled by one company.

 

2) Architecture of participation: whereby you watch what your customers do, encourage them to do it more; and figure out ways to let them build your business; e.g. Amazon’s recommendation system. All successful Web 2.0 businesses in one way or another figure out how to get their customers to build their business.

 

3) Innovation in assembly: Much is free on the Web. The value lies in how you package it, put it together, and deliver it. In Web 2.0 business innovation and assembly are key.

 

4) Lightweight business models: Businesses can be set up cheaply now using open source software and leveraging contract relationships e.g. Boing Boing a blog, has over 2 million readers & an overhead of £1000 a month, setting up such websites in the 90’s may have cost millions

 

5) Power of the tail: there are many opportunities in leveraging down the tail. Content providers can find bliss & an audience in the small, and make money without having to reach the head (e.g. Adsense is an excellent example of harnessing the tail, matching lots of advertisers and buyers using advanced technology).

 

6) Search rules: search is important in the economy because it drives web 2.0 businesses. The search is driving audiences and that is driving business.

There is still a significant gap between web advertising spending and web usage; but the money is gradually moving to where the audiences are.

Content is king: the best content gets found and once it is found, you can build a business around it. Media 2.0= lower barriers to entry so all comes down to who has best content:

Federated Media Publishing has been set up to make blogs profitable: to help leading independent authors turn their publications into sole-proprietor media businesses, at the same time providing media buyers with a scalable mechanism by which they can tap the audience loyalty and engagement that are fostered by the best blogs.

 

Judy Gibbons

Venture Partner at Accel. Non Exec Director of O2

 

Judy highlighted a number of key recent trends which she believes characterise “Web 2.0” and lead to opportunities for innovation:

 

Broadband penetration  The Internet is now constantly available and has become an intrinsic part of our lives. Broadband has also facilitated the “always-on” applications and enabled a new breed of applications (e.g. Instant Messaging). Users have moved from a transactional relationship with the internet, to an interactive relationship.

 

User Power: if someone doesn’t like you product or service, they are one click away from finding another one. There is now a “Darwinian” element to success on the internet: it is a “survival of the fittest” in terms of content provision; If your product is good it will get engagement, if its not good you will find out quickly.

 

Democracy. Extensive content coupled with online communities and the power of viral marketing mean that success on the internet now is democratic: users choose what they want, and so the key to success is to provide the best content.

 

Evolving Business Models: none of these ideas are new, people came up with them 5 years ago, the problem was they couldn’t build businesses out of them then as it was too costly, and you couldn’t get any revenue, whereas the advertising has changed this now. Huge amount from big advertisers around creating relationships online.

 

Less is more: a levelling of the playing field, the democratisation of participation. The barriers to entry are low, and if you are deeply connected in your niche area, getting constant feedback loops, allowing you to constantly refine and upgrade your product is a huge advantage over larger organisations, which have long product development cycles.

 

More exit options: large organisations cannot innovate at the speed of entrepreneurs. There will be a massive appetite from companies like Yahoo and Cisco to develop a core competence in acquisition and incubation.

 

Range of devices: People now depend on and are “addicted” to the internet in so many areas of their life, and want access everywhere they go: this presents massive opportunities with mobile internet people want the internet on the phone. While many operators have invested in their own ‘walled and semi-walled gardens’ for internet content, higher speed browsing on more capable handsets is likely to demand for access to the broader Internet.

The forces of openness from the PC internet are so overwhelming, that fairly quickly, one by one there will be an embracing of new open model, as the internet comes to mobile device. The paradigms of the value of the Internet in a mobile device are different, people will want to use it in a different way i.e. personalisation and location, so therefore there will be fantastic opportunities for start-ups.

 

Simon Levene

Managing director of Corporate Development Yahoo.

 

Amount of M & A has grown rapidly within Yahoo over the past few years

The opportunities with Web 2.0 are enormous, and gives rise to great investment opportunities.

The challenge that investors will face is that companies such as Yahoo are increasingly going to compete with VCs for deals. Historically Yahoo looked at VCs as a partner.

