Can Microsoft reinvent itself?

Microsoft released its third quarter numbers the other day and while revenue growth was strong, the stock got hammered and dropped over 10%.  Why? Microsoft plans on investing for the long term and putting another $2b into the Internet and other new technologies like the XBox.  To sum it up, here is Rick Sherlund, Goldman Sachs’ Software analyst, "It sounds like you’re building a Google or building a Yahoo! inside the company."

Looking at the long term, I am quite excited about the prospects of all of this money coming into help grow the Internet sector and SaaS.  First, having another big player push the concept of software as a service will only help further educate and soften the market, particularly business customers  Secondly, this will mean that Microsoft will be aggressive with hiring and with acquisitions.  I remember being at the Microsoft VC Summit a couple of years ago and hearing Steve Ballmer talk about his acquisition strategy.  He would either do huge, billion dollar ones or look at acquisitions less than $20mm.  That has been changing and will change rapidly with this renewed empahsis and focus.  That only means good news for VCs and entrepreneurs.  And as a VC, I wholeheartedly agree with Microsoft’s CFO, Chris Lidell when he says, "Today, we believe we face the largest array of opportunities for growth and innovation the company has ever seen." I certainly feel the same way from a VC investment perspective.

Whether Microsoft succeeds or not is another story, but $2b invested in new technologies will go a long way towards solidifying their position.  I would say that they did alright in 1995 when they decided to point their guns at Netscape to make sure the browser and Internet would not circumvent their monopoly on the desktop.  The problem is that once they won the browser wars, Microsoft became satisfied, fat and happy. And as we all know, fat cats don’t hunt.  Others came around and outinnovated them – Firefox, Google, etc. 

This is Round 2, which really started with Microsoft’s purchase of Groove Networks and Ray Ozzie last year.  To refresh your memory, I suggest reading Bill’s email from October 2005 (also see the Ray Ozzie memo) where he leads the battle charge for the next generation web, the SaaS era. 

Today, the opportunity is to utilize the Internet to make software far more powerful by incorporating a services model which will simplify the work that IT departments and developers have to do while providing new capabilities…..

However, to lead we need to do far more. The broad and rich foundation of the internet will unleash a "services wave" of applications and experiences available instantly over the internet to millions of users. Advertising has emerged as a powerful new means by which to directly and indirectly fund the creation and delivery of software and services along with subscriptions and license fees. Services designed to scale to tens or hundreds of millions will dramatically change the nature and cost of solutions deliverable to enterprises or small businesses.

And yes, it sounds alot like the memo Bill Gates wrote 10 years ago called the Internet Tidal Wave where he helped the big battleship called Microsoft reposition itself and point its guns at Netscape and others.  Round 2 is no different from Round 1 but the stakes are higher and it will cost Microsoft oodles more cash this time to create a dent in this market.  While we all know that memos often do not mean a whole lot, it is clear that Microsoft is quite serious as they are not afraid to piss off Wall Street and really put dollars to work for the long term position of the business.  This will certainly be an interesting battle to watch over the next few years.

DIY in the Enterprise

As I wrote last year, this "web as platform" gospel is starting to spread quickly from consumer to thoughts on the enterprise.  In my mind, what has enabled this enterprise web phenonomenon has been two thoughts – lightweight and simple.  Of course, lightweight and simple equals cheap and fast to implement.  It is quite easy now for sophisticated users to find and download new software and run it themselves, for them to take simple scripts and tie together various web apps.  We are quickly moving to a world where the end user on the edge can and has taken matters into his own hands rather than wait for IT to get something done for them. I call this the age of DIY (do it yourself) in the Enterprise.  Why go through centralized IT and their processes when I can get something done with my own departmental budget?  Linux, Jboss, and many of the open source opportunities started at the edges first before being brought into the centralized IT organization.  As we all know, many new technologies are typically adopted by consumers and then pulled into the enterprise, not pushed.  Amazon and other web apps started exposing their APIs and existed long before 

