Standards-based startups

By The Chilli analysts

An oft-repeated word of advice to startups, and a critical part of The Chilli value test, is to focus on a well-defined niche, which is forecast to expand into a sizeable market. Clearly timing and selection are two very important attributes that have to be taken into account, as well as staying ahead of the commodity curve.

Much of the high-tech industry relies on internationally agreed standards to facilitate interoperability. One can think of countless communication standards, including RS-232 (the humble serial port), IEEE-1284 (parallel port), USB, Firewire, Bluetooth and Wi-Fi, as well as standards for multimedia, including MPEG.

The standardisation process presents an opportunity for companies, both HTSU (high-tech startups) and established outfits, to contribute to the process, and start design work early on as the standardisation work proceeds.

It's a great idea - a new market with a reasonably solid standard [Editor's note: standards are not perfect from day one, over time they get clarified as interoperability is tested out. This is a natural evolution for all standards]. It's such a great idea in fact, that 10-20 startups have the same idea, as well as several corporate titans. This, in effect, sows the seed of commoditisation.

Commoditisation

The commoditisation of a market can be summarised in a number of steps:

1. Standards work is progressing; market research indicates that there will be a very large market

2. Numerous startups are formed to enter this market and receive VC backing

3. Existing corporates look at the activity. Not all will enter the market immediately; some will prefer to track the market for now and watch

4. More products start to flood the market, which is, at this time, too small to support the number of entrants

5. A price war erupts; the ASP (average selling price) collapses and margins shrink, to the point where there is a $ loss per unit shipped