Trident Capital Blog

Notes from the 2010 Pacific Crest Technology Conference (Part 2)

Last week I provided my notes on the SaaS workshop that was organized as part of the recent Pacific Crest technology conference in Vail.  Today I’ll talk about online advertising which was another major theme at the conference.

• Online advertising continues to grow in spurts.  Ad budgets remain volatile even though the presenters at the conference talked about a 10% online ad budget growth during 2010.  Spending looks better for 4Q10 and into 1Q11, assuming that the economy doesn’t continue to decelerate.  Campaign planning continues to be on a quarter by quarter basis.  The online display ad market will grow by 20% this year, faster than search advertising (12-15%).  This is one of the highest growth rates of all types of online advertising.  Only social advertising surpasses with an annual growth of over 30% but the social advertising market is much smaller.  These growth rates corroborate the 17% growth rate that Forrester recently provided for that market.  Mobile and social are becoming increasingly important drivers.
• Today 14% of the total ad dollars are going to online. Advertisers continue to cancel their print buys and move their budgets to online.  Larger companies are moving to online faster than in previous years.  TV planners are trying to determine how to move money to online video.  Most online ad programs are coming from agencies rather than directly from advertisers.
• In late 2009 and early 2010 the display market moved away from ad networks and towards Demand Side Platforms (DSPs) and ad exchanges because marketers wanted to be efficient and consumers demonstrated that they wanted to visit multiple sites to find the most appropriate content.  Data will play an increasingly important role in the rapidly evolving display ad technology.  Its use will lead to improved targeting and higher accuracy in bidding.  Today even though Real Time Bidding (RTB) is consuming much of the discussion around display ad technology, none of the DSPs are real time yet.  Marketers don’t perceive a significant difference in the ad effectiveness of the Yahoo and Google ad exchanges though the two exchanges employ different bidding strategies.  Search is still the best suited method for performance-based selling, lead and generation.
• While the technology panelists who sat on the future technology trends panel identified mobile internet as the top trend to watch for (the other being cloud-based application delivery) the advertising executives in the online advertising panel and workshop claimed that the next two years the shift from print to mobile will not be as fast as the shift from print to desktop online.  However, the shift to mobile will continue gaining steam.  There are several issues resulting in the slower move to mobile including the problem with redeeming coupons through mobile devices. Ad tech is viewed as a means to improve the margins of online advertising.

The information presented at the conference’s online advertising panels has the following implication for Trident:

1. Ad tech for display advertising will continue to evolve rapidly with new Demand Side and Supply Side platforms emerging.  Online advertising agencies are racing to develop the right infrastructures to take full advantage of the emerging technology.  Turn (www.turn.com), one of our portfolio companies, is emerging as one of the key DSPs.
2. Data will be playing an increasingly important role in ad targeting and pricing decisions. 
3. Mobile advertising in its various forms (in-app, in-game, in-browser) continues to move from experimentation to mainstream though still the budgets are not reaching the projected levels.
4. Advertising in social media is attracting strong attention and budgets are increasing rapidly.  We have invested in Extole (www.extole.com) that is developing a SaaS social marketing platform and is becoming the system of record for its customers’ social graph.

Notes from the 2010 Pacific Crest Technology Conference (Part 1)

I was on the road for almost two weeks.  During the early part of last week I was in Vail to attend Pacific Crest’s annual technology conference.  I’ll consolidate my notes around three topics of personal and investment interest that were covered in the conference: SaaS, online advertising and future technology trends.  This week I’ll cover SaaS and next week online advertising and future technology trends.

The SaaS workshop had 60 attendees (private company executives and venture investors).  The discussion was motivated by two surveys that Pacific Crest conducted.  The first was a survey of 80 CIOs and IT executives that Pacific Crest conducts annually for the past 3 years.  The second was a survey of 80 private SaaS companies which they conducted for the first time this year. 