Jeff Nolan points to an interesting post from John Hagel which highlights this changing enterprise world. What has been deemed as the agile enterprise driven by SOA has actually turned into anything but.  The enterprise version of "lightweight" called SOA stands in stark contrast to the next generation web perspective of lightweight.  As John correctly points out, enterprise lightweight in the form of SOA means plumbing, it means expensive, it means complex, it means lots of consultants, and it means lots of dollars.  In contrast, next generation web technologies are easy, incremental, and driven by the edge and focused on people, not plumbing.  While some of these next generation apps may not scale, there is clearly something that centralized IT can learn from the edge, their frustrated internal customer, that things can get done more quickly and more cheaply.  As these two philosophies become more tightly coupled we will have some interesting opportunities to invest and make money.  While not directly related to this SOA/web mashup discussion, one of the companies I have always found interesting is Splunk which is bringing a Google-like approach to network management.  It is downloaded, driven by the edge user, and then pulled into the corporation from the bottom-up rather than the top-down.  It stands in stark contrast to EMC’s (Smarts) and IBM’s (Micromuse) way of selling and using their respective products.  There will be many more opportunities like this in the enterprise as enterpreneurs leverage user interfaces and technology from the consumer world in the enterprise. Of course, this means a whole new way of reaching customers (frictionless sales), selling to them, and supporting them but this is saved for another future post.  The good news is that this new age of DIY in the Enterprise is not going away and is only getting stronger everyday.  This also means the creation of many more disruptive enterprise software opportunities in the next 5 years.  I agree with Jeff that this is an interesting area to watch and is beyond web mashups-rather, it is a philosophy enabled by all of this new technology, the philosophy of DIY in the Enterprise.

VCs and VOIP

Here is a link to an article on VCs and VOIP (via Andy Abramson of VOIPWatch).  There are some VCs who think it it too crowded and others (like myself) who still see opportunities.  However, the one thing I was not pleased about is that the only quote the author uses for me did not include the rest of our conversation.  I should have just pointed her to my blog post from last September on the topic where I say that:

This battleground is about software and not devices which is why I believe companies entering this market from a telephone-centric view of the world will miss out on a big opportunity.

When I say, VOIP is "moving beyond Vonage" what I mean is that the opportunity is not about making and receiving calls but about how VOIP becomes seamlessly embedded in all applications, into the very fabric of the web.  Imagine seeing any phone number on a web page and clicking it to dial seamlessly.  Or how about being in your CRM application and knowing which of your sales reps are online as you are reviewing the pipeline and clicking to IM or call them through the CRM app.  When you call them, you have no idea if they receive the call on their home phone, computer, wifi device, or cell phone.  All you know is that they are available and that you can call them with one click.  This is the direction we are heading in – it will take time, but it will be interesting and it is certainly more than just a phone call.  If you want to learn more about this I suggest reading Alec Saunders from Iotum’s post on Voice 2.0.   As Alec says, :

In the voice 2.0 world any application, within the bounds of permissions set by the subscriber, can access presence; initiate, accept, and redirect calls; and query directories.

Alec gets it and this is certainly some of the stuff we have up our sleeve at Sipphone, developers of Gizmo Project.

Red Boss – will it truly be open?

It seems that the open source business model has been top of mind for many in the technology industry as of late.  First comes Checkpoint’s attempted purchase of Sourcefire and now comes Red Hat’s announcement that it will acquire JBoss.  The acquisition price of $350mm is pretty sweet validation for the open source model considering that the multiples are about 20x trailing revenue ($20mm estimated revenue in 2005) and 6-7x forward ($50-60mm estimate for 2006).  And on top of that the company only raised $10mm which means it was incredibly capital efficient.  That being said, we have to remember that this is not going to change the corporate IT landscape overnight.  First Red Hat may end up competing with many of its partners like IBM who have helped validate Red Hat by offering the muscle and handholding of the IBM brand and employees.  Secondly, just because Red Hat’s name is on it does not mean that CIOs will immediately change their buying decisions.  As I mention in an earlier post in 2004, Red Hat has needed to find more avenues for growth and what better way to do that than moving up the stack from the OS.  Here is an excerpt from my post in 2004:

It seems that many of the bigger open source players are building out their own stacks ala Microsoft and others in the pursuit of growth and profits like traditional closed-sourced software companies.  Isn’t this the antithesis of what open source stands for?  Rick Sherlund, Goldman’s software analyst, says that it makes sense from a financial perspective since it allows vendors to cross-sell and lock-in the customer – customer retention is a good thing after all, isn’t it? While all of the open source players did their best to dodge this question and claim that they are really open, MySQl was the only company that really seemed credible here as its goal was to be part of everyone’s stack, including the Microsoft .NET one.  JBoss and RHAT clearly seemed to be building their own middleware and open source stacks while at the same time claiming an open architecture.

Fast forward 18 months later and you have the first move in that model – Red Boss.  Sounds like Microsoft?  I thought part of the reason technologists bought open source was to not be locked in to any one vendor.  This will be interesting to see as the need for revenue, growth, and profits drives some of the larger open source players and to see if they continue to remain 100% truly open.  Should I tweak the JBoss app server just a tad to make it work better on Red Hate vs. Suse or .NET?  Let’s watch how Red Boss balances the need to meet Wall Street expectations for quarterly numbers with the need to make its customers happy by helping them avoid proprietary vendor lock-in.

