If it’s not love, then it’s the bond, then it’s the bond that will bring us together.~ The Smiths, ‘Ask’The announcement of BlogBurst (yikes! Web firms everywhere, please consult me for naming before launching your next projects!) reminded me of

An idea that has recently been spreading through the VC and
innovation blog niches is that the VC industry is ready to be
disrupted. Here’s a "meme highlight reel" that showcases the best of
this conversation.

On (a) - Bnoopy (July 29, 2005) does note the phenomenal drop in the hardware/infrastructure costs. I would not dispute that. Yet hardware is a ‘set-up cost’ (the maintenance and/or depreciation components are minimal in the high-tech industry) whereas. The cost that will multiply your burn-rate is the labour costs associated with your product development. It is here that the costs are unlikely to fall, despite outsourcing to offshore centers like India because most of the IT-subsectors where US VCs invest are what I would call ‘professional software design’ where atomization of the product development process is either impossible or, if possible, carries an immense downside risk.

I think the fallacy in the Fraser’s (and Rick Segal’s, who has a challenging piece on this also) argument is a focus on a relatively narrow sub-sector of IT-sector innovation. Namely, they zero-in on the ‘consumer-focused’ innovation – technology serves as a tool to implement an entrepreneurial idea. Fraser’s citation of Posima is an excellent example here. Posima does bring an extremely useful service by enabling efficient, quasi-professional website design. Yet this is only a small part of what the high-tech sector is all about. If you look at Thomson’s VenturExpert database, ‘computer software’ makes up less than half of total IT-sector VC investments in 2005 and significantly less before that. Indeed, disaggregating this sub-sector further, one sees that amongst all the different software headings, “Banks/Financial Institutions Software” and “Firewall/Encryption Software” are the two largest software components. These are ‘professional software design’ cases and are only two examples amongst many others in the same sub-sector. (incidentally, feel free to get in touch with me if you would like to see the charts I refer to – VenturExpert is proprietary and I’ve had to work a bit to get these data together). If you talk to the programmers who build these things, the product development process is fundamentally iterative – from the functional specification sheet, through to the technical specification sheet, writing of the code and, finally, testing. And I am simplifying the process. Offshoring of these tasks would involve a major change to the management structure – you would have to ensure that your functional spec sheet is extremely detailed, your tech. spec. sheet is meticulously thought-through. All this pales in comparison with the problem of dealing with code-writing decisions that have to be made by experienced programmers, not simple code-writers, as the software idea is actually realized. All this may sound trite, but with your programmers sitting in South Asia or Russia or even Eastern Europe, you WILL have communication issues and your development process can be bogged down for periods of time that are unacceptable for a startup that is trying to get a product to market. An entrepreneur is faced with the choice - reach for the low-hanging ‘fruits’ of lower programmer wages but be prepared for the ‘worm’ inside them of poor technical performance.

On (b) – The opportunity for lower labour costs during the product development stage are thus fraught with downside risks I outline above. The VC, however, has a niche here – to ameliorate some of this risk through his/her network capacity. Offshoring of product development needs to be managed, and the skills necessary are not what an entrepreneur is likely to possess – this is a clear opening for VCs. More specifically – the VC may be able to offer an entrepreneur access to a dedicated offshoring ‘body-shop’ where a (preferably proprietary) relationship with this shop and management methods, to handle the differences in product development model due to offshoring, have been honed over some significant period. This suggestion merely emphasizes the ‘don’t-be-an-ATM’ idea in Fraser’s post and is one step towards the ‘VC-as-incubator’ concept that he discusses in his later post. Undoubtedly, the other characteristics of an incubator may be invaluable for a seed company, but the focus here is on the lowering of product development costs.

Interestingly, this is something that a VC firm, with capital behind it, can have a clear advantage over an angel, or an angel network, even allowing for the prior that lower start up costs permit these private investors to support a startup to a more mature stage than before.

I can see some drawbacks here, naturally. One is that the process of writing innovative software, at some core, cannot be atomized further. The definition of such a ‘core’ depends on the nature individual project and cannot be set a priori. There will always be heightened risks in sending large parts of product development across a couple of oceans. Grafting such radical outsourcing tactics will, by definition, be marked by ‘teething troubles’. Yet, a recent poll of relatively young, high-growth firms by PriceWaterhouseCoopers noted that the two things that are on the minds of the high-tech firms are – ‘lack of qualified workers’ and ‘developing new technologies/services’. Combine these two facts and outsourcing may soon grow to become a competitive necessity, rather than an advantage.