End of the Era of Large Scale Venture Backed Innovation?

The years 1964 and 1965 mark important milestones in the history of computing and telephony.  In 1964 AT&T opened the first central office in the United States.  This was the beginning of the migration from operators and five digit dialing, to a nation-wide deployment of circuit switching technology and ten digit dialing.  In 1965, IBM introduced the S/360 mainframe computer.  When I think of the big bang moment for the telecom, computer and internet industries I think it started in 1964-65.  We have gone through 45 years of distributing the power of the mainframe and the CO into the network and users.  Now we are at a very interesting point in the network and I think it would foolish to assume that the distribution of computing and networking power will recede.  I think it will accelerate.  The hypothesis I am exploring is: we are at the inflection point in the network that was dreamed about and theorized about ten, twenty years ago and now that we have arrived, is the market only accessible to public companies capable of large scale R&D efforts?

I have spoken to many a VC who thinks that innovation rarely occurs in large companies, yet I would offer up as counter argument that it is true that large companies become trapped by their legacy products, but it was large companies that gave us the MAC, Razr, iPod, iPhone, iPad, DQPSK, Pentium, InkJet…we could write a very long list.

Some Data to Consider

I looked at some of the data from the National Venture Capital Association as well as a model I created of annual revenues for 18 companies.  I chose these companies at random and maybe if I was sitting at a Factset terminal I could produce a broader, more complete model, but I was just looking for a mix of large cap to small cap, networking, storage, telecom and enterprise focused companies.  The companies in the model are:  CSCO, JNPR, Alcatel, LU, NT, BAY, CIEN, BRCD, ERIC, NTAP, INFN, APKT, EMC, ARUN, TLAB, FFIV, RVBD and ADTN.  I left out HPQ, DELL, AAPL and many more companies.  My selection was random as this is a blog – not a market study.

Chart 1 below shows the combined revenue of these companies from 1995-2010.  It also shows the investment in the networking and equipment sector on an annual basis from the NCVA.  I also marked what I termed as the Lost Decade for VCs from an earlier post.  If you did not read that post I describe the period from 2001 to 2010 as a lost decade because many of business plans from 2001 are now valid, one simply needs to erase a zero and make 2001 read 2011.

Here is chart 2 in which I added the VC investment in internet specific companies.  I understand that the capital intensity of internet investing is far less than hardware companies or real science based investments.  I would note that the creation of internet specific companies are drivers of network usage and thus can be considered a growth engine for network infrastructure they are using and the creation of long form content.

Here is the third chart and I extrapolated some expected growth rates for the 18 sample companies into 2015.  Note that even the global credit crisis in 2008-2009 is a blip.  As VCs have been avoiding the networking and equipment market, revenues have been going up and the drivers of the new network are going to cause an explosion in network usage and investment.

Concluding Thoughts

When I look at these charts I talk to entrepreneurs and VCs I am increasingly convinced that there still is a hangover effect from the 2001-2002 investment cycles, but I also see increased complexity and cost in the product cycle for system level products.  Can venture backed companies still innovate in system level networking or is it all about low cost web based models that take $10M of capital to provide a proof before deciding to scale out the business?  Is large scale venture backed innovation dead?  If you believe in the thesis that Carlota Perez created about markets, then we should be in a new golden era for networks.  Here is reproduction of her model:

In 2006 I produced the following chart as part of manuscript I wrote thinking about Perez’s theories.  I dug it out and updated the model below.  It is reasonably accurate, but a few corrections are in order.  I called what became known as cloud computing, grid computing.  I had the content model correct, just not the all players.

At a recent lunch meeting I had an interesting thought expanded upon by a person who has been in a number of VC backed startups.  We were talking about the how the process of creating a horizontal company along the lines of the World is Flat theory enabled companies like Huawei to get where there are today and that there is an accelerating trend towards vertical integration (back to the past) in technology.  More in house silicon than you think: JNPR, AAPL, CSCO…the list goes on.  Companies want to protect IP and move away from homogenized designs using common components, merchant silicon and they way to do that is either through software or custom silicon.  For the networking companies that is where the future lies and even Huawei knows it.

I think the opportunities in the new network are massive, but I also think many investors are going to miss it because the capital required to be in the market is still handcuffed from 2000-2001 collapse and the lost decade.  The drivers are omnipresent: 100G, LTE, Real time content, Long form (or big data) content, Cloud Computing, Persistent connections and all photonic switched DCs.  It appears that VCs are going to leave these markets to public companies.

/wrk

* It is all about the network stupid, because it is all about compute. *

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