1. Corporations are increasing their use of SaaS applications.  The biggest reason for the use of SaaS is ease of deployment and integration.  Security is becoming less of a concern.  According to the Pacific Crest's CIO survey, during 2010 and 2011 60% of the budgets for new software acquisitions will be allocated to SaaS and cloud computing, with over 50% going specifically towards applications.   These are similar trends to what was reported on a Goldman Sachs research note that was published on 8/17 by Sarah Friar.  CRM, HCM and collaboration are the top three SaaS applications in terms of new licenses and renewals.  CRM, excluding sales force automation, has been the top application choice, 3 years running in the surveys conducted by Pacific Crest.  The optimism of the CIO survey was also reflected in the SaaS company survey where it was reported the median YoY revenue growth during 2010 will be over 40%.  However, the survey also showed that the majority of the SaaS pureplay vendors still don’t make it to the CIOs’ radar screen.  While this realization may not be of great concern to SaaS vendors, since they tend to sell to LOB executives rather than IT executives, we are seeing IT playing an increasingly prominent role in SaaS licensing decisions, particularly in F1000 companies.
2. Increasingly SaaS companies are being asked by their customers to use all the data in their disposal to provide benchmarking services allowing each customer to compare to its peers.  It appears that companies are switching from being concerned about their data being stored in the cloud and, moreover, in the same database with data from other companies (some of which may be their direct competitors) to trying to gain insights about their business through the analysis of all the data managed by the SaaS vendor.
3. Most of the surveyed SaaS companies whose applications command ACV that is higher than $25K are adopting hybrid sales models (inside and field sales).  Few such companies appear to use a self service-only sales strategy effectively.  According to the survey results, the self-service sales model is more effective with products that have ACV of $5-10K.  These results are consistent with what we see in our relevant portfolio companies.  However, for the stage of companies that were surveyed, the reported CAC ($0.75 in CAC for every $1 of first year license) is too low, compared to what we are seeing in our portfolio companies, as well as in SaaS companies that are asking for investments. 
4. In terms of operational metrics, most surveyed companies expect to realize 70% gross margin and 12% operating margin by the time they have reached $50M in annual recurring revenue.  The companies sign one year contracts with more regularity and most are now able to get paid for the entire subscription upfront.
5. By the time companies reach expansion stage, i.e., revenues of $15-20M, they will most likely need another $10-20M in investment to achieve breakeven, implying $35-45M in total investment from inception to breakeven.  Those of the surveyed companies with revenues that are below $40M expect to be acquired by either a SaaS or an on-premise software company rather than go public.

The results of these surveys have four implications for Trident:

1. Our firm’s overall SaaS investment thesis should remain intact.  In fact the results of these surveys, (combined with the solid quarterly performance of our SaaS portfolio companies, which I have been reporting on this blog, and the performance of the public SaaS companies) further strengthen our SaaS investment thesis.
2. Our SaaS portfolio companies must continue to aggressively educate IT organizations about SaaS and cloud computing.
3. We must continue to encourage our SaaS companies to make better use of the data they capture to provide business insights to their customers and help them constantly improve their businesses.
4. We need to pay more attention to amount of funding SaaS companies will ultimately require as a result of the higher costs and smaller margins associated with the use of hybrid sales models, compared to self service or inside sales-only models.
   

The discussions on online advertising and ad tech were very interesting and will write about them in my next post, along with my comments from the panel on future technology trends.

IBM's Business Analytics Blogger Event

Last Tuesday I was invited to speak at an IBM event for technology bloggers. The event addressed two topics that represent key growth priorities for IBM: business analytics and smarter planet. IBM’s Fred Balboni, Global Business Lead for Analytics (responsible for all business analytics services at IBM), Rod Smith, VP of Emerging Technologies, and Mike Rhodin, SVP Software Solutions Group (responsible for all business analytics, BI, and collaboration at IBM) participated in the meeting, along with two IBM clients the Beacon Institute and the NY Tax Office. IBM invited seven bloggers to the event: Erick Schonfeld (Techcrunch), Derrick Harris (Gigaom), Alex Williams (ReadWriteWeb), Larry Dignan (ZDNet), Mike Vizard (IT BusinessEdge), Mike Loukides (O’ReillyMedia) and Mark Kobayashi-Hillary). I was asked to talk about why VCs are interested today in business analytics.

My presentation followed the talks of the three IBM executives who stated that:

1. Worldwide customer demand for business analytics services is so strong that IBM is now trying to hire an additional 3000 consultants in Fred Balboni’s group. Just a few months ago that group was supposed to have 4000 consultants.
2. IBM customers are starting to ask for Hadoop-based data warehousing and analytics solutions in order to determine if they can them to a) manage and analyze large data sets more cost-effectively and b) to quickly perform exploratory data analyses on multi-dimensional data. However, the case studies provided by Rod Smith of IBM customers using Hadoop today were not dealing with big data (i.e., TB- or PB-scale data sets).
3. As part of its smarter planet initiative IBM continues to expand its collaboration with cities around the world where it applies business analytics and uses business processes from the corporate world in order to streamline and optimize the operations of cities.
4. Even after spending several billion on BI-related acquisitions, IBM intends to continue building out its business analytics technology stack through additional acquisitions and internal product development.

