Happy New Year and what an exciting start to 2010! Already we have seen the acquisition of Quattro by Apple, the launch of the Google-branded and specified Nexus One phone and growing anticipation of an Apple Tablet computer. I wanted to summarise some of my thoughts on what these events may mean for the Venture Capital.
Anyone familiar with the VC industry will know the bulk of positive returns tend to be driven by a fairly concentrated set of investments made by the Venture Capital industry. Often literally a handful of companies can drive the bulk of the entire venture ecosystem return over the course of a decade. Obvious examples over the last few years have been Facebook, Google, Youtube, Skype*, Betfair* and perhaps a few more companies spread over enterprise software, semiconductor and cleantech. Notably absent are any venture-backed businesses which have used the mobile platform as their primary means to establish a multi-billion dollar company. In fact the mobile applications sector has been a virtual black-hole for venture capital. Money poured in, yet between Jamba selling to Verisign in 2004 until the recent exits of Admob and Quattro, examples of good venture-backed exits have been like parrots in the Arctic – that is non-existent.
Why mobile (mostly) sucked for so long for VC?
I would boil it down to four major factors:
- Operator Channel – Selling products and services to a mobile operator or relying on mobile operators to get applications to market has dire economic consequences for most VC-backed companies. Revenue share is typically exorbitant driving low gross margins. The length of the sales cycle and also the subsequent qualification, testing and implementation burden imposed by operators drives overheads to a level which ultimately can’t be funded.
- Device Fragmentation – This kills an application or services company for two reasons. Firstly the cost and complexity to build, test and support an application on multiple handsets (which are subsequently configured differently by the operators) is prohibitive. Secondly and less well understood, marketing a service to a fragmented device ecosystem is much harder. In particular viral channels break down where people cannot easily adopt applications and services unless they share exactly the same device as their friends and colleagues. The perception that having a few common operating systems would largely solve this problem is I believe wrong. A standard OS helps, but if factors such as screen size, CPU performance, memory, user input mechanic and sensors (e.g. cameras, tilt-sensors, multi-touch, GPS) even differ slightly across phones running on the same OS, then the application developer still faces a meaningful fragmentation problem. This is particularly true for complex applications such as games. Hence why Google changed course with Android. Originally Google was adamant that Android was their mobile offering and they wouldn’t offer a phone per se. The launch of the Nexus One is I believe driven the realisation that that to build an application ecosystem to rival Apple’s, they need to specify the device as well as the OS or else the fundamental fragmentation problem is not solved.
- Low smartphone penetration – Until recently, simply not enough phones in circulation had the screen size, CPU, browsing ability etc. to provide an audience large enough to build a big mobile application company around.
- Consumer confusion over mobile data tariffs – The emergence of flat-rate plans played a key role in the initial phase of consumer internet adoption on the PC (e.g. Freeserve in the UK). Before these emerged people were nervous and unsure of what costs would be incurred when logging on. Mobile flat-rate plans are now widely available and bundled with most Smartphone purchases, although some areas such as international roaming can still spring nasty surprises on consumers.
As a result of these factors, Index Ventures over the last few years made relatively few investments in the mobile area and those that we did such as Rebtel* had business models which we believed specifically avoided the pitfalls outlined above.
Now however after 10 years of false dawns and frustration, the next few years could be very exciting and highly rewarding for VCs who place the right bets. Firstly almost all the issues listed above have now been largely eroded, at least in the high-end smartphone sector. While this still accounts for a small portion of the overall market, it is growing the fastest and is the most profitable sector. Apple alone may account for as much as 50% of all handset industry profits despite having one phone model (thanks Hussein.)
Another critical factor which will drive better VC returns is the very aggressive turf war that is now playing out:
- Apple will want to extend its iPhone dominance as the high-end smartphone sector moves into the broader mass market;
- Google needs to ensure its dominant position in the web advertising is preserved and extended as consumers increasingly access the internet from mobile devices;
- Operators will try to dress themselves up as anything other than the dumb-pipes they seem destined to become;
- Nokia, Motorola, Samsung and other handset makers will need to decide how to fight more convincingly in the handset sector or whether to retrench to low-end phones or developing markets;
- Facebook, eBay, Amazon and other web players will also need to invest in providing existing web customers with new and better services which leverage the mobile platform;
Which will mean acquisitions – Admob (Google), Quattro (Apple), and Jajah (Telefonica) will be just the beginning. I will get as involved as I can in finding great companies to invest in in this sector. Good luck to everyone for 2010!
*Current or past Index Ventures investments.