Startups still the key to innovation despite economic downturn

June 1, 2001


The promise of continued innovation for the optical-networking industry was the hallmark of the Next Generation Network Ventures (NGNV) conference held last April in Burlingame, CA. In his annual forecast of promising startup companies, Dr. John McQuillan (McQuillan Ventures) emphasized at the conference once again that the real innovators are not the industry giants, as one might expect, but rather the newest and brightest startups.

While large companies seem to focus on meeting the larger needs of carrier customers, detracting somewhat from the ability to concentrate on small niche market technologies, they are holding the door of opportunity wide open for a select group of startups. Armed with innovative, disruptive technologies, these newcomers have a chance to greatly influence the direction of the telecommunications industry, according to Dr. McQuillan.

In the last two years, Dr. McQuillan's startup "classes" have performed very well. From the class of 1999, 11 companies have gone public, 22 were acquired, and eight remain private. Among the younger class of 2000, three have already gone public, 11 were acquired, and only one failed. The successful sectors have clearly been in components, optical networking, and next-generation telephony.

"I'm very confident that this year's class will go on to great success, just as the classes before it," says McQuillan. "The thesis on which I founded this conference is that the best way to understand innovation and networking to predict the future course of our industry is to watch the top venture-backed startups. This assertion is all the more valid in the current economic climate, when incumbents are cutting back their research and development in order to improve their earnings per share. Downturns favor startups."

Although the technology market crash has erased nearly $5 trillion of wealth over the last year-half of the gross domestic product in the U.S.-McQuillan still sees a ray of hope with the optical core. Companies providing optical switching and routing products, particularly OC-192 (10-Gbit/sec) equipment, actually outperformed the NASDAQ, unlike most other telecommunication segments.

Overall, however, slower network growth is expected as service providers get squeezed between cut-rate competitors and capital markets that will no longer finance growth ahead of profits. "This leads me to believe that innovation has outpaced our ability to pay for it," says McQuillan. "Since many of us are innovators and entrepreneurs, this is an important inflection point-but I think brighter days are ahead."
In terms of the criteria determining success of a startup company, the bar was raised significantly between 1998 and 2000 (a). However, the criteria for the next few years are expected to decline back to expectations of 1998, regulated in part by the economic climate (b).

In fact, some saw the downturn as a great opportunity-particularly startup component manufacturers. Andrew Rappaport, a partner with August Capital, left this year's Optical Fiber Communications (OFC) conference in Anaheim, CA, thinking that a downturn in the industry might have been the best thing that could have happened in optical components. The downturn follows a period in the last few years in which practically any product built, regardless of its state of evolution, found a market because it was deemed "bandwidth enhancing."

"In an environment that is more economically rational-one that is catching its breath and providing time to think-my hope is that we'll see much more emphasis on innovation toward those things that turn out to be most forward-looking and economically rational," says Rappaport. "Therefore, the experimentation will start to lead to clearer thinking about where things will really head over time."

Dr. Bob Lucky, corporate vice president of applied research at Telcordia Technologies, also made an observation while strolling among the endless exhibits at OFC 2001. How were all these companies making money? How can that happen? How long can these companies remain successful? The answer may be attributed to who gets the venture capital and who does not.

"It sounds to me like the venture capitalists may be the ones to determine who the winners and losers are in terms of successful startups," says Dr. Lucky. "The people who don't get money to go ahead with their R&D [research and development] plans cannot succeed."

One opportunity still remains: the Internet. The problem, however, is how to transform the Internet into a profitable business. Since the very essence of the Internet has always been that everything is free-browsers, content, incremental usage, and e-mail-it has yet to provide a sound basis for profitability.

"The Internet is something new and different," says McQuillan. "It will re quire the development of new and different business models. Along the way, however, we continue to make a fundamental mistake. We keep thinking if we make the core of the network faster and smarter, it will solve the problem. But the real limits to growth and adoption of these new technologies come at the network edge, where people interact with the system."

Hyperchip, a Montreal-based petabit-router manufacturer, agrees despite the company's charter to produce the industry's first "built-for-speed" core-routing product. But speed isn't what most carriers require for today's optical network.

"It's not about pure speed, it's about lowering cost," says Richard Norman, chief technical officer at Hyperchip. "Lowering equipment costs and data transport costs increases profitability for carriers. We're also looking for those killer applications that will create demand for more bandwidth."

In building the new optical network, McQuillan believes there will be "revolutionaries" and "evolutionaries." The revolutionary view of transforming the Internet into a profitable business is to take a "brave new world" approach and build products that take several years to develop and bring to market, are capital intensive, that often require end-to-end adoption, and may be incompatible with the way people manage and operate their networks today.

The revolutionary approach favors faster, better, and cheaper solutions that are rapidly delivered to market, incrementally, and interoperably. The innovator's dilemma is that the revolutionary approach provides disruptive innovations, while the evolutionary approach brings about sustaining innovations. Although there's a widespread belief that for the next year or two, the networking business will be characterized more strongly by sustaining innovations, there's another camp with a different view.

"We feel that, at the end of this business cycle, those startups working on revolutionary innovations are going to be strongly advantaged," says McQuillan. "We've had a stock market 'bubble' of historic proportions and a record-setting crash that followed it. That's caused many of us to rethink the network and how we're going to rebuild the public infrastructure."

The opportunity is evolving, despite the economic slump, to take brand new innovation and use it to lower cost, increase bandwidth availability, improve transport capability, and otherwise improve optical-networking technology for tomorrow's killer applications. In accomplishing this, our revolutionary, innovative startups will likely pave the way.