Investing in World Eaten by Software

In 10 years, there will only be 2 kinds of companies: those in the technology business, and those no longer in business.

– Aaron Levie, CEO of Box (Twitter, May 2, 2013)

Today is both the most lucrative and challenging time to be a technology investor. We are in the midst of a generational technology shift from the client/server architecture of the last 25 years to a new IT paradigm characterized by openness, flexibility and heterogeneity all delivered as an on-demand service which can be accessed from billions of endpoints, most of which fit in our pockets. This shift has fundamentally made us rethink how applications are developed, delivered, consumed and monetized and has functionally democratized IT, equipping end-users and organizations of all sizes with enterprise-grade technologies that are now remaking their lives and businesses, respectively.

Technological gains of the last several years – powerful distributed compute and storage, enterprise-grade SaaS and pervasiveness of Internet-enabled access points – leave businesses with an enormous opportunity to create tools designed to disrupt established markets and advance new ones. Further, as we have raced up the technological learning curve in the last few decades, today’s engineers have eschewed out-of-the-box proprietary solutions with rigid licensing contracts in favor of flexible, open source and largely heterogeneous architectures with consumption-based pay-as-you-go pricing.

What this all implies is that barriers to entry, innovation, adoption and distribution have been virtually (pun intended) shattered. IT – and every industry that it touches (and will soon consume) – has become a true meritocracy driven by the most basic Darwinian principle: the best (e.g. most aligned with customer needs and expectations) product wins. Older tech giants who won their fortunes in the client/server days – Intel, Microsoft, Oracle, HP and even Cisco – are struggling to find their way in a world where underlying infrastructure is rapidly commoditizing (thanks to software-defined anything) and cloud and mobile are the new normal. Meanwhile, the playing field has never been more level for upstarts competing for share of corporate and consumer wallets. Companies are employing user centric, cloud + mobile-first strategies to achieve unprecedented scale leading to burgeoning riches (see: Dropbox, Snapchat, GitHub, WhatsApp, MongoDB, Box, New Relic and the list goes on and on).

This rapid (and accelerating) rate of change we see in IT creates enormous opportunity to achieve out-sized returns for investors but also implies that risk has never been greater. In a world of fickle end-user preferences and requirements, failing to innovate is the quickest way to lose; today’s disruptor is tomorrow’s disruptee.

Because of this phenomenon, I’ve heard multiple people describe this as the single best and single worst time to be an IT investor – particularly at early stage venture capital. I would tend to agree with both. If you apply yesterday’s venture capital rules of thumb to today’s companies, you will certainly lose, but if you adapt your mental models to today’s ways of doing business, then, in my mind, you’ll be deploying capital in one of the best times/markets in history. Below, I briefly explore what has changed along the two axes (markets and management) which most early stage IT investments are measured and what new criteria or characteristics should be explored.

Markets

Software-based automation and intelligence is now transforming every industry, implying the potential opportunity set for investors has never been larger. Whereas previous generations of investors restricted their focus to verticals such as semiconductors, comm. equipment or software, today’s investors would be wise to look at industries such as transportation, manufacturing and retail – e.g. verticals where innovation has been at a standstill for several decades – as areas of potential explosive growth. Two of recent history’s most successful venture outcomes – SpaceX and Tesla – competed in old, slow-moving and highly-regulated markets. Lesson for investors: don’t’ limit your coverage universe to traditional IT sub-sectors; what was old is new again thanks to cloud, mobile and big data.

Management

Investors tend to feel safe with experienced management teams who have lived the inevitable ups and downs of scaling a business. Sure experience still matters, but in an IT world where the number one constant is rapid change, experience is less relevant if for no other reason than what you’re seeing in the market today is drastically different than in your previous go-around as boss. Malleability, coachability and contagious energy are the top qualities I see when looking at the most successful leaders at the helm of top tech companies. These tend to be younger folks who are driven by the success of their customers and build a company ethos that anticipates and caters to the needs of their end-users.

So what do I look for as someone going into venture? I’m looking the hungriest, product-driven, customer-centric entrepreneurs solving complex problems either deeper in the IT stack or in old, stodgy industries that have yet to be transformed by intelligent software. I believe the opportunity set has never been more ripe for investors, but the same rules that apply to companies in this new paradigm apply to VCs: adapt or die.