Friday, February 18, 2005

The Software Industry’s Growth

I published this article a few years back in a local publication in Egypt. It didn't take me long after that to realize how extremely naive I was at the time (so please no comments about how naive this article is, I've already said it). Yet still, I wish things were that simple and easy, so I'll share my thoughts then again here. Oh, and I really hated myself then when I reread it and counted the number of "should's". Who am I to give myself such authority. Anyways, this is the unedited version of the published piece (so its alittle long):

Strong industries result in strong economies. One of the strongest industries now a days is the technology industry, because of its impact on human lives. The industrial revolution has passed; we are now in the high tech revolution, which could be passing us by soon. Venture capital is of essential importance to the existence and growth of a high-tech industry. High-technology startups are the trend in economic development. Venture capitalists can incubate many of those startups and help in the growth of many small companies, creating a strong industry which would eventually benefit the overall economy.

There are some differences between Venture Capital (VC) firms and Incubators. VC firms provide capital only to start-up companies, whether seed capital, at the initial stage of starting a company, or at later stages of the start-up's growth. VC firms typically select the start-ups to fund based on the experience of their management team, the competitiveness of their idea, and the need of the market for such an idea. The VC firm will typically own part of the company, aiming at a high return on their investment through an Initial Public Offering (IPO) in the stock market, or by selling out the start-up or merging with a larger company.

Like VC firms, Incubators provide capital to start-up companies, however, they also provide a multitude of other services such as office space, financial resources, tools, equipment, professional guidance, administrative assistance and management expertise. Those services are intended to turn a vague idea into a product that can prove itself in the global marketplace.

In a developed country such as the United States, there would typically be far more VCs than Incubators, while in a developing country, such as the case in Egypt, more Incubators would be required.

Start-up companies funded by Incubators do not necessarily have to be started by recent graduates as it is commonly perceived. On the contrary, experienced people, technically and business wise, have a higher potential of success than inexperienced graduates. Typical start-up scenarios in other countries is when highly experienced engineers, who have been working for many years in large multinational companies start their own companies, building on their strong technical experience and aiming to satisfy a market need (which has been realized from their involvement in the market), through a new competitive idea that can be evolved into a product.

Another form of start-up companies that can be encouraged, is spin-offs from existing IT companies. Existing IT companies that want to get into new technology areas and develop products in different fields than their current domain of expertise can spin-off start-up companies that would benefit from the management and business experience of the existing parent organization.

In an emerging Information Technology industry such as the Egyptian one, strong support needs to be provided by the government, probably represented by the Ministry of Communication and Information Technology (MCIT), which is considered quite a progressive and forward thinking Ministry by many in the IT community, and is thus capable of contributing a great deal to the growth of that industry.

There are four components that are important for a successful start-up; capital, market need, competitive idea with solid technical capability, and good management.

For the Incubators and VC firms to be successful in funding a start-up to maturity, all the other three components have to be satisfied, and then capital would be their supporting axis. The following is a snapshot of each component mentioned above, except for the management component which is an issue that is being addressed by all industries. In the following discussion, some of the missing aspects in each component will be mentioned, as well as some of the work that needs to be done, by the IT community and government entities, to fill such gaps.

Creating the Market Need

What is missing

Start-ups that don’t understand the market need and are not capable of serving it well, are doomed to fail. Understanding the market needs is an essential factor in determining whether a product will be successful in penetrating a market or not. A start-up company that is starting by developing one or two products has to make sure its product is catering for a market need, otherwise failure of its initial products in the market means failure of the whole company. Therefore, the target market – whether local or global, which is the main playing field with other competitors – has to be well understood before embarking on starting up a company to serve that market. While studying the market, future trends, and the changing needs of that market has to be considered as well, because as the product is developed and by the time it is available in the market, the needs might shift, or change all together.

What can be done

More efforts need to be put in gaining a deeper understanding of the technological part of the local industries, and to disseminate that knowledge to interested parties in the software industry.

Technologies that are imported and used as components in locally developed products, or are used to develop those products should be studied for potential creation of local development opportunities of those components. An example, is embedded software, which is software that controls all kind of equipments, from wrist watches, to mobile phones, to elevators and traffic lights. Software that runs machineries of factories in Egypt, or that is part of an automobile assembled in Egypt could potentially be developed locally. Understanding such technologies which is already in use could lead to the creation of start-up companies that would capitalize on such needs, developing part of such technologies, as well as updating, maintaining and supporting them.

Start-ups targeting such markets can then identify possible outsourcing and off-shore-development opportunities to foreign companies that initially provided those technologies to local factories and companies.

