Welcome to part 2 of my 6 part series on how the cloud is changing the economics of business. This post focuses on why VCs are investing more heavily in B2B and less in B2C than in past years. In the B2C world, VCs are investing in the “number of eyeballs” with the hope that those eyeballs can generate ad revenue (fantasy). In the B2B world, VCs are investing in subscription based revenues (reality).
Why are VCs shifting their investment strategies?
I recently read this article from PEHUB which discusses some strong points about why VCs are turning their attention to B2B plays. The author points to some telling metrics which show that B2B plays have been way more profitable than B2C for the last 5 years despite the heavy investments in B2C.
You can see from this image taken from the PEHUB article that there is a difference of over 50% in performance with B2B plays far out performing B2C plays. There are always the exceptions like Instagram, but they are few and far between. The author also points out that in years past, B2C plays were much cheaper to start up than B2B plays, but with the advancements in cloud computing B2B plays can now get to market with very low up front costs making them more attractive to investors.
I think there are a few other factors as well. First, look at some of the B2C IPO flops like Facebook. Even though Facebook has huge retention, engagement and acquisition metrics, ad revenue models are very unpredictable and hard to maintain. If that is true for a giant like Facebook, imagine the pill investors must swallow for lesser known and early stage B2C plays. Another factor is that consumers are getting accustomed to everything on the web being free. It is extremely hard to get customers to sign up for a premium service and even harder to keep the ones that do sign up. When everything is free, a B2C app must be incredibly valuable to get consumers to pay. Many B2C plays can only count on ad revenue and with thousands of b2C apps in the market, how many companies can a brand distribute content to before they lose sight of the effectiveness of their spend? Sure there are numerous companies sprouting up to help brands figure out the ROI of web and social advertising, but a B2C site must be very influential before those companies will invest in adding the data collection and analytics of a B2C site to their platform. To sum up my B2C thoughts, VCs have some egg in their face from many lackluster B2C investments including Facebook. There are too many B2C companies chasing the same advertising dollars at the same time that consumers expect free services and rarely pay for premium services. And finally, many B2C plays are subject to consumers’ short attention span. Whether it is consumers getting bored with raising animals and buying virtual nonsense on games like Farmville or consumers fleeing a product like Instagram when they change their privacy policy, consumers have too many choices and very few B2C apps have the stickiness required to deter them from moving on.
B2B on the other hand is on fire. The stats mentioned above are one indicator but I believe those numbers are just scratching the surface. What is happening is that enterprises are finally starting to believe in the cloud and the 2013 budgets are loaded with dollars for cloud initiatives. Not only are businesses trying to transform their data centers to private and hybrid clouds, but they are also moving to SaaS for many of their non core competency needs. This is where the real money and opportunity lies. As I mentioned in my previous post, cloud cultures are quickly implementing a new breed of self service, drop dead simple B2B apps for a fraction of the price of the legacy, complex and expensive enterprise software. The days of spending 7 or 8 bills on enterprise software are numbered. Now enterprises can pay for only the features they need, when they need it and without hiring staff to manage and maintain the software and hardware required to use the product. No more long procurement cycles, extremely expensive professional services engagements and proprietary processes to implement. Over the next several years, enterprises will start converting budget dollars off of expensive legacy software to new SaaS software with pay as you go pricing. Server and CPU licensing and seat cals will be nothing but a distant memory and not a fond memory at that. B2B software, especially those used for critical business purposes like payroll, accounting, human resources, code repositories, etc. are very sticky. Once a company puts its data in and gets accustomed to the business processes, it often requires a compelling business case to move to another solution. Moving from expensive legacy on-premise software to pay-as-you-go software is easy to justify. Moving off of a SaaS solution to another rarely happens unless the solution does not meet the needs and/or is under performing. That is very different than the B2C world where one may wake up and choose not to use the website again. Changing direction is a more strategic event when you are paying for something. Paying for software increases its stickiness.
Putting it into perspective
So what does this all mean? Investors are realizing that we are entering an early gold rush movement for B2B software. Over the next few years the death of enterprise legacy software will be apparent to those not paying attention. This movement is very similar to the push to Internet enabled apps during the dot com days. B2B founders don’t necessarily have to invent new ideas, they need to take old ideas and start doing them in a cloudy way that delivers automation, integration, speed to market and ease of use and charge at a pay as you go or monthly subscription rate. These revenues are much more predictable than ad revenues and in many cases these revenues can be locked in for terms that span multiple years. The economics of this movement bring drastic strategy changes within corporations. Big companies typically struggle to innovate and bring new products to market. Buying nimble startups and their staff will replace many R&D budgets. Startups do not have to deal with culture transformations when moving from legacy to the cloud. They are “born in the cloud” from the start. Corporations keep consultants like me very busy because they need cloud evangelists to come in and convince their staff to shift to the cloud. There is so much hierarchy, politics and resistance in many corporations that moving to the cloud is an extremely expensive and risky proposition. Many corporations will buy their way into the cloud which is why VCs are shifting their attention to the B2B plays.
Summary
Corporations are shifting a massive amount of energy and budget dollars to the cloud. This presents a huge opportunity for B2B cloud based companies to capitalize either by beating the incumbent legacy software providers with modern solutions at lower costs or by being acquired. I believe that many corporations will try pushing their IT organization to shift to the cloud and will become unsatisfied with the results both from a speed to market perspective and a cost perspective. This is due to the lack of skills required, the impacts of organizational change and conflicting priorities. Some will prevail but most won’t and the management team will outsource and or buy the cloud technologies they desire. Fast forward 5 to 10 years and corporate IT teams will be much more focused on integration and much less on building software. Corporate IT budget dollars will be spent more on vendors and vendor solutions and less on internal labor and infrastructure.