The cost of entry for many Web 2.0 companies is small; you can start businesses using open source software, get to market very quickly and cheaply, and monetize without having a sales force. Such companies capital needs are very modest, so VCs need to invest in companies at early stages, as there may never be a later round.

Its possible to tell whether a company will be successful very early on by looking at the frequency of usage. Such companies are very de-risked. & What Goggle, Yahoo etc have begun to realise that there is no value for them in waiting for month 12 before acquiring a company.

Nick Kingsbury

Global head of software at 3i

Drivers of Web 2.0

We are now in a post-broadband era.

This means that industry is no longer interested in the buying patterns of government defence departments nor enterprises but an increasingly focused on the end consumer. i.e. (typically Chinese female teenagers).

 

Opportunities

It is not one market; as it is not just one market, but thousands of markets.

Security could be potential serious bump in road. We need better security solutions, particularly where there are situations where there is trading going on.

3i have made a series of investments around the area of web 2.0.

 

Issues

US has been tapped into Web 2.0 ahead of

Europe

, but there is no reason why European businesses can’t succeed: just look at Skype. And remember that with the web, Geography does not matter.

The amount of money needed by Web 2.0 businesses are going down; web 2.0 businesses are capital efficient.

Is there a Bubble? There’s a simple way to answer this question: to look at price on the way in & the price on way out. As a VC in

Europe

the pricing of deals in the way in is not at crazy levels. In US, prices often too high. On the Way out: the success stories are getting very high valuations, but there are also numerous other underperformers. So in

US

bubble maybe developing, but not to degree of before because today there are real customers etc.

There were two things wrong with Web 1.0 (which have been solved with Web 2.0)

1) Timing. VCs overestimated how quickly it would happen. Change/ buying patterns take time. 5-10 not 2 yrs.

2) Impact. In 2000 VCs actually underestimated the impact of the web. . The impact of the technologies which we were looking at then and seeing now, are much more profound than we thought.

European vs. US venture deal pricing

European VCs face price competition not just from corporate acquirers but also US VCs.

VentureSource stats suggest 2004 Median pre-money valuations were at $12.5 in the US, but only €5.5mn in Europe.

It is true that the European venture market is still a little behind the US when it comes to competition on deals (Private Equity conversely are well used to the harsh winds of competition). It’s one of my jobs to tell VCs when they have lost a deal and I promise you, when it does happen, they don’t like it.

I recently asked a European VC about this US vs. Europe venture price discrepancy: Why, I asked, does it exist?

“From the demand side, there are comparably less VCs with smaller funds chasing deals”

But the next bit was what surprised me:

“From the supply side, European entrepreneurs are not sophisticated enough to run competitive processes and decide to go with an investor pretty early in the process”.

Early stage VC being killed by Internet companies?

The Web2.0 event we held last week was a roaring success.

I will be posting a full overview of the presentations as soon as we have done the aggregation, but in the mean time I want to do a few posts on some of the important themes.

 

VC experiencing competition on deals from Yahoo.

Simon Levene at Yahoo gave a careful warning to Venture Capitalists that, if they hadn’t already, they were soon going to be competing for deals against Yahoo!

This links to my experience of many entrepreneurs, who still pre revenue, are asking me for an M&A process rather than VC.

(its not just Yahoo though: could Google also be on the case?)

Simon Levene gave the particular example of Accel being out bid by Yahoo on Flickr, which has been well documented elsewhere.

The more I think about this the more I think it is a quirk of this particular moment in the expansion for web 2.0.

I have raised this with a whole range people and there are two people (who I asked at the recent Silicon Valley comes to Oxford event) who I think are worth citing;

Allan Morgan from Mayfield:

His point was that, like many times before, we are part of a cycle, and right now this is frothy phase where certain coampnies are paying up. This has also lead to the Angels coming out again in a way we’ve not seen since the last bubble.

(Note. The logicial conclusion of this is that Angels see a quick return on the horizon and the company goes for it: remember off a $250k investment it’s pretty easy to turn an impressive IRR in a 12 month window.)

Allan believes there will still be many businesses who want to grow a significant stand alone business and these will always need venture.

Evan Williams founded Blogger and sold it to Google. Now in his second start up, Odeo, he’s raised venture this time around. Why?

