Nothing ventured, nothing gained

I've always found it interesting that the shortest day of the year is the first day of winter. As we descend into wintry gloom, it actually starts getting lighter longer. Let's hope more light seeps in longer during the telebomb's nuclear winter. In this Halloween season, anything else is really scary.

A true scary reality is the lack of creative thinking about fixes for the multitude of things that ail us. What follows is an idea I've been sharing with people. It is a high-level think piece that addresses one aspect of the broken value creation chain in the telecom industry. I have been told it is like good wine, i.e., it needs more time (read that pain) before it gets attention. Fortunately, I am a patient optimist.

The problem

The engine that turbo-charged marketplace innovation--breakthrough intellectual property funded by venture capital firms to seed development companies through prototyping and product commercialization, with a revenue event for the backers--is what needs repair. A disruptive intervention in the value chain through a reoriented funding vehicle, what I call "The Channel and Services Fund" (CSF), could be the answer. (More on this later).

The vicious cycle

1. For the foreseeable future, in the global communications service provider sector:

• The number of service providers will dramatically shrink

• Survivors will keep capital expenses on a very strict diet

• The vendor list to the surviving service providers will be substantially winnowed. In a self-fulfilling process, with a few exceptions, incumbents--those service providers deemed to have the best survivability prospects--will survive. This will be done by service providers to:

      a.  Increase buying leverage

      b.  Decrease sparing and training costs

      c.  Increase supplier accountability

      d.  Rationalize network migration and growth planning.

• The surviving vendors will continue to have margins punished and will continue to "right-size" themselves to assuage angry shareholders.

• While service providers need to outsource significant portions of their networks and back offices, they lack trust in current suppliers. They are particularly worried about vendor elimination of the most knowledgeable support people, and excessive account representative churn. This when service providers need more, not less, support. They also see cutbacks in commitments to installed products for which they have people trained, and which still have long depreciation lives, as troublesome.

2. Dwindling service provider capital outlays will cause vendors to further shed unprofitable products and reduce R&D. This will exacerbate supplier/service provider tensions.

3. Pressures on the integrated systems and professional services companies (Lucent, Nortel, Siemens, etc.) to further right-size means that they will:

• Remain unavailable as an exit strategy option for start-ups

• Be guardedly opportunistic using start-up products to fill portfolio holes

• Be problematic as strategic investors.

4. For venture capital firms, this means more pain:

• Start-ups with finished or almost finished products will have limited channels to market and few post-sales support options

• Earlier-stage firms may have to develop their own channel and support capability as strategic options fade. This will raise the ante on the money and the talent needed

• Without post-sales integration and support from an entrenched vendor with long-term service provider relationships, VC portfolio failures will increase. Service providers have demonstrated they will not trust start-ups that do not have impeccable service and support capabilities.

What is ugly is that there is little in place structurally to stop the industry's ratcheting down momentum.

For VCs, the success/failure ratio is ballooning. Portfolio triage is on most front burners. The lack of "quality opportunities" is a common refrain. Worst is the angst of investors whose patience is wearing thin. VCs themselves are now targets for restructuring. 

Of course, nobody is shedding tears for VCs. They have only themselves to blame. Despite all their lip service to building long-term value in sustainable enterprises, everyone knows the only thing they want is a "monetary event" that justifies the large fees they charge their limited partners. This has been, is and will be (unless behavior changes) about "the big score" and raising the probabilities of getting one. It has never been about building companies. Ask any entrepreneur.

This does not have to be the case.

The CSF: Creating a virtuous circle

Interesting, despite the above, a Phoenix can rise from the ashes.  A virtuous circle can be created to supplant the vicious cycle. 

It is painfully apparent that TRUST--the confidence of positive outcomes from repeated interactions with business partners--has to be re-injected into the vicious cycle to create the virtuous circle.  That TRUST can come from the VCs creating a Channel and Service Fund (CSF) whose sole function is to pay for system integrator investment in the acquisition of professional service and support resources.   

 

The CSF would:

 

1. Provide targeted funds to integrator service organizations serving the world's leading service providers. Funds would be for integrator development of dedicated sales and post-sale support resources for CSF portfolio companies systems and software.

 

2. In return for CSF investors would receive:

• Channel support exclusivity for its portfolio company products

• A negotiated percent of the profits from the sale and support of portfolio company systems, software or other intellectual property

• Equity in the integrator

• An option to buy some percentage of the service and support organization should it become an independent company (assuming it is not)

• A seat on the board of the service company chosen

• Anything else the CSF legal advisors deem to be reasonable and appropriate

• The chance for portfolio companies to survive and prosper.

3.  The integrator would receive relief from their financial pressures and the ability to fill strategic holes in their product lines--a true win-win.

What gives?

So what's been the pushback so far, you ask? In short, integrators are very interested while VCs are not. 

VCs say they could never ask their limited partners (investors) to accept the un-extraordinary returns this proposal implies. VCs would rather live with closing down and writing off 19 of 20 deals (up from the 4 out of five in the good old days) on the hope that one deal will be so spectacular the limiteds will continue to be impressed, than invest for the longer term. Annuity revenue streams at reasonable returns are for the meek.

As was stated above, clearly we have not experienced enough pain to modify VC behavior yet. I contend that the old cliché about "nothing ventured, nothing gained" makes more sense. So does the one, "no pain, no gain." Based on the latest statistics about VC investments in the sector being down another 50% in the last quarter, there certainly is nothing being ventured. What a pity when there is so much to be gained.

Peter Bernstein is President of Infonautics Consulting Inc. He can be reached at pb111451@optonline.net.