In my presentation I claimed that VCs are investing in business analytics for the following reasons:

1. The impact of cloud computing. Cloud computing is enabling the creation of new analytic applications, such as Infopia's ecommerce analytics application, and others about which I had written here, where analytics are embedded in the application from the beginning rather than as an afterthought (as it used to be the case in the past). It also enables new takes on existing analytic applications, such as the SaaS corporate performance management application developed by Host Analytics. Finally cloud computing promotes new usage patterns in BI solutions such as collaborative decision-making across the extended enterprise, i.e., across customers and partners, and better economics, i.e., better price/performance, over equivalent on-premise solutions. As an example of collaborative decision-making, I mentioned that cloud-based BI solution vendors can offer their clients corporate benchmarking services (think of it as Insight-as-a-Service) by analyzing uploaded and collected data from across their entire customer base, identifying important patterns, and translating them into the appropriate business actions.
2. The emergence of big data. Ever increasing volumes of structured and semi-structured data, including web data, such as that created by ad networks, and sensor data, such as that created by he Internet of Things, are starting to test the scalability of existing data warehousing solutions, make such solutions prohibitively expensive, and inhibit the timely creation of actionable analytics. I had written about the data volumes created by the web applications and how a new generation of analytic applications and data warehousing infrastructures need to be created in order to effectively deal with it here and here. During the meeting the director of the Beacon Institute spoke about the institute’s collaboration with IBM to monitor the Hudson River using Complex Event Processing and streaming databases. This solution generates real-time analytics from the voluminous data (most of the data being of little interest but 2% being of extreme interest) produced by thousands of sensors that Beacon has deployed on the Hudson. VCs have already begun to make investments in companies (e.,g., Cloudera, Aster Data, Karmasphere) that are developing solutions for these problems.
3. The need to analyze mobile and social data. The continuous growth of the mobile internet and commerce, as well as the accelerating growth of social internet and commerce create new sources of data and the need for new types of analytics. 

One of the questions asked was whether IBM’s BI acquisitions are leading to an increased VC appetite for business analytics companies. Over the past couple of years business analytics, BI and data warehousing are experiencing a renaissance that is indeed leading to an increasing funding activity. However, this activity has nothing to do with IBM's acquisitions in this area. In fact, IBM's acquisitions only serve as additional validation of the importance of these areas. Forward-thinking VCs have been funding BI and DW companies for as long as BI existed, certainly before IBM started its BI acquisition spree. Over this period VCs have created many successful analytics, BI, and data warehousing (think of companies like Netezza, Datallegro, Omniture and more recently Greenplum). However, it is also true that certain subsectors are getting overfunded.

This was indeed a very interesting event and I look forward to reading the other blogs that will be written about it.

2Q10 Proved Harder than Expected but SaaS still Comes Through

We are in the midst of the reporting season.  Several public SaaS companies have already reported the results of their 2Q10 financial performance and a few more will do the same in the following days.  These reports continue to tell a very positive story for SaaS companies as the majority of the companies met their financial targets demonstrating a 10-30% revenue growth with the majority in the mid teens.  During a series of board meetings and calls over the past 2 weeks, our own SaaS portfolio companies also reported their 2Q10 performance.  This quarter was more challenging for our portfolio companies than 1Q10 (see the 1Q10 analysis here).  A summary of our conclusions from these meetings:

1. The same number of companies made their numbers as in 1Q10.  However, new deals were harder to close and many of them came at the end (last 2 weeks) of the quarter.  In past quarter we were able to see a better “pacing” with deals closing every month. 
2. QoQ revenue growth in the 5-10% range.  However, after the performance of 1Q10, we were expecting revenue growth in the 20-30% range.  Peeling the onion we saw the following:
1. While the US market appears to have been slower during the quarter, the international markets for SaaS are starting to open up.  Even our smaller companies are starting to receive inbound leads from European and Asian corporations that are now considering SaaS solutions.
2. Upsell targets were met or oftentimes exceeded as existing customers expanded their use of SaaS applications.  Furthermore, renewals and upsells were done on time compared to new deals that, as I mentioned, closed at the end of the quarter, implying that customers continue to see strong value with SaaS
3. SaaS adoption by larger companies continues to accelerate while the small businesses continue to struggle as they try to exit from the recession.  Over 60% of the deals closed by our SaaS portfolio on the aggregate are now coming from larger corporations (with over $300M in annual revenues).
4. Larger companies signing annual and multiyear contracts, rather than going month to month or six-month contracts, implying that they are embracing SaaS quickly and their comfort with the use of SaaS applications continues to increase.  This corroborates data recently reported by Gartner and IDC.
5. International markets are coming on strong.  Many of our smaller SaaS companies are starting to sign deals with international customers.  They have also started receiving inbound interest from international partners.
3. Social media and word of mouth are playing a more prominent role in demand generation, much more than I had expected for enterprise software.  During the quarter, webinars proved again the most effective lead generation channel.
4. Continued growing emphasis on field sales.  Prospects are asking for more elaborate and company-specific evaluations of the SaaS applications requiring more touch.  As a result of the increasing emphasis on field sales, the gross margins continue to be negatively impacted. 
5. Partners are becoming more engaged with SaaS application companies and are initiating more sales opportunities for our portfolio companies than in the past 3 quarters, i.e., it’s becoming easier for our portfolio companies to sign up partners and the partners become effective faster than before because they see market demand and are figuring out how to make money through the model.