Kinnernet 2006 – geek camp

I just got back from a week in Israel having spent some time in Jerusalem for an Answers board meeting and then making my way to the Ohalo Resort on the Sea of Galilee for Kinnernet 2006.  Kinnernet is a techie geek camp organized and run by Yossi Vardi (cofounder of ICQ).  At Kinnernet, I had the privilege to spend time with some great people from Israel, Europe, and the US.  I suggest checking out Jeff Pulver’s blog and going to Flickr and searching for Kinnernet2006 for pictures and more thoughts on Kinnernet.  There were lots of robots, aerial shows with model planes and helicopters, great discussions on current technology trends, and of course, plenty of beer and laughs. 

One of the discussion groups that I led with Simon Levene (heads up Corp Dev in Europe for Yahoo and Yair Goldfinger (founder and CTO of ICQ and Dotomi) was titled "Are Internet VCs Dead."  You know the backdrop – it costs less to get a company started and to generate users and Google and Yahoo are agressively snapping up companies before VC rounds.  Google’s expertise seems to be buying engineers, many times before a product is even launched.  Yahoo, on the other hand, prefers to buy companies that have some nice user base, maybe no revenue model yet, but also before a VC round.  The last point is that companies are now more capital efficient (see an earlier blog post) where $10-15mm can get a company to cash flow breakeven vs. $30mm.  So what do VCs that invest in Internet companies do? Before I go there, I would flip the question and ask what do entrepreneurs do?  From my perspective, I wouldn’t take in more than $1-2mm to get my company started with a developed product and an idea of what usage will look like.  At that point, as Yair suggests, it is decision time.  Some of the questions to ask include:

1. Do I have a product or feature or can I build a real company (i.e., a growing cash flow sustaining business)? 
2. What is the risk I face in building a company for the long term vs. selling today. 
3. And finally, do the math – if I take in VC money I will clearly have to sell for alot more tomorrow than what I sell for today in order to generate the same or greater value.
4. Do I want to do it?

As a VC, I truly would not want to invest in a company that has not thought about all of the above with a founding team that is fully behind building out the company for a longer term play. All that being said, the numbers are still against the entrepreneur.  While there have been a number of acquisitions in the past year, it is still a fraction of the number of companies started.  Since it is so cheap to start a business, you can have anywhere from 5-10 companies out there in each category.  In addition, it is not clear that many of the acqusitions during the past year could have built real businesses rather than being a feature of a much larger entity.  While the math worked for a number of enterpreneurs that sold, one of the decisions you need to make is the likelihood and timing of being crushed by a larger player if you decide to go alone and raise VC funding.  Whatever you start, I would suggest thinking about what your potential revenue model is from day 1 and thinking through the economics.  Hell, it may change a couple of times, but building a company with the sole purpose of flipping is the wrong idea as your odds of success are very low.

Despite this, the opportunity for entrepeneurs and VCs could not be greater.  There are clearly more users globally, broadband is everywhere, users are more educated, companies can target more, capital efficiency has increased, and there are real business models out there generating tons of profits.  I do not think that Internet VCs are dead, but rather, need to reinvent themselves.   It is also clear that the VC model is broken and needs to change.  As you can see this is slowly starting to happen as smaller funds ($200mm vs $750mm) are being raised, VCs are doing less new deals per year and sitting on less boards, and many are trying to get in earlier.  Having a smaller, more focused fund allows a VC to make some investments during the Angel round ($500k-$1mm), watch the company closely, and give VCs the opportunity to lead the first real institutional round.  If the company has the chance to flip, then great, everyone wins.  If the company want to take the next step, then we can be there to lead or co-lead the next funding round.  It is imperative for VCs to get in early and structure their funds around this because in the Internet space companies can build momentum quite quickly which also means that valuations tend to move quickly as well.  That is also why the Googles and Yahoos of the world are trying to identify the emerging opportunities before the VCs get involved. 

All in all, it was a wonderful time, and I feel honored to have been one of Yossi’s guests and for having had the opportunity to network and participate with Israel’s tech elite.  Unfortunately, I had to head home on a redye Saturday night, but many of the attendees ventured to the Marker Tech Conference where 3500 people were expected to attend and hear panel discussions led by many of the participants at Yossi’s Kinnernet.  Kinnernet was great and I had a blast, made many new friends, and came away clearly impressed with Israel’s thriving and talented startup community.