Monday, July 20, 2009

Wanted: Small, No-Name Customers

Readers of my blog should be familiar with my deepening preference for software companies, especially those that exhibit a low cost structure and high margin sales (not all software companies do). However, increasingly I prefer to characterize my investment focus less by sector, and more by the sales and go-to-market strategy. Specifically, I find myself favoring companies that use the Internet to sell directly to small businesses and consumers, and skeptical of start-ups that build their strategy around selling to large, strategic customers. For a variety of reasons, it has simply become more expensive and less rewarding to sell to large customers, regardless of whether this is a Fortune 500 company, telecom operator or hardware OEM. At the same, new marketing and delivery methods have made focusing on small, no- name customers more capital efficient and scalable.

In the first decade of Israeli venture capital, entrepreneurs and venture capitalists had a natural bias towards start-ups that focused on large, marquee customers. Wins with such customers meant large deal sizes, the attention of strategic partners/acquirers, and a rush by other customers to emulate the early adopters and thought leaders. Always preferring a technical sale, Israeli start-ups preferred large customers with a strong understanding of technology. Conversely, we venture capitalists eschewed start-ups that focused on small businesses or consumers, mostly because there was no cost effective way to reach them from Israel. Even if you could reach them, it was widely felt that these small customers do not appreciate cutting edge technology and are partial only to established brand names. Furthermore, while the strength of Israeli high tech was generally built around product sophistication, performance and intellectual property, selling to small, no-name customers required a product that emphasized design, usability, simplicity and price.

Large Can Be Longer, High Touch, Expensive, Non-repeatable & Unrewarding

A lot has changed since then. First of all, post 2000 these large customers have grown wary of working with and relying on start-ups, hundreds of which have disappeared, changed direction or simply never reached scale. The result is that the sales and testing processes of large customers is longer and more arduous for start-ups than ever before. Additionally, the procurement process of these large customers is more stringent, built on the premise that they are always better off buying from a select group of large, established vendors(even with an inferior product). Even where they have no alternative, their reluctance to buy from start-ups persists with attempts to indentify a middle man, place the start-up’s IP in escrow(in the event of shut down), or extract a hard commitment to fulfill the product roadmap(rarely accompanied by any NRE dollars). And once an order is finally placed, the long coveted joint press release is blocked by the legal department.

Secondly, the established competition has become more proficient at thwarting start-ups’ efforts to penetrate their strategic customer base. The competition knows to take advantage of the customer’s preference for buying a full portfolio of products and related services by bundling products and offering their variant of your product for free or at cost. The weak start-up market bolsters the larger competitors’ attempts to sow doubt about start-ups’ long term viability. Even Oracle’s sudden shut down of Virtual Iron only a month after acquiring them can be seen as a message to enterprise customers that even M&A provides little assurance for product continuity. This systematic obstruction was always present, but has intensified with industry consolidation in networking, semiconductors and enterprise software.

Lastly, penetrating a couple large customers no longer provides the same currency it once did. Not so long ago, regardless of sales growth and profitability, a few big customers wins made you “acquisition material.” Such customer wins meant the company was turning a corner, and generally made the start-up “financeable” by fellow VCs. Investment bank research analysts would warn larger competitors of the upstart’s superior technology and growing traction, and the young start-up’s credibility would rise remarkably. Today, this connection has been severely weakened if not completely dislocated. This is partly due to the challenge of a repeatable sales process among more skeptical customers, but also due to the indifference of potential acquirers.

Small Can Be Quick, Low Touch, Repeatable & Inexpensive

With large customers no longer worth the effort, start-ups should consider focusing on smaller customers and/or consumers. Luckily, several trends play in favor of such a “no-name” customer strategy. Performance marketing including targeted online advertising and affiliate networks allows start-ups to reach a wide audience cost effectively and with minimum up-front investment ( see “When Marketing and Sales Becomes Scientific”). Similarly, advancements in delivery methods, including downloads, virtual appliances and software-as-as-service lower the cost of sales, deployment and maintenance. Of course, strategies focused on small customers and consumers do not preclude sales to large customers as mentioned in my previous blog post “A Preferable Route to Market.” The challenge for Israeli companies is to build a product that emphasizes usability and simplicity as much as technology and performance. I have little doubt that such skill sets exist in Israel, but the key is to make this a priority.

The start-up and venture world has undergone a flip over the past 10 years. Large customers, once thought to provide a short cut to success, are now seen as more demanding and less loyal than before. Fortunately, smaller customers scattered across the globe are now accessible and serviceable via the web. Telecom once has its version of “small” customers called CLECs, while the semiconductor companies focused on Original Design Manufacturers(ODMs). In both cases, the smaller customers proved to be short lived or unreliable. I believe software delivered over the Internet could be both long-term and successful, but in the very least it’s an inexpensive model to experiment with.

Saturday, July 4, 2009

High Tech Won't Solve Israeli Driving

Israel is known for many great things, but its chivalrous driving is not one of them. Israel does have more roads per kilometer of road than any other country…but I would bet also fewer traffic cops per capita than most. Blame it on the hot weather, the tense political environment, old or young drivers, one of several minorities, the religious, the high tech employees with leased cars or wealthy elitists, either way Israeli drivers rival Italians in their aggressiveness, and South American’s in their disregard for laws.

Israeli high tech has produced start-ups like MobileEye, GreenRoad, Sensomatix and Traffilog to improve driver safety and behavior, but it will require a cultural change to turn Israel into a genuinely friendly place for drivers. As a frustrated driver myself, I have assembled a list of observations and camera phone pics for those unfamiliar with the experience of driving in Israel. All pictures are courtesy of my faithful Blackberry Bold.

1. Tailgating at speeds of 120kmh is a true sport in this impatient land. The logic goes something like this: “The closer I get to the car in front, the clearer I will become in his rearview mirror…and the more likely he is to move out of the way in haste.”

2. Shoulders on the side of the road are for those people in a real hurry and who didn’t know there would be traffic.

3. While frightening, it’s completely routine to see cars enter a highway and then slowly reverse after changing their minds.

4. Crosswalks merely indicate where a pedestrian might be run over if one is so bold as to cross the street. Conversely, drivers only have to stop at a crosswalk if a pedestrian has fully stepped off the pavement.

5. Mopeds, ATVs and small motorcycles can morph into pedestrians at will and use the crosswalks to get around a red light at an intersection. Consider this the next time you marvel at the speed of your pizza delivery.

6. Disabled parking spots tend to be occupied by luxury sedans and SUVs. In fact, I generally associated illegal parking in the cities with luxury vehicles whose drivers are above the law.
(graffiti on wall reads: "Disabled Parking is for the Disabled Momo!")

7. Don’t be alarmed to see seemingly senile pensioners taking their motorized wheelchair on main roads during rush hour. It’s part of the fearless, laissez faire culture we cherish so much.

8. If you want to meditate while driving, you can always read the religious graffiti on the road signs. Na, Nach, Nachma, Nachman Meuman is a chant of the Brezlov Hasidic sect. Why they feel compelled to use spraypoint is beyond me.

9. Israeli road signs are conveniently translated into English and Arabic. However, don’t be surprised if the English name of your destination appears to change its spelling as you drive along. Netanya may become Natanya. Zichron Yaakov may become Zikron Yaakov or Zikhron Yaakov. Petah Tiqwa, Petah Tikva or Petach Tikva…and so on. This should change soon with a harmonization in tranliteration, but in the meantime it must really confuse tourists.

10. Traffic cops exist, but you have to look carefully. And when you do, you will see that justice eventually comes to all repeat offenders regardless of their status.