The results of 1Q10 had left us particularly enthusiastic about the prospects of our SaaS portfolio companies for the remaining the year.  While the 2Q10 results tempered the enthusiasm they continued to validate the power of the SaaS model.  Because of the overall macroeconomic trends, particularly in the US, our partnership and our management teams realize that achieving the budgeted financial targets will require even harder work than we had thought at the end 1Q10.

Lessons from the Past Ten Years (Part 3)

Following a brief digression to write about big data, I return today to the final piece on the lessons I’ve learned as a VC over the past 10 years.  After talking about training and making investments, today I will talk about managing investments.

1.       You’re the coach, not the quarterback.  No matter how hands-on investor you are or want to be, you need to understand that, on a day to day basis, your CEO and his/her management team is running the company.  You must trust them to work through the operational issues that arise.  As a coach you can:

a.       Let your management team know that you are always there to help them (around business models, sales models, sales compensation issues, hiring decisions, etc).  I’ve come to learn that investors with operational expertise are highly valued by entrepreneurs, particularly now that the times are tough.

b.       Constantly evaluate your management teams from top to bottom.  You need to learn to trust your management teams and when you stop trusting them, it’s time for a change.  If a team is starting to struggle and execute inconsistently, make the appropriate changes quickly.  Strong execution rarely returns to an inconsistent team.  For this reason have learned not to wait until the board meeting to find news about the company’s progress, but I frequently talk with each portfolio company’s CEO.  A quick call every couple of weeks, particularly for early stage companies, does wonders.  It is important to establish a healthy dialog with the entire management team starting with the CEO.  They must all feel comfortable telling you good and bad news, and seeking your input.

c.        Know when to accelerate and when to put on the brakes.  Understanding how your management team is performing will also allow you to determine whether to make changes to the company’s burn rate, some times going against your CEO’s opinion.  Such decisions obviously impact hiring, market expansion plans, product development, etc.  They also play a pivotal role when considering future financing rounds.

Actually, if you try to analyze this point a little more extensively you will come to realize that as an investor board member, and unless you are the only investor in a company, you are not the only coach.  Each investor with a board seat is also a coach.  Oftentimes the coaches’ interests don’t align, even if at the time of the investment everything appeared perfect. For example, you may want to let an executive go, slow the burn, sell the company, invest less money in the company, etc. while your co-investors want to make different decisions.  CEOs may try to capitalize on such differences of opinion and attempt to create a split between you and the other co-investors and/or independent board members.  For this reason …

2.       Make sure you’re always on the same page with your other board members, particularly your co-investors.  I have made the same point during the second post in this series when discussing lessons around the process of initially investing in a company.  But while it is important to be on the same page with your prospective co-investors while you are considering an investment opportunity, it is doubly important that you agree throughout the investment’s lifecycle on issues such as management team performance, burn rate, milestone achievement, valuation expectations (for future financing rounds and potential exit), exit scenarios, etc.  Make sure you have a good understanding of each such issue before even trying to discuss it with your co-investors and fellow board members.  Steve Blank recently wrote about the current exit environment for technology companies and its ramifications to VCs.  Being on the same page always increases the probability of success even when the company faces challenges.

3.       It’s about the money you return, not the money you invest. In the last post of this series I wrote how you should treat your LPs money like your own.  Your LPs expect you to provide them with superior returns.  Realize that it is not about how many investments you have made, the amount of money you have put to work and how many boards you seat on.  It is about ROI and IRR.  For this reason, you need to be thinking about the lifecycle of each portfolio company and the overall investment it will require, rather than just the round you invested in.  In the process you must be able to evaluate and determine whether you have reserved enough money to protect your ownership after subsequent rounds, some of which may be down rounds, and others may need to be inside rounds.  You also have to be prepared to stop investing in a company or even walk away from underperforming investments once you feel you realize that your actions no longer result in the desired outcome.  While such actions may not endear you to an entrepreneur or a management team, remember this is not a popularity contest but an ROI contest. Even if there are hard feelings initially, at the end management teams always understand the rationale of such actions. 