Simple really

Because this time “The opportunity was big enough”

It seems some things never change: venture capital is most perfectly suited to entrepreneurs who have a compelling path to a half billion dollar business.

Not a six month flip.

Web 2.0: forthcoming London event

So we have decided to follow up on our previous two events (opensource and mobile multimedia) with one event which, in my mind, draws many of the themes we've been discussing together under the moniker of web 2.0. I know there are many people who hate this term and many people who think it very useful ; I think it's a very convenient way of pulling together the themes that I see pre-occupying many of the more visionary VCs and underlying the more strategic acqusitions.

If you want to come along drop me a mail or apply via our website: http://www.firstcapital.co.uk/news/events.php

Its a great speaker panel:

John Battelle Founder of Federated media publishing http://battellemedia.com/

Judy Gibbons, Board of Directors, O2. Corporate Vice President, MSN Global Sales and Marketing. http://www.02.com/about/gibbons.asp

Simon Levene, Managing Director, Corporate Development Yahoo!

Nick Kingsbury, Global Software Head & Partner, 3i. http://www.3i.com/contacts/biographies/nickkingsbury.html

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Web 2.0: disruption creates opportunity

"Thomas J. Watson famously said that he saw no need for more than five computers in the world.

We now know that he was wrong…

...we now know that he overestimated the number by four."*

Web 2.0 is here but how do VCs and entrepreneurs make sense of the disruption and identify where the real opportunities lie?

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The speakers are:

* John Battelle, Founder and Chairman of Federated Media Publishing. Previously, Battelle was founder, chairman, and CEO of Standard Media International (SMI), publisher of The Industry Standard and TheStandard.com. Prior to founding The Standard, Battelle was a co-founding editor of Wired magazine and Wired Ventures. He is the author of "The Search: How Google and Its Rivals Rewrote the Rules of Business and Transformed Our Culture" (Portfolio, 2005).

* Judy Gibbons, Board of Directors, O2. Corporate Vice President, MSN Global Sales and Marketing.

Judy founded the MSN business in the UK and then went on to manage MSN Europe and then MSN International. She was most recently responsible for MSN sales and marketing across the US and 39 other markets worldwide. Prior to joining Microsoft, Judy held positions in systems engineering, applications development and marketing with Hewlett Packard and Apple Computer. In 2004, she was presented with an award for 'Thought Leadership' by the IVCA for her contribution to the digital economy.

* Simon Levene, Managing Director, Corporate Development Yahoo!

The Yahoo! corporate development group reports to Terry Semel, Chairman and CEO of Yahoo!, and is responsible for developing corporate strategy and leading transaction activities across the company worldwide. Prior to Yahoo!, Simon was at AOL Time Warner, Excite@Home, Goldman Sachs and the LEK Partnership.

* Nick Kingsbury, Global Software Head & Partner, 3i. Nick's role involves setting the strategy for investment in software and he is a key member of the team reviewing all software investments globally. He also works closely with the major IT corporates to ensure that 3i understands their strategies, and makes introductions at very senior levels for 3i's portfolio companies.

*Credit to Clay Shirky.

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The Internet is being transformed by lightweight & compatible software services, business models that rely on efficient lead generation, a very low cost of entry, and an equally low cost of scaling with huge operating margins.

ASPs, mashing, P2P, user generated content, monetising the long tail, podcasting, blogging, media convergence, AJAX, REST, cooperating internet services, multi device software, data syndication. What is this brave new world and where is the smart money going?

If the web is truly becoming one big operating system in the sky, how should VCs differentiate between the fads and the longer term trends?

This event is bringing together key individuals from the venture capital community, the entrepreneurial community and industry to stimulate ideas and discussion, through a number of short presentations from industry leaders, followed by a panel debate.

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Registration will commence at 8.15am with coffee and pastries, with presentations commencing at 9am. After the debate there will be an opportunity for networking, and the event will finish at 11am.

This seminar is by invitation only, and is open to venture capitalists, strategic investors, business angels and entrepreneurs.

Mobile and Multimedia: Do new mobile revenue streams present opportunities for venture capital?

