|
What do VCs Want from CE?
Convergence brings together venture capital and consumer electronics to stimulate growth and ideas in CE-related start-up companies.
For all of its mystical and romantic properties, innovation would shrive up and die without one basic food source: venture capital. The vital money that helps a technology idea grow from concept to creation (and eventually to market penetration) greases the wheels of capitalism and ensures that better mousetraps out there get their chance to compete in the marketplace. Without venture capital, ideas would languish in basements and on notepads-unable to convince risk-adverse banks or corporations to make the big bets necessary to let them prosper.
 Most venture capital, however, has flowed to computer- and software-centric niches over the years, with VCs paying far less attention to consumer electronics (CE) devices and components. Much of the reason is that CE products operate in a risky and largely cut-throat retail environment.
"The challenge for VCs in consumer electronics is that it's very competitive," says Mathias Schilling, co-founder of BV Capital with offices in San Francisco and Hamburg, Germany. "Pushing a product into retail requires a different set of expertise than [venture capitalists] are usually comfortable with." Changing consumer tastes also can be a challenge, he says: "It's a very difficult task to predict the reaction of consumers to a new product."
"I think the opportunities in consumer electronics are huge," says Len Rand, a managing director at San Francisco-based Granite Ventures. "There are technology dislocations and convergence into the networking space... Any VC who doesn't understand the game is in trouble."
Not only that, but the CE industry has conditioned consumers to expect constantly plummeting prices-even when quality is rising exponentially. And that can put substantial pressure on profitability and return on investment. For that reason, many big CE firms have their own venture arms to seek out innovative, early-stage companies themselves.
"You don't normally see VCs investing in the CE space because of those low margins," says Brad McManus, director of investments for Panasonic Venture Group, which tries to find companies that could benefit by leveraging Panasonic's vast distribution power.
"They're obviously looking to get value from Panasonic," he says, noting that large CE firms like Panasonic can, in turn, integrate those technologies into their products. In fact, CE's dominance by large players with tight locks on retail distribution creates a perception that CE lacks that Anyone-Can-Become-The-Next-Google mystique often attached to the computer and dot-com worlds. "It's also hard to push people off the shelf at Best Buy," McManus notes.
Jay Eum, managing director of Samsung Ventures' U.S. office in Silicon Valley, agrees that it's difficult for new CE firms to get a foothold in the marketplace without help from a connected player. "You're playing with the big boys," he says. "And the margins are pretty slim."
Even when a start-up has a particularly hot technology, it's difficult to keep the market to themselves for long, Eum says: "The big boys catch up pretty fast."
Indeed, with notable exceptions such as the explosive introduction of the TiVo digital video recorder and, more recently, the quieter launch of Sling Media's "Slingbox" place-shifting media-streaming device (see sidebar), most CE innovation over the last several decades has come from established CE brands. "It's unusual that a TiVo or a Sling can have that kind of success," notes McManus.
Convergence Changes Everything
Nonetheless, the dominance of large CE firms still has produced plenty of innovation over the years, bringing us everything from compact discs to DVDs, to the high-definition HD-DVD (Toshiba) and Blu-Ray (Sony) video discs just now hitting stores. But recently mainstream venture capitalists have started to refocus their attention on CE-related start-ups-eliciting interest not only from major CE makers' VC arms but also from traditional VCs.
Why the change? In a word-convergence, which has changed core consumer expectations in recent years. No longer do consumers simply expect devices to dazzle them with quality and value; they want integration with other technologies such as wireless networks and computers. MP3 players and smart phones, for example, have seamlessly integrated the computer and CE worlds into one massive ecosystem that appeals to several demographics and blurs once well-defined technological boundaries.
"I think the opportunities in consumer electronics are huge," says Len Rand, a managing director at San Francisco-based Granite Ventures. "There are technology dislocations and convergence into the networking space... Any VC who doesn't understand the game is in trouble."
"VCs may say they want to see a viable business model and don't want to hear about exit strategies. But that doesn't fly in CE." -- Rory Jones, Business Intelligence Associates.
Of course, while convergence has elicited more interest in CE from VCs recently, it isn't necessarily a panacea that will shift massive amounts of VC money to the CE space. CE by definition caters to the much larger and more complex world of consumers-a reality that still elicits some apprehension from VCs used to funding firms that focus on niche business markets and other more manageable and predictable segments.
"You've got the technology risks, but you've also got fickle consumer tastes," says C.J. Fitzgerald, a partner in the Palo Alto, Calif., office of Summit Partners, which focuses on later-stage funding and private-equity of somewhat established companies. "You've got to battle both of those things."
In the consumer space, the need to establish a brand from scratch can be a debilitating prospect that requires an enormous investment of time, effort and money. "Establishing brand is paramount in consumer sales," says Rory Jones, a principal at San Francisco-based Business Intelligence Associates. "It is also impossibly expensive."
As a result, he says many CE start-ups have limited "exit strategy" options other than the hope of acquisition by a larger firm. "VCs may say they want to see a viable business model and don't want to hear about exit strategies," he says. "But that doesn't fly in CE. Not only must the business model appear viable, but it must be attractive to as wide a range of buyers as possible."
Integrate the Device
Another factor related to convergence: CE firms must show VCs that their products aren't just about the hardware but also about the software interfaces that help those devices talk more easily to other gadgets. In fact, that has become a major new area of focus. The iPod's introduction, for example, wasn't just about a sleek device whose internal widgets worked well; it was about an easy-to-use software interface that mesmerized consumers and opened up digital music to the masses.
"If you want to get it into the mainstream, it has to be able to operate easily for the consumer," says Fitzgerald.
McManus says that "value-add applications and services" has become a major focus of Panasonic, which "needs to look up the value chain" as Apple did when designing iPod's user interface. "That's how you're going to differentiate yourself in the marketplace," he says.
McManus and others point out that integrated user interfaces that work across platforms also create "a critical mass for all content creators" that further will strengthen VC interest in CE start-ups and components innovators.
 "You've got the technology risks, but you've also got fickle consumer tastes... You've got to battle both of those things." -- C.J. Fitzgerald, Summit Partners
"Software becomes so much more important," notes Schilling. He says such factors helped convince his firm to invest in digital audio firm Sonos, whose software interface allows easy integration of consumers' digital music collections throughout the home.
But while the iPod and other devices are moving the ball forward, experts note that VCs still face significant risk as content creators and manufacturers work out their differences on key matters such as digital rights management (DRM).
"What is a player without something to play?" says Jones. "The studios simply are not putting content out for DRM reasons, stifling the development of video businesses as a result. It becomes circular."
But despite the risks and challenges ahead, venture capital continues to flow into a CE space increasingly linked to the traditional VC-funded segments of computer, Internet and software technology. There are no guarantees for VCs, who certainly can't depend on fickle consumers to tell them what will be the next big thing. But there seems to be a growing sense that the stars are aligning more so than in the past when it comes to VC investments in CE.
"At the end of the day, to be quite honest, it's a gut feeling in your stomach," says Schilling. Indeed, that gut feeling has always been a VC's best friend. V
By Michael Grebb
September/October 2006
|
