VC’s and the Offshoring of Keiretsu

February 14th, 2006

Daniel Popov has added a lot of value to my posts on the changing Venture Capital industry through thoughtful comments, and all of them should be read by anyone who found my posts interesting (aside: when is someone going to find an elegant way to direct readers to key comments?). I’ve been processing everything that he has shared and am aiming to address some of his points in future posts.

In one of his comments Daniel shares the following:

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.

When I read this I started nodding my head in agreement - it made sense that this would be a valuable service for VC’s to offer their portfolio companies: finding, establishing, and managing a relationship with an offshore ‘body-shop’ yields best results when the relationship (trust, communication channels, …) has time to mature and develop. This relationship development is a better fit for a VC firm than for an entrepreneur. A service like this not only acts as a competitive advantage for attracting and negotiating with start-ups, it also helps the ROI as it drives down costs for portfolio companies.

I’m a young guy who is just thinking through all of these ideas for the first time and I believed that this specific thought made too much sense to not be happening already.

So I went looking.

And here’s what I found: the Venture Capital Journal has an article from September 2004 titled “Outsourcing Is In” that discusses the issue. The article talks at length about the venture capital industry’s interest in investing in Business Process Outsourcing (BPO) firms. Not only do VC firms like the potential returns from the sector, but the VC firms are leveraging the investments to help their portfolio companies cut costs.

Not only are VC’s developing strong relationships with offshore “body-shops” — they’re investing in the offshore companies themselves! A foreign investment in an offshoring firm that then is leveraged throughout the portfolio. Outsourcing/offshoring keiretsu? Interesting to say the least.

Viewing 7 Comments

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    I suspect the problem of finding quality workers who are "product" rather than "service" will right itself over time. If one treats the BPO industry as a product, and allowed it to have the traits of a traditional product, I think it would be fair to say that the BPO "product" is still at an early development stage. Over time we'll see the "product" develop as the market for the product's benefit grows and matures. In fact, I think we're already seeing this. 4 years ago the idea that an oursourced firm could offer valuable input on a business process other than transcribing/customer service/... seemed far fetched. The industry has made great strides beyond this and I think it's a fair assessment that going forward the trend towards more advanced/valuable input will continue. Products like iRise that Eric mentions will help lower the barriers to this happening and as these products develop the traditional challenges will fall, and the ability to add product development overseas will increase. Especially when VCs create a positive relationship with a BPO firm - investing time and money in the relationship rather than just plugging a name into a rolodex. (aside: does anyone use a rolodex anymore? Or better yet, does anyone who is advanced enough to be leading the outsource charge still use a rolodex? It's late, and I'm tired :))
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    Fraser, flattery works for all! :-)

    I am really enthused to see that something I have been thinking about is already being done - namely incorporate offshoring into the VC's "arsenal". I am going to be conducting a survey of VCs in the near future as part of my research and I am definitely going to try and follow up on this trend.

    The one thing that this entire business model does not address and something that, according to case-studies of US-based high-tech startups offshoring to India, is the difficulty of hiring talanted workers in India - the workers that are 'product' rather than 'service' oriented and will fuse with the US part of the product development team, contributing originally, rather than simply punching out code. In my experience the 'no-name' firms in India have had a lot of problem with finding and retaining workers - acceptance rates are below 50% (after an offer has been made) and annual attrition can be in the same ballpark.

    Perhaps what needs to happen is to distinguish between the start-up that already has a beta product and a product development strategy that can be fragmented and the seed company which is still working on its beta. (Although the latter is probably not seeking VC money yet...)

    The devil is in the detail - principles of offshoring development can be great but it seems that ultimately each start-up will face its own, unique problems with this strategy and a VC must be flexible and experienced enough to help/advise/guide the entrepreneur. (So if the VCs merely get a BPO guy's name into their rollodex, this will not work)
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    Fraser, flattery works for all! :-) I am really enthused to see that something I have been thinking about is already being done - namely incorporate offshoring into the VC's "arsenal". I am going to be conducting a survey of VCs in the near future as part of my research and I am definitely going to try and follow up on this trend. The one thing that this entire business model does not address and something that, according to case-studies of US-based high-tech startups offshoring to India, is the difficulty of hiring talanted workers in India - the workers that are 'product' rather than 'service' oriented and will fuse with the US part of the product development team, contributing originally, rather than simply punching out code. In my experience the 'no-name' firms in India have had a lot of problem with finding and retaining workers - acceptance rates are below 50% (after an offer has been made) and annual attrition can be in the same ballpark. Perhaps what needs to happen is to distinguish between the start-up that already has a beta product and a product development strategy that can be fragmented and the seed company which is still working on its beta. (Although the latter is probably not seeking VC money yet...) The devil is in the detail - principles of offshoring development can be great but it seems that ultimately each start-up will face its own, unique problems with this strategy and a VC must be flexible and experienced enough to help/advise/guide the entrepreneur. (So if the VCs merely get a BPO guy's name into their rollodex, this will not work)
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    Here's a link to Eric's post on iRise

    "These change orders can be reduced (by up to 70% iRise states) by providing overseas developers with an iRise model of the software that needs to be built. The iRise model allows the developers to “use” the start-ups’ software via the simulation in the iDoc which gives them a much better idea of what they need to build."

    As offshoring moves from simple tasks (customer support, transcribing, ...) to more advanced business processes and functions a significantly sized market will be created for allowing these complex ideas to be effectively communicated.

    iRise has done a great job of this, and I imagine every area of business that is being offshored will have a similar player emerge.

    What will be interesting to see is if VC's take an active role investing in these companies to help their other portfolio holdings.
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    <a href="http://www.ventureweek.com/blog/2005/09/30/softwa...rel="nofollow">Here's a link to Eric's post on iRise"These change orders can be reduced (by up to 70% iRise states) by providing overseas developers with an iRise model of the software that needs to be built. The iRise model allows the developers to “use” the start-ups’ software via the simulation in the iDoc which gives them a much better idea of what they need to build." As offshoring moves from simple tasks (customer support, transcribing, ...) to more advanced business processes and functions a significantly sized market will be created for allowing these complex ideas to be effectively communicated. iRise has done a great job of this, and I imagine every area of business that is being offshored will have a similar player emerge. What will be interesting to see is if VC's take an active role investing in these companies to help their other portfolio holdings.
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    Definitely an interesting phenominon. I profiled a US company a while back called iRise. iRise has developed software that allows developers to create a very effective model of the software they want to build. There are a couple benefits to creating this model:

    1. Allows the entrepreneurs to bring something to the table in initial meetings with VCs.

    2. Allows the entrepreneurs to send a detailed model of what they want to offshore developers which cuts change orders by a large margin (iRise claims 70 percent) and therefore cuts development costs.

    Reason number two is why I am writing this comment. A number of VCs have invested in iRise to aid their offshore development efforts and their portfolio companies alike. Looks like VCs are really trying to solidify this model and continually make it more cost effective.
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    Definitely an interesting phenominon. I profiled a US company a while back called iRise. iRise has developed software that allows developers to create a very effective model of the software they want to build. There are a couple benefits to creating this model: 1. Allows the entrepreneurs to bring something to the table in initial meetings with VCs. 2. Allows the entrepreneurs to send a detailed model of what they want to offshore developers which cuts change orders by a large margin (iRise claims 70 percent) and therefore cuts development costs. Reason number two is why I am writing this comment. A number of VCs have invested in iRise to aid their offshore development efforts and their portfolio companies alike. Looks like VCs are really trying to solidify this model and continually make it more cost effective.
 
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