We ran the second in seminar in a series looking at the web and convergence.

We wanted to focus this one on investing in mobile applications: multimedia over mobile is ticking up and convergence trends suggest that consumer want content irrespective of device or platform.

Here is a resume & semi transcript of the event:

On our panel was;

• John Yeomans, Director of FirstCapital
• Voytek Siewierski, Senior Vice President of DoCoMo Europe
• Charles Grimsdale, General Partner of Eden Ventures
• Patrick Parodi, Chairman of the Mobile Entertainment Forum

A wave of venture investment was made between 1998 and 2002 in the expectation that mobile applications and services would become the next engine of mobile revenue growth. Disappointment ensued as the market did not develop as fast as most had hoped or expected. However the sense is now that the tide has turned. Ring tones alone have become a $3bn market worldwide. Mobile data and applications are growing by about 20% per annum, and outside of the more established texting part of the market, the growth rates average around 40% pa or more.

John Yeomans of FirstCapital opened the seminar by stating that the nervousness in the minds of many VCs over the financing of mobile applications was for several reasons:

• more than most other areas of technology, telecoms came through more slowly than expected in the period 2001-2004; operators particularly cut back their capex; 3G took its time.
• small, venture backed companies could not control the end customers experience, which depends on the handset, the mobile operator and on the venture business' service.
• the industry structure, where most small venture businesses in this field, are constrained to dealing with about 500 large operators as customers.

However, he went on to suggest that things were looking up "the industry is into its next wave of development" with fast 3G roll out now underway, and High Speed Data services getting closer, giving a mobile phone the speed of a fixed broadband connection. For venture companies, he highlighted perhaps the most significant development as a large number of potential new customers, in content providers. With a whole new class of applications like content delivery; mobile data; streaming audio; video clips and even a mobile TV channel, the 'traditional' providers of content like Warner Music, EMI Music, and Paramount Pictures are joined by new entrants, ranging from Premier League Football Clubs to FT.com. More people to sell to, potentially unblocks the bottleneck in the industry structure, with a small number of large operators driving the whole market.

He identified a number of pre-requisites to achieve the goal: data services that work; service providers who know how to sell them; flexible billing and charging options; and still more attention on service integration.

In closing John categorised venture businesses in this field into three classes:

• the first wave, involving businesses such as iTouch (one of the biggest players in the field in the UK sold for an estimated £180m to For-side of Japan, which also recently bought Zingy and Vindingo in the US in a series of acquisitions creating a global player) and Bango, which is floating. He highlighted examples of this trend continuing, including Sorrent of the US, who joined with Macrospace to form Glu Mobile earlier that week. In general these businesses involve B2C type sales to end customers, with products including ringtones, games and consumer marketing.
• the second wave, typically platform plays and middleware providers, both of which provide server or handset platforms to support applications and simplify their development. Ongoing financings are prevalent here, at least for the players who have gathered market momentum. In the UK in the last 18 months, there have been 18 wireless and cellular financings, 9 of which were in the field of mobile applications. Of these 7 were platform players like mBlox or middleware players like SurfKitchen.
• the third wave, of start ups in new application areas. The range is wide and these are only starting to enter the VC market, but applications are in the new multimedia areas like audio and video streaming, management of content libraries, etc.

Voytek Siewierski of DoCoMo Europe focused on the importance of mobile operators in acting as an enabling platform, to allow venture capital backed companies and particularly mobile content companies to flourish. He highlighted the very good clusters of innovative, promising companies that develop content for mobile phones, which in most cases have been kept away from the consumer by mobile operators.

He went on to suggest that outside of SMS, the mobile data market in Europe is yet to be built, which is predominately due to the ambition of the mobile operators to control the entire value chain, arising from the simplistic belief that they control the customers. He asserts that operators in Europe have only a small window of opportunity left to generate revenues from the mobile data market but they can only do it by enabling other companies. He said "Operators must understand that they have to create a third party friendly ecosystem, create an open gate to other networks and then they should take a lead in mobile centered community. If they don't do it others will". In support of this assumption, he cites the success of DoCoMo's wireless internet portal i-mode which has 45 million subscribers: 90 % being active users. This generates revenues for both the operators and also the third parties, through a positive feedback virtuous circle, whereby the more content providers there are, the more customers come to the platform, creating a self profit mechanism.

