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Does IT Still Hurt?
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
April 26th, 2002


By Brent Holliday
Greenstone Venture Partners

 

"Don't call it a comeback
I been here for years
Rockin my peers and puttin suckas in fear" - LL Cool J, Mama Said Knock You Out

Last time, I started off by stating that these are wildly unpredictable times, and then followed up with a summary of where experts think the telecom industry is headed. This time I want to focus on another broad sector, Information Technology or IT. Why these two industries? First and foremost, a lot of people employed in the technology industry in BC sell products or services in these sectors. Second, that's where I spend all of my time, so I can speak somewhat intelligently about the area. {Yes, I hear you snickering.}

What's the difference between Telecom and IT?: Glad you asked. Really simply? Networking vs. applications. In more detail: The telecom industry includes wireline voice and data and wireless voice and data. Telecom starts at the network edge of the enterprise and provides all of the functionality in the city, out to the regions, across the country and around (or above) the world. My definition of IT is products and services from the edge of the enterprise inward, with the broad exception of applications that interconnect enterprises. Of course, there is big overlap as companies that sell to the telecom industry players may also sell to the enterprise or IT industry. Confusing?

Another way to look at separating IT from telecom is through the 7 layer OSI (meaning Open System Interconnection, not Steve Austin's boss Oscar and his covert organization...) model of networking (see here for definition). This standard protocol for networking starts at the physical layer (ingeniously called layer 1) which is the actual electrical pulse, light pulse or radio wave. By layer 6, the presentation layer, we have figured out how two computers, PDAs or cell phones connect and send data to one another. But layer 6 and layer 7, the application layer, are all about the usefulness of this connection. The end user needs the application and the translation from application code to networking language in order to actually do something that makes their job simpler or make them more money. So layers 1 to 5 are telecom industry and layers 6 and 7 are IT industry. Right? Well, not always.

There that was easy.

The reason for the long definition is to help set up the really big point: IT has gone from a few disparate software programs 20 years ago to permeating every business process short of the handshake today. For better or worse, IT products and services are integral to business today. The promise of IT is that it makes business faster, more accurate, cheaper to run, more automated and, at the end of the day, more profitable. It took a long time to get the systems and the internetworking cheap enough, robust enough and scalable enough to rely on them for critical aspects of business. And the complexity is still mind-boggling. Y2K is a great example of how complicated the underlying systems have become. In an ironic twist, one of the hottest areas in IT today is enterprise application integration (EAI), which is essentially an IT industry sector making money because the IT systems in place to make companies more profitable are too complex, or weren't designed to talk to one another. Soon, EAI will be everywhere, mediating and interpreting the legacy applications for a fee. Kind of like a lawyer.

IT has become a massive industry with some of the biggest companies in the world providing software, hardware and services to the enterprise. The gorillas (Microsoft, IBM, Oracle) are generally horizontal players, meaning that they dominate a certain type of software or hardware and sell to many different enterprise sectors. The value proposition of the horizontal player is standardization, leading to efficiency and cost savings. But, IT is more than PCs and Windows 2000. It is about how business works and making incremental improvements to the business process. That is why vertical or industry-specific IT providers do well. They understand the business that they are selling in to and make their value proposition the short learning curve and increased functionality for the user's specific daily work process. Then, there are the embedded players. These are the many, many software and services companies that sell to manufacturers of other products, helping them make their manufactured goods or machines work better or have more desirable features.

What Is Happening Now and in the Near Term for IT? - At the moment, IT is still somewhat horrific. The enterprises of the world have spent 2000 and 2001 slowing spending dramatically because they blew their brains out with Y2K and then the dotcom collapse ended any urgency for e-commerce. As I have said before about this industry, there is no new thing that everyone needs. ERP (enterprise resource planning) has had its day. CRM and SFA (customer relationship management and sales force automation) have had their run. B2B commerce has been re-constituted as the supply chain, but it has not caught on in a huge way, yet. PCs are reaching the saturation point and no one expects the days of 30-40% annual growth to ever happen again. Security is about the hottest thing still around, with distributed storage a close second. But the most important factor is the attitudes of the enterprises towards their own business prospects. IT goes as the economy goes, especially in the absence of a new new tech thing to get hyped about. As many businesses focus on cost cutting to improve profits in the wake of slowing or shrinking revenue, IT budgets freeze or decline.

