Milestone Group Quarterly: January 2004
Articles
Investment Viewpoint:
Ray Lane, General Partner, Kleiner Perkins Caufield & Byers
Milestone: You’ve been quoted as saying the tech industry has created a huge credibility problem over the past 4 to 5 years with buyers of IT. Can you elaborate?
Lane: IT is still the only industry that feels it can develop and sell software without paying attention to how the software will work when it’s installed in its end user environment; unlike other industries like automotive, aerospace, utilities or most any other. Tens of billions of IT has been bought by corporations with little thought of how it will all integrate together by the vendors themselves. After all, the real source of profit for IT suppliers is creating proprietary technologies. Microsoft isn’t worried about integration to Oracle; Oracle isn’t worried about integration to PeopleSoft or SAP. The result is customers have to do all their own integration and the value of IT to the corporation is sub-optimized. So when CEOs are asked if they are ‘happy’ with the billions they spent on their IT investments over the past ten years, they question the true value, because IT, even after the investment is made, remains the number one challenge to moving quickly to new markets, acquiring and merging other companies, reorganizing and many other strategically important activities the CEO would like to happen faster. Being proprietary is good from a technology vendor’s perspective because it gives them competitive advantage and an ability to defend their technologies’ positioning, but this in no way advantages their customers. Most CEO’s are thus disappointed overall with the return on IT investments.
Milestone: How will selling technology change in the future? What is the role of the sales team in tech companies going forward?
Lane: I was hopeful a couple years ago that when the balance of influence swung heavily to the buyers of IT because of the recession, we would see major changes in selling technology. The traditional role of the direct sales person, selling perpetual rights to use software at high discounts in order to sell more than the buyer can use, I thought might change more to a model of receiving value before you paid for it, a more ratable ‘pay as you go’ model of purchasing, moving towards rentals and service provision. In fact, this new model, “software sold as a service”, I believe is the way of the future, but it will take strong leadership from the management of both selling and buying institutions. For me, it’s a bit like the drug business. Who’s to blame – the supplier for maximizing how much product is sold, or the user for being more attracted by the price negotiation than the total business value. Purchasers look like heroes for buying at a huge discount and this is addictive, and sellers look like heroes because they exceed sales goals, and this is addictive, but these bad habits usually result in a poor outcome for shareholders if total business value is not tested up front.
Milestone: What’s the future of the software industry as you see it? Will it become commoditized? Where will value migrate to?
Lane: I’ve heard this commoditization analogy used in the software business as long as I’ve been in it. I just don’t buy it. Software is not a commodity for a lot of the reasons I just discussed, mainly, it has proprietary characteristics. Gold, wheat, corn, these are commodities. They are totally interchangeable and the only differentiating characteristic is price. But software does decrease in value over time, and it becomes less differentiated, and therefore more price sensitive. Value will always migrate towards innovation. And innovation has to be associated with a big change in the way something is done. When Microsoft adds features to Word, is that innovation? When SAP adds functionality to the general ledger system, is that innovation? Both examples are unlikely to be viewed as innovation and therefore value diminishes, and so does price. Would I start a company to compete with Microsoft or SAP today? No way, they can add features at a marginal cost, so and customers come to rely more and more on the vendor as their own development team, and there’s no room for new players. But innovation in our industry is unabated; however, it will be more frequent in new functional areas that will undoubtedly take advantage of the commodity-like environment set up by mature players. Interesting areas for us are in the business user arena, where a programmer is not needed, innovation in how to build applications faster, assembling components, integrating data and applications, search and networking as a substitute for static data – all are interesting areas to watch for future innovation. Then there is the area of opensource. Most mature vendors do not consider opensource software development to be innovation. What they are missing is the innovation that is happening with the complete delivery and usage paradigm that opensource development invokes. It’s like the old adage that the railroad magnates in this country in the early 20th century failed to recognize they were in the transportation business, not the train business, so when more efficient modes of transportation were invented, they couldn’t compete. Software makers have to understand they are in the business of changing how a job is done, not in the coding business.
Milestone: What do you see as the emerging economics for building viable software companies?
Lane: We have passed through a bubble, and we have to recognize that nothing that happened during the bubble can be used as a long-term economic benchmark. We have to go back to our industry prior to 1995, to obtain benchmark economic models for the software industry. Conventional wisdom then was you couldn’t put more than $20M of investment capital into a software company and expect to get venture returns; we’re back to those times.
Milestone: How can a startup find a space that's large enough to attract venture capital, but not large enough to attract strong competition from the big software companies?
Lane: That succinctly is the entrepreneurial problem. The interesting phenomena about the venture world today is there is no lack of capital to be invested. There is far too much capital in the market. Thus, any time an entrepreneur comes up with a good idea, there will be a lot of ‘me too’ investing. It’s very difficult today and will remain so until the venture industry shrinks, and does so significantly. The fear of other startups being well funded is a greater problem for good entrepreneurs than worrying about the big companies in the industry coveting their space. If they have a really good idea and a top team that can execute, it’s rare when the big company notices soon enough to react and incorporates the DNA to understand and quickly prosecute the opportunity. They really don’t have to fear the big companies, because the reality is big companies just aren’t suited to execute quickly. This has been well explained by Clayton Christianson in his first book, Innovator’s Dilemma, where he uses endless examples of how large successful companies typically miss innovative opportunities because they are so focused on serving their customers with more of what they already have.
Milestone: There seems to be this phenomenon in tech where a portion of Founder CEO’s are incredibly driven and bright, but also autocratic, closed to ideas other than their own, and not able to allow executive staff to manage properly. How do line managers and executives working for Founder CEO’s best survive in such situations?
Lane: Those companies eventually lose the talent war and do not retain the best people. Eventually you lose the A players and are left with the B and C players. These companies get left with people who are trained to do what they are told to do as opposed to doing what’s best for the company. This I think is the main challenge for boards of directors today. You have to know when to make the tradeoff between the incredible visionary focus and ruthless pursuit of counter-intuitive dreams, and the professional leadership needed to scale an opportunity. I tend to favor sticking longer with the visionary founder, and then playing catch up once it’s obvious the company needs mature leadership.
Milestone: Switching gears, do you think Oracle is a viable company without Larry Ellison? What’s your take on the executive announcements yesterday?
Lane: I’m not sure it’s a relevant question since Larry plans to be at Oracle forever. But if and when the day comes, I think Oracle is viable without Larry Ellison. Today, Oracle is Larry, and it has no chance to be anything else. That’s OK, Oracle is strong, has an unassailable position in the database market, and has Larry as a business and technical leader in this market, and you have to argue there’s no one better to compete in this market. Oracle without Larry isn’t better or worse, it’s just dramatically different. Larry provides certain advantages and disadvantages. He provides strong leadership and decision making, especially in the database market, but it’s his way or the highway – it’s centrally controlled, and right or wrong, it is the strong intuitive opinion of Larry Ellison that will determine Oracle’s direction and success. Without Larry, the company must run differently. I suspect it will be a strong executive leader that will depend more on a functionally competent leadership team. The leadership team will make more of the decisions, and the CEO will ensure strategic consistency. Today, most decisions are made by Larry. All that means is that you have a certain management team that will stick with him. Gerstner ran IBM differently than Tom Watson did, Steve Ballmer runs Microsoft differently than Bill Gates, Jack Welsh ran GE differently that Reg Jones; these are all successful companies under radically different leadership styles. As for your second question, it’s been pretty clear for awhile that Jeff Henley wanted to retire and making him Chairman makes a lot of sense actually from a Sarbanes-Oxley perspective where separation of CEO and board leadership is a good thing. The other part of the announcement is puzzling and makes less sense to me. Oracle now has two ex-bankers as Co-Presidents, with little operating experience, running a global organization with 45,000 people. I’m not saying they’re not smart enough to figure it out, but from my perspective, it just reinforces Ellison’s central decision-making philosophy even more. I’m not sure I get the Co-President thing either. Hasn’t Larry said for years now he will never again have a president and COO? Now he has two? I don’t view this as shared power; in my mind Larry still has all the power. It’s all an optical illusion to make it appear otherwise.
Milestone: It’s been seven months since Oracle’s hostile bid for Peoplesoft and still no conclusion. What’s your current take on things?
Lane: I’ve believed since the beginning that Oracle would never buy PeopleSoft. Should they, yes. I think it’s a good move, but it should have been done differently. PeopleSoft has good products. The PeopleSoft HR product is better than Oracle’s. To say to the world that you’re going to shut it down is silly. Why do it? It’s obviously a consolidation move that eliminates a competitor and allows the industry to support higher prices. That’s what you want to do in mature businesses, eliminate a competitor. How much you’re willing to pay to own second place and what’s that worth is the question. Now Oracle is stuck in a position where they will unlikely get it for $18 a share, it’s going to be $25 before they will ever be able to consummate a deal, thus pushing any deal over $10B. They won’t keep all of the Peoplesoft customers, so the question now is it worth $10B to have second place and only say 75% of PeopleSoft’s customers. While it might look like a bad deal for shareholders, I think it still makes sense; it’s a good deal for the Oracle management team which has failed to organically win second place in the applications business. Essentially, Oracle will now be using its economic strength created by it’s dominance in the database business to “buy” a long-term position in another important market. Microsoft has been doing this for years.
Milestone: Do you think we will we be seeing more hostile takeovers in tech?
Lane: I don’t think many, but we’ll certainly see more. If there’s a company that wants it bad enough, we’ll see a few more hostile offers. It makes sense – the tech industry is maturing and if you can get it done, it’s often worth the pain.
Milestone: From a VC perspective, where do you think we are overall in the investing cycle?
Lane: We’re in a rare period of normalcy. We’re not way high or way low. We’re seeing lots of great entrepreneurs, with good ideas and reasonable pre-money valuations around them. It’s also balanced between life sciences and information technology and other opportunities. The late 1990’s was about pushing all the chips to the middle of the table and focusing on the internet. 2004 will feel very “normal”.
Milestone: Where's the KPCB portfolio headed? Where are the opportunities as you see them?
Lane: We see good opportunities in the areas we have always pursued, life sciences and information technology. Although both of these markets have had their unique business cycles, we remain committed to the long-term prospects of both.
Milestone: If you were an LP and had $10M to invest in a competitors fund, who would it be and why?
Lane: Probably Sequoia, but I think there are a handful of really good long-term venture investors at the top of our business. I joined Kleiner because I thought they were the best, I wasn’t wrong. There are other firms that have been successful for a long time in the venture business that I admire, but none of us has a secret formula other than having a mix of good operational and financial skills and a willingness to work hard for the entrepreneurs we support.
Ray Lane is a General Partner at Kleiner Perkins Caufield & Byers (www.kpcb.com), joining in 2001. Previously he was President and COO of Oracle Corporation, where revenues grew from $1B to over $10B during his tenure.
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