Charles Grimsdale of Eden Ventures focused on the problems of the digital media market, which has been a difficult but not impossible market. Charles suggested that the peer to peer phenomenon created a tough environment for anyone trying to sell digital media today; the low price point of $0.99 per song creates a very low margin business, which may cause huge problems for record industry and retail in the future. He highlighted that when the transition occurs within the mobile space the mobile operators and content providers are going to have to increase the price to the consumer or the market will remain challenged. He went on to propose that the market has also been hindered by a lack of DRM standards, which makes content owners reluctant to release their content. However, he recognised that the introduction of OMA v2.0 could make a huge difference to the market, where by most of operators and device manufacturers have got behind it, creating a platform upon on which content providers can build a business, with a common infrastructure.

• Devices and operating systems are becoming very sophisticated - so the possibility of creating native applications, very high performance applications, native games and media applications to run on these devices, starts to become more realistic. There has been some consolidation in the operating system world, starting to think about deploying one application across multiple devices is becoming more realistic, but it's still a challenge, albeit more realistic.
• We are seeing mobile phone and consumer electronics convergence - consumers only want to carry one device - want to store, photos, music, games, video.
• The challenge that introduces is that not all of the media is going to be download over the operator's network: the vast majority will already be sitting on someone's PC. We need to approach how we are going to get that content onto the phone seamlessly.

Patrick Parodi of Alcatel, and Chairman of Mobile Entertainment Forum

• The Mobile Entertainment Forum is seeing a shift from being focused on games, messaging, to music and now to the mobile video space. The objective of the MEF is to accelerate the growth of the mobile entertainment industry, by getting the traditional entertainment industry companies to embrace it and recognize it as a place that's safe for them to generate revenue.
• We are still at the tip of the iceberg, even in the ring tone business - still a lot of revenues to be generated - download separate ring tones for each contact. The ring tone business needs to be tracked, e.g. through the ring tone chart which was launched in 2004, with the intention of showing record labels and publishers that it's not a fad.
• There is a 3 billion dollar gap between where the operators are today in terms of value generation, and what people are generating in terms of revenue from mobile content itself. That gap is going to increase because these handsets & devices have a capability that extends beyond the operator's ability to launch new services.

   

• 130 operators have launched mobile video services, and there are estimates of a multi-billion dollar market moving forward. (The statistics are starting to come through eg Mobile TV in France - 59% of 3G users are streaming video for over 20 minutes per month with over 5 minutes per session. Patrick noted the Orange France 3G TV service was launched with Alcatel )
• The paradigm is shifting - putting tv on a phone results in network being consumed more like a media company or broadcaster than a standard two way communication network. What we are seeing is a convergence of communication and delivery of video, moving forward very fast. Other points Patrick made:
• Global retail value of mobile content is $15 billion today expected to grow to close to $60 billion by 2009.
• 70% of the value being generated with mobile content is tied to the drivers: personalization, messaging, choice and convenience.

 

• The total value of mobile music market to rise by 39% in 2005 to nearly USD 5 billion.
• According to Juniper, gambling and games will dominate the market (after adult services) ($19 billion & $18.5 billion respectively). Mobile video will be next.
• According to Strategy Analytics, global sales of music and video by operators amounted to just $792 million last year, including revenues for both network usage and content fees. The total market for mobile content delivery services was approximately 4 times bigger.

 

• The number of rich media enabled devices and the consumer demand for rich media is growing faster than the operator's ability to address them with services. The operators are not keeping up with device capabilities and an "off portal" market has emerged.
• With operators now offering video content over relatively low-speed networks, Strategy Analytics estimates that by 2008, over 250 million users worldwide will be wirelessly accessing video clips (including sports, movies and adult entertainment), generating revenues of just under US$4.7 billion.
• Video streaming has had a successful 3G take-off. e.g. there were 11,000 video greetings on New Year's Eve according to Orange Intense, Dec 2004.