4.       Keep your partners informed of the state of each of your portfolio companies.  I cannot stress the importance of over-communicating with your partners.  It’s also always OK to ask them for help and to collaborate with them around a particular investment, if you believe that this increases your probability of success, i.e., providing superior returns.  Ultimately it is about the investment’s success, not about whether you’ve achieved it on your own.

5.       Failure is always one of the possible outcomes.  You need to understand that regardless of how careful, analytical and diligent you have been during the pre-investment process, how hard you have worked as a board member, how strong of a management team you have, and how good your co-investors are, companies, particularly early stage ones, fail more often than they succeed.  Dealing with failure and trying to maximize returns even during the failure is part of being a VC.  If failure appears inevitable, then work with the company’s management team and your co-investors to consider all the options and create a win/win experience for everyone.  For example, rather than closing a failing company down there may be an opportunity to merge it with one in the same space that is performing better, even if you become a minority owner in the resulting entity.  Learn from such experiences, repeat the positive and try to avoid repeating the negative.

And finally, regardless of your successes, remain humble since prior successes don’t guarantee future outcomes.

Thoughts on Big Data

Earlier in the year I wrote about areas of investment interest for 2010 and included Big Data aggregation, management, and data mining/processing.  A couple of weeks ago I had attended Gigaom’s Structure 2010, a conference devoted to big data.  As is also noted by Derrick Harris here there is a growing market of vendors that are working around open source tools to support big data initiatives.  I wanted to summarize my thoughts from the conference but travel got in the way.  When EMC’s acquisition of Greenplum was announced big data came to fore again since Greenplum had created a good implementation of MapReduce into its platform (even though I think EMC has been thinking along more traditional data warehousing lines with this acquisition).

1. Only 10-20 companies have a good grasp of big data issues and are innovating in this area.  Though many companies in the Fortune 1000 are starting to experiment with Hadoop, today only 10-20% of enterprises need big data solutions.  This number could grow as high as 40-50% in 5 years. 
2. NoSQL databases are emerging as the preferred systems for storing and managing big data sets.  The data in these sets is at the terabyte or petabyte scale, it is semi-structured, highly distributed, and much of it is of unknown value so it must be processed quickly to identify the interesting parts to keep.  NoSQL databases provide efficient and effective storage, management and processing of such data sets at low cost.  However, it is unlikely that these databases will evolve into general purpose platforms, like relational databases did.  It will therefore be important to match the big data problem being solved to the right database.  Data analysis and business intelligence are emerging as the best applications for taking full advantage of NoSQL databases.  Almost every company that presented at the conference discussed such applications.
3. Too many NoSQL database companies have already been created (Cloudera, 10gen, MongoDB, VoltDB, CouchDB, etc).  While the user interest in such databases is increasing (many Fortune 1000 companies have started Hadoop evaluation projects), the market won’t be able to sustain them.  I expect to see significant consolidation in the next 3-5 years.
4. Today there is no “LAMP stack” equivalent for big data processing and analytics and I think that there is an opportunity and need to create one.  As Jim Kobielus at Forrester wrote in his blog, there is not going to be a standalone market for Hadoop.  The pioneers of the big data movement, e.g., internet portals, social networks, ad networks, etc., are creating ad hoc “stacks” using open source tools for data management, data aggregation, in-memory storage.  In most cases they extend/modify these tools heavily.  In addition to base Hadoop, tools such as Hive, Cassandra, Scribe, memcached, MapReduce, Google App Engine are part of such stacks and, consequently can be the components of a pre-integrated, pre-certified Big Data Platform.  Using these tools still requires a programmer’s talents (PIG, and QL are efforts to provide a higher abstraction programming layer to Hadoop and Hive respectively so that database administrators can interact with the databases).  The Big Data Platform must be usable by business analysts, as well.  Hadoop client-side applications such as those being developed by Karmasphere and Datameer provide steps in the right direction but they remain standalone. 
5. For no reason apparent to me, NoSQL database companies are trying to reinvent the data warehousing and business intelligence infrastructures that have been created over the years. Some of the “reinventions” may be absolutely necessary and will lead to important innovations.  However, these companies appear to be also ignoring important aspects of the data management and data analysis technology that has been developed over the years around data warehouses built using relational technology.