But wait, isn't the economy recovering now? Didn't we avoid a recession, even after September 11th? Yes, but for IT prognostications one has to look at the industries that spend the heaviest on IT and see where they are. Number one sector for IT spending worldwide? Telecom. Oops. Number two sector for IT spending? Financial services. Double Oops. Number three sector? Govt and Military. OK. That's a bit better. Here in BC we are cutting government like crazy, but worldwide this is a healthy sector. Manufacturing is another heavy spender in IT and indications are that IT budgets were largely frozen and not decreased in that sector. But a closer look (probably indicative of all sectors at this point) shows that IT managers in the manufacturing enterprises are looking for ways to get more out of existing major investments through incremental improvements. Big projects are off the table. That bodes well for IT services that offer maintenance and improvements, rather than big ticket products.

I mentioned EAI earlier. There has been a heap of companies that tried to productize EAI and failed. This is largely a service business now (creating custom connectors and glue for each individual enterprises' integration problems), but a new light is shining in this sector because of web services. The promise of web services is a robust and scalable architecture for communicating data between web based applications. It is the jumble of acronyms (XML, SOAP, WDSL) that allows different businesses to communicate using different applications built with different programming languages. This should kill EAI right? Fat chance. It will be a decade before old applications are completely thrown out for the new web services model.

Nevertheless, web services is hot. Venturewire lists 11 web services companies funded last quarter. For over a year, Microsoft and Sun have been sparring over their web services platforms (.NET and J2EE) which has caught the attention of the IT industry. Any company that made a business based on a web based application (that has not already disappeared) is converting all of their old code to web services to ease the burden of upgrading and adding features.

In the near term, over the course of the next year, IT should improve. The economy is gaining speed. The PC lifecycle means that all of those bought in 1998 and 1999 ahead of Y2K are seeming old and slow. In general companies have cut to the bone and are looking for large efficiency and productivity gains from remaining employees. Outsourcing of non-core IT functions like storage, network management and security has increased dramatically during the time of cuts. All of these factors add up to an increase in IT spending across the board in services, software and hardware.

As a small IT company that has survived the downturn intact, you should think about being a vertical solutions company or an embedded player. Trying to build the big horizontal play, a la Pivotal or Crystal Decisions, is inadvisable in a market where buyers are looking for incremental improvements to core applications over the next while. Enter and dominate a vertical for now. The next big reason for enterprises to buy new systems is not apparent yet. Unless, of course, you are convinced that you have the next CRM or ERP idea. Then, convince your local venture capitalist and be on your way.

Letters From Last Time –

Brent;

Nice article on the Telecommunications Sector. A couple of thoughts:

1) If Wireless is indeed the bright spot in this otherwise beleaguered sector, then this should bode well for the local economy. After all, Vancouver is a renowned wireless innovation centre, is it not? Shouldn't we see local Venture Capitalists spending in this sub-sector?

2) You emphasized that the telecommunications companies are stretching their replacement cycles. This makes sense, however they could further leverage their existing equipment and networks by adopting and integrating improved innovations such as Voice Recognition Software. Are you seeing any examples of this in the big 14 (or 5?).

3) Finally, what do you think of the prospects for laser communications? This is another innovative technology that should reduce operating costs and increase subscriptions for the telcos.

These 3 queries should reflect optimism for the local Vancouver players, don't you think?

Bryan Buggey

Bryan:

To Question #1 - Absolutely. Wireless is the only bright spot in the telecom horizon and we have a plethora of innovators and entrepreneurs here in BC. The newly created industry group, WINBC (Wireless Innovation Network at www.winbc.org) claims over 100 companies in this sector and lists over 60 as members. The local VCs are funding a few of them and more will certainly be funded in the coming months.

Q2 - Definitely not. There is an old telco mentality of monopoly that says that change is scary. Most of the decision makers in the surviving telcos do not want the latest and greatest even if it saves money in the long run. They have their fiefdom back after the CLECs dies and they are going to sit tight for a few years. They will never admit it publicly but look at BCE's changes this week. Boring cash flow is in and new bold initiatives are out.

Q3 - If you mean free space optics when you say laser communications, a la Fsona in Richmond, then yes they do have some advantages and should have a bright future, eventually. But looking at my answer to Q2, it won't replace any wireline stuff, but rather provide redundancy/backup. If you mean optical networking (because a laser is always the source of light pulses in fiber), then I would say the future is out a few years further. The buyers are sitting on their wallets in wireline long-haul. The only bright spot is in the urban areas or metro networking space where optical networks have yet to penetrate and have obvious advantages. But even this will be slooooww uptake.

Thanks for a great letter.


What Do You Think? Talk Back To Brent Holliday

 



Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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