Question and Answer Session

A lively panel debate followed the presentations, covering a range of issues. These included exploring the market potential of mobile applications, the value attached to the mobile data market and where the revenue streams exist.

A point from the floor questioned the rational behind the closed approach of European Operators compared with the i-mode approach. Voytek noted that European Operators currently believe that they control the value chain and so take a closed approach to extracting value from it. He argued that this has not been successful and for the market to thrive European operators must open up their platforms.

Voytek highlighted that an initial set back limiting the success of i-mode in Europe was the availability of handsets. "European manufacturers treated i-mode expansion into Europe as a threat from the Far East initially and some how slowed it down, fortunately this way of thinking has changed and now we have all the major mobile phone manufacturers working with our i-mode partners, and i-mode is doing very well in countries like the Netherlands, France and Spain and hopefully it will do well in this country soon as well".

Peter Gardener, 3i, asked the panel whether they actually see the mobile date market becoming a viable commercial service that makes money. Charles commented that mobile applications could be successful, but it is dependent on whether there is going to be a traditional access method. "If it was an open broadcast and was funded purely by advertisements from the broadcaster, I could see it taking off rapidly". Voytek agreed, "I think it will be very successful, but we shouldn't think about it as a linear extension of the existing services on other platforms. Think about the internet, the new media never replaced the old media; you still read your newspapers, so the internet created demand for a new type of content; more personalized, there will also be a great opportunities for businesses providing personalised services".

Patrick went on to suggest that in the future music artists may do deals exclusively with mobile operator, and it could be a very interesting high margin business. He noted that there is an opportunity for the artists to stick it to the labels, but at the same time the labels need to educate the artist community about what's happening in mobile and how they can start building some margins in the mobile business.

Gerry Ennis of Doughty Hanson asked the panel how they thought the advertising market on mobile phones would develop. The panel contended that opportunities were definitely there. Charles commented that he could see a model emerging in which there are free to air channels which are subsidised by advertising. Voytek agreed, "While DoCoMo has tried to spare its customers from push advertising, this may change in the future. With the advertisers paying for the content and the end user having to watch the advert in order to get the free content. There is no other device that allows for a one to one relationship like the mobile phone, that is why the advertising community sees the mobile phone as being bigger than TV in the future".

The seminar concluded on a note of consensus that there are high growth, large market opportunities in the mobile sector, that there are increasing numbers of innovative new companies based on novel technology, and that venture funding in the area would show strong growth over the next few years.

Does open source software “change the game” for venture capital?

We ran a seminar on Open Source Software, trying to find out if some of the recent Open source software deals really did "Change the Game" for traditional software models, particularly:

1) Investment appetite for open source companies. (My research shows that the VC community has invested over $1.25bn into Open Source software companies since 1999. Furthermore this interest is accelerating. In 2004 there were 10 first round investments into new open source companies, which represents a level of activity in a sector of the early stage market not seen since the tech boom of 1999 – 2000. )

2) Does the trend fire a warning shot across the bows of more traditional software models, which form a significant part of many VC portfolios. (see details of the seminar transcript below to answer this one for yourself).

On the panel were

• Jason Purcell, CEO of FirstCapital
• Danny Rimer, Venture Partner at Index Ventures
• Deborah Magid, Director of Strategic Alliances at IBM
• Damian Reeves, CTO and founder of Zeus Technology

Open source is no longer just Linux operating systems. Venture capital investment is growing rapidly into a new breed of open source software companies, with a diverse range of offerings up and down the application stack. This has potentially profound implications for a wide range of companies which rely on selling expensive licenses for their proprietary software.

Jason Purcell opened the seminar by stating ‘In 1999 and 2000 much of the activity was in Linux based-businesses like Red Hat, SUSE Linux and Ximian. Now we are seeing a new diverse and exciting range of companies up and down the application stack: from CRM provider Sugar CRM through to server virtualization company XenSource.’

