Whether providing software-as-a-service (SaaS) for enterprise resource planning (ERP), on-premise ERP, infrastructure-as-a-service (e.g. offsite servers and storage), security or something else, enterprise tech companies have been a relative bright spot in U.S. markets compared to overly-hyped consumer facing companies such as Groupon (77% of value lost since IPO), Zynga (66% of value lost since IPO) and the mercurial Facebook (about 25% of value lost since IPO, but up from a low point of 52% down in September).
Last September, a Wall Street Journal article titled “Revenge of the Nerds, the Sequel” illuminated this sea change, noting the performance of new enterprise-serving market entrants (albeit two have since faltered): Splunk (real-time data indexing of apps, servers and network devices, -2% post-IPO), ServiceNow (SaaS for IT Management, +37% post-IPO) and Infloblox (software and hardware to automate network infrastructure, -10% post-IPO after a dismal November).
But more important than these short-term stock fluctuations is the shift in Valley attitudes described in the WSJ piece. Most telling was the anecdote regarding Guidewire, an enterprise company that’s seen a 90% increase in its stock price over the past year:
When Marcus Ryu took his company, Guidewire Software Inc. public in January , he says some investment bankers told him he couldn’t hope to land a similar valuation to Groupon’s or Zynga’s—even though his firm, which makes software for insurance companies, was increasing revenues by double digits to around $175 million a year and was profitable. The bankers said “there’s magic in those names…we got the feeling we were a second-tier name.”
In addition to these up-and-coming players, growing powers Teradata (big data analytics, market cap $10.48 billion), Seagate (storage, $12.36 billion), Salesforce.com (customer relationship management software with emerging social media analysis capabilities, $24.85 billion) and established industry titans Cisco, SAP and Oracle, representing another $370 billion in combined market value, display the lucrative opportunities in selling tech to businesses.
So what about China?
Given the relative success of these companies in the U.S., the game-changing trends they are bringing to market and the intrigue they’ve generated among investors, will Chinese entrepreneurs and venture capitalists follow the lead and attempt to duplicate these models in China? At the time of Groupon’s meteoric and misguided rise in pre-IPO valuation, China saw thousands of unprofitable group buying copy-cats emerge (5,058 according to this 2011 China Early-Age Startups summary by Tayler Cox) which continue to sputter out or consolidate.
I spoke with Innovation Works’ investor Mickey Du to learn whether the trend might repeat itself—albeit not on the group buying scale—with enterprise tech in China. Du played a large role in the fundraising for the Kai Fu Lee-led Venture Capital firm’s oversubscribed $275 million second fund and has been looking closely at enterprise opportunities in China.
Du shared that Chinese start-ups are not ready to simply duplicate Valley models, but that enterprise tech will emerge organically here as the base infrastructure matures: “It’s just a matter of time. The growth of the sector is an inevitability.”
Du said that U.S. startups targeting the enterprise can operate on far less capital than their hypothetical Chinese counterparts, as they are able to plug into mature and dependable platforms like Amazon’s cloud services: “At Innovation Works, we believe China is not caught up to the U.S. in terms of ecosystem maturity. The base infrastructure has not been optimized.” Du commented that the relatively slower education of key decision makers has impeded adoption as well: “the whole concept of cloud computing is just starting to stick…China is 3-4 years behind the U.S. in this regard.”
At the core of the infrastructure problem is regional and ISP fracturing. According to Du, the resulting limits on transferring information make building a layer of cloud services impossible for a startup. Du said the loss in speed of data packets and lower reliability challenge all internet companies in China, but are by virtue much more damaging to enterprise-targeting start-ups who aim to sell reliability and real-time solutions. Chinese and western companies are growing China’s cloud at a stunning pace, however. According to Gartner, though only 3% of the global cloud computing market now, China is growing by 40% per annum.
Beyond infrastructural issues, Du referred to the Chinese business tendency to “throw warm bodies at a problem” as a limiting factor in ERP adoption. Indeed, even if Chinese companies adopt ERP, they may be resistant to the necessary business process reengineering (BPR) that makes ERP effective.
Du said platforms such as 37 Signals or Salesforce, while successful in the U.S., are less scalable in China and require door-to-door salesman. Du compared Google and Baidu to illustrate fundamental differences in sales and adoption in China and the U.S. Unlike Google, Baidu has tens of thousands of sales people offline peddling their products and selling advertising.
Who will pay?
While other China-based VC’s have expressed that the lack of Chinese businesses willing to pay for these services would limit their success, a sentiment Microsoft’s struggles with piracy might support and one echoed by the Silicon Dragon VC Panel last October, Du did not think this was a real factor. Citing the Chinese business paradigm that earning an additional RMB in revenue is better than saving 5 RMB in costs, Du said that most important for ERP or other services targeting Chinese companies is that they “tangibly add value and contribute to day-to-day revenues or operations”.
This is not to say that there aren’t already domestic players. Indeed, a now dated 2005 study by AMR, “Inside the Chinese ERP Market,” found that Chinese companies UFIDA (now Yonyou), Kingdee and Digital China were out-performing their western competitors by large margins in China. While SAP has chipped away at the leaders, it still struggles with meeting local needs and gets just 3% of its global revenues from China.
Barriers to Entry in Enterprise Tech
Responses from a Quora thread “Why don’t more startups target the enterprise” propose a number of factors which naturally limit the number of enterprise startups, all of which may be especially applicable to the more nascent Chinese tech sector. A common answer proffered that younger entrepreneurs are less able to create enterprise-targeting companies because they lack the work experience to understand and improve upon existing marketing, sales, HR, finance, customer service processes. Others noted that selling to enterprises is difficult, as is the necessary after sales service to make them successful with the product (in China: the lack of BPR accompanying ERP). That enterprise tech valuations have been more rational than those for consumer-internet products like Groupon or Instagram also diminishes the appeal of the sector. However, as China’s young base of tech entrepreneurs matures and appreciates the nuances of local business needs, one would expect more related start-ups to blossom. Chinese companies looking to go global or grow along with domestic consumption will need services that help them retain talented employees, make sense of huge quantities of data and reduce inventory.
Looking to Invest
Du shared that Innovation Works first fund of $180 million was intended to last three to four years, but was quickly allocated in the first year to make timely investments in mobile related to Android’s emergence. He said a much larger proportion of the firm’s second fund will target start-ups in the enterprise space with some promising players already identified.
Du said Innovation Works is not excited by horizontally-oriented enterprise start-ups like SalesForce, and that companies who excel at one thing are better bets in China:
“[We] look for companies which serve a large enough vertical and not those building a horizontal platform who are vulnerable to other vertical players.”
One of Innovation Works (loosely) enterprise-related investments is AnquanBao. Essentially the CloudFlare for the Chinese market, AnquanBao protects businesses websites from viruses and security breaches and optimizes their loading times—highly valuable to frustrated Chinese internet users. AnquanBao was founded by one of Innovation Works entrepreneurs in residence (EIR) who previously led one of China’s top security software companies. Du said Anquan Bao currently has over 15,000 customers, some of which are premium paying customers. Innovation Works recently participated in AnquanBao’s Series B funding, led by Northern Light Venture Capital, which raised well over $10 million.
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About the Blogger
James Hopkins is an American working for Alibaba.com in Hangzhou, China. He previously lived in the tech-heavy district of Nanshan in Shenzhen. The views expressed here are his own and do not represent those of his employer.
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