Creating the Competitive Idea

What is missing

Having a unique idea that can be evolved into a proven product in the local and global markets is key to the success of a start-up. That idea has to be backed by people with strong technical capabilities who can achieve results and deliver competitive products.

As there is no better place that breeds ideas and innovation than universities and research institutions, the need for a strong cooperation between academia and the industry becomes eminent. That cooperation should lead to incorporating research done by academia into development done by the industry.

While a good idea alone will not make a company, its uniqueness and applicability to the market will help kick it off the ground. Numbers from VC sources show that only one out of a thousand business plan makes it into a successful company that goes public.

What can be done

Collaboration between the IT industry, universities and research institutions for conducting research in specific technology areas should be encouraged. Such collaboration should lead to the software companies adopting leading edge research and technology which would help it become competitive in the market. In order to promote such collaboration, visibility to the research work conducted at universities and research institutions should increase, directing that work more towards the needs of the software industry and the market, with a focus on the global market trends. Efforts should be put to commercialize market-oriented research with the aid of Incubators and existing large IT companies.

The knowledge of the people behind that research and those working on developing high technology products are the industry’s main asset. Therefore, the capability of our human resources reflects directly on our capacity in generating ideas and evolving those ideas into proven products. Without capable people there would be no IT industry. Hence, it becomes critical to evaluate the capability of our human resources to effectively build on that strength, and strengthen any weak parts. Some of the questions that need to be answered:

  • What technical strengths do recent graduates have?
  • Where are the experienced technical people in the industry?
  • What is the level of expertise, and depth of knowledge of the experienced engineers in the industry? How high is the technical ladder in the Egyptian industry?
  • What gaps of knowledge need to be filled, for which people, and to satisfy the needs of which new area that we are penetrating in the industry?
  • Can Egyptians abroad with strong experience in missing areas in Egypt be recruited to fill the gaps?

Obtaining the Capital

What is missing

Start-ups are looking for one service from venture capitalists; capital. Hence, capital and funds –local and foreign– need to be directed towards creating venture capital firms that can support and invest in creating start-up companies and the growth of existing ones. Along with the abundance in capital, there should be strong business expertise that can evaluate management teams tapping them for funds, financial analysis capabilities to be able to valuate companies and their potential generated returns, and of course, technical knowledge that can understand ideas presented and assess their potential success in the market. VCs provide the capital and are looking for high returns on their investment, so the success of the start-ups funded is the success of the VC firm. As a result, Venture Capitalists become part of the company, sitting on boards, and keeping a close eye on management, and they become working partners in the business, possibly consolidating two or more businesses in the process.

What can be done

The IT community should take the lead, encouraging investors, banks, funds management firms to create a pool of capital and invest it through Incubators and VC firms in high growth IT companies and start-ups. The support of the government would be essential to encourage and back such an effort of massive mobilization of capital and investments towards a solid and rapidly growing IT industry.

Case studies and examples can be drawn from previous experiences of countries which have maintained solid growth in the high technology industry, such as China, Ireland, India and Israel. Learning from the experiences of others could help in creating our own ideas for investment and creation of start-ups. One of the existing interesting examples is a government that assumes the risk by funding the first stage of a start-up company. Whereby, a successful start-up will repay the loan, but one that never makes it off the ground will not pay back anything.

While the traditional venture capital firm is a solid model for funding early stage companies, it is not necessarily the only model. There are other common successful models, which ought not be undermined. Successful start-ups in the past have acquired funding from personal savings of friends and relatives, wealthy founders, suppliers, business partners, customers and large corporations.

Industry Dynamics

The figure below shows what the IT industry can evolve into, and the dynamics of that market as a result of such development. The provision of venture capital is an important success factor for the growth and creation of many start-ups. Specialized VC firms in the field of IT can boost the growth of that industry.

There are some examples of venture capital providers in Egypt, but such examples are both limited in quantity and in scale of operations. Of those examples are, the Commercial International Investment Co. (CIIC), which has injected funds in a few IT companies, and we are yet to see those companies mature, and the high return on investment realized. There is also a technology incubator, Ideavelopers, created jointly by MCIT and CIIC which is in its early stage itself. And then there’s the well established governmental Social Fund for Development. While it does not provide venture capital, with some focus on funding high technology start-ups, it could be a good model for financing such start-ups.

Successful examples of Egyptian start-ups are probably numerous, most of them working in an independent manner to fulfill their success factors. However, a collective effort needs to be exerted to achieve the rapid growth desired for that industry.


Anonymous said...

Article is too long, but looks very well organized. Sorry, I could not really follow the whole argument, but I really liked your sense of humour in the first paragraph.

Good luck.

Matt said...

Very informative article, I really liked the use of humour to keep the reader interested.