It was within this context that the panel members were asked to give their views on the opportunities created by open source software, particularly considering the following issues:

• Market: how big, when and how?
• Is there an investment strategy unique to open source?
• Customers: why do they like it; why do they buy it?
• Issues for existing software portfolio companies?
• IP, licensing & open source: compatibility problems?
• And to Exits…

Index Ventures has invested in a number of open source companies such as Zend and MySQL, and Danny Rimer commented that many have criticised these companies, suggesting they are more able to generate mindshare than revenues. Rimer however, said ‘The rate of growth of customer deployments of open source projects is astounding’. Rimer went on to argue that the LAMP stack (Linux, Apache, MySQL and PHP) are enjoying incredible growth within the enterprise, not only with online businesses like Google and Yahoo, but also ‘traditional’ businesses, for example Lufthansa runs its ticketing operation on PHP and Rentokil’s entire IT infrastructure is based on open source.

There are many good reasons lying behind the strong uptake of open source software: it is robust, reliable, good value and it avoids vendor lock-in. In fact some vendors are finding that the customer demand is so strong that they are struggling to fulfil it, for example MySQL which operates a rigorous filter on its customer leads to work out which of €200k leads can turn into €500k deals. 

Part of the reason for immense growth is explained by Open Source’s ‘stealth entrance’ into the enterprise. Developers like open source, and are excited by it, often introducing it into an organisation without the knowledge of the senior management. Rimer told how when Index made due diligence calls on a potential investment to NASA, the management didn’t realise that they were running several mission critical open source projects. In these circumstances, IT managers welcome the entry of commercial organisations to make the software robust and guarantee ongoing support.

Index Ventures’ investment criteria for open source companies include the following 3 necessary pre-conditions:

1. Community (has to be large, loyal and evangelistic)
2. Price elasticity (even if the software is cheap, it has to be able to defend this price over time)
3. Commodity (has to solve a discreet and common problem)

VCs also need to be alert to the potential impact of Open Source on their portfolio companies, with the proviso that while some software companies may be negatively impacted, open source does not necessarily sound the death knoll for traditional software. Deborah Magid of IBM argued ‘There is still a bright future for traditional software companies addressing difficult problems in vertical industries. Some applications will never be appropriate for the open source model.’ She pointed out that you wouldn’t get an online trading application, or a Dassault Systemes from the open source community.

Damien Reeves of Zeus Technology, which has competed in the past against Open Source companies, highlighted the benefits of open source development tools for creating proprietary products. He said ‘Using open source code lowers the barriers to entry for new companies, reducing R&D spend. It allows emergent businesses to focus on building value for their customers in a shorter time frame.’ He also commented that companies with open source solutions can sustain lower-cost sales channels. The distribution model and lower price-points means the software can be sold over the internet, avoiding the need for an expensive direct salesman turning up at customer premises brandishing a CD.

Reeves went on to warn how investors should not be fooled by companies jumping on the open source bandwagon. He warned that it is a classic way to generate cheap mindshare in the early stages of development, and some of the newly emerging businesses seem to have little else than an open source ‘spin’.

Nick Kingsbury at 3i, asked the panel how venture backed businesses could use licence models to protect IPR. Magid noted that it could be done, but more than ever developers have to be careful about choosing an appropriate license, especially as modern software will have been developed with, or will integrate to open source architectures. Damien Reeves agreed, pointing out that there are two simple models to understand open source software. One is where all the individual contributors own the IP. Here it is much harder for a single company to exploit the software, though competitive support and maintenance businesses can be can created (as with Linux). The second model (followed by MySQL) is where one company controls and, in effect, owns all the mass produced copyright. In this model the development path, IPR and licensing patterns are much easier model to control.

The panel then turned to the exits for venture capitalists. Apart from IPO opportunities, who are the buyers of open source software companies? The entire panel agreed that trade sales are likely to be the incumbent software vendors who want to have a dual approach of proprietary and open source systems, and there are a growing number of these companies, emanating not only from software product companies but also from services and solutions organisations.

The panel also commented that Europe has a good opportunity to gain a leading position in open source, in contrast to many software sectors which are dominated by the US Rimer pointed out that it is the large developer base in Europe which is ‘fairly socialist’ in attitude, which is contributing time and expertise to open source projects.

Jason Purcell concluded with optimism on the opportunity for European businesses: ‘The open source phenomenon presents an incredible opportunity for European VCs to seize the initiative and take the lead in open source.’