The mobile black hole – can VC finally escape?

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.

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  • Patrice Peyret

    All true. But I would like to add that several impediments faced by many VCs w.r.t. mobile have been of their own making:
    – lack of international savvy: unlike with the Internet, mobile is not the same model everywhere. I bet many US-based VCs would still be surprised today to hear that consumers in other parts of the world do not pay for receiving mobile calls or messages…
    – lack of cultural understanding: how many VCs have I heard lecturing me about how SMS / texting would never make it in the US because “we are an email country”?
    – lack of interest for consumer-facing ventures during the earlier industry years before Facebook/ Google. How many millions sunk in “mobilizing the enterprise” when it was obvious that most employees walk into the office every morning with their own cell phones, not cellphones imposed on them by their CTO….

    The next billion mobile subscribers will not be in the developed / Western world, so VCs also need to be prepared to dust off their passports.

  • indexben

    Agree Patrice – Europe used to be ahead of US in the mobile area, but last few years have totally changed the picture. All the best and thanks for yr comment. Have a great 2010

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  • James Sherwin-Smith

    I would also agree that the next decade will see these inhibitors as
    you mention above become increasing marginal.

    On 1, the emergence of the apps/widgets model served over saas will
    overcome this. Thanks to Apple's big push into this space (cf their inescapable
    “there's an app for that” campaign), consumer awareness has increased
    massively, and established players have had to work fast to keep up
    (cf. RIMs announcement re the BlackBerry AppWorld at last years sxsw).
    With another open platform in the form of Android hitting the
    mainstream, this will put further pressure on Apple's closed AppStore
    platform, and add some much needed competition.

    On 2, the key remains to deliver your app as a browser based session
    if you can, that way you negate some of the issues you raise here. But
    even so we've seen significant consolidation in the device market with
    Symbian and Windows ME and now Android. Outside those three, you will
    have the BlackBerry OS and the Apple OS, but those 5 will take you
    above 95pc market share I'd wager. The key point here is that its not
    just first adopters who change their phone every 12 months, pretty
    much everyone does. But these mass market users probably hold on to
    their desktop or laptop for 36 months or so, which means change and
    adoption cycles are much faster in mobile. So if I was a developer
    today, I'd probably only bother coding for apple, blackberry and
    android (I wonder if google were tempted to name it after a fruit
    instead :-)

    3 and 4 strike me as entirely related to one thing, bandwith. There's
    little to no point having a fantastic device if you can't get the
    media on an off it easily – my poor analogy would be there's no point
    having a high spec laptop if the only input/output method is via
    floppy disc. I'd be fascinated to see the upgrade stats from iPhone
    2.5G to 3G users, but my guess is that most have done it as soon as it
    was available and economic.

    I think the key turning point will be the growing adoption of
    connecting your mobile device to a WiFi base station when at work or
    home (or even potentially on the go, with taxis, trains, planes and
    hotels all offering WiFi now). In my opinion it will be this
    proliferation of “wirefree” Internet that will really grease the
    wheels. By wirefree, I mean not only going wireless, but more
    importantly, that this is being offered for free, with only minor log in
    requirements, which means it is actually usable to the masses.

    As users become accustomed to the fact that they can connect their
    devices at broadband speeds, leapfrogging 3, 3.5 and 4G connections
    that are offered by the mobile network operators, then the full
    potential of having a smart phone in your pocket will be realised.

    With Skype (send and receive calls), email (send and receive text
    messages and attachments) and Google voice (transcribing any voicemail
    I receive to text) running over WiFi everywhere I go on my iPod touch, enabled
    with Push technology (aka notifications) – remind me again why I would
    even need a sim card, let alone a contract with a mobile network

    Sent from my iPod touch over hotel wirefree in Mumbai.

  • indexben

    I think that's the my first blog comment from an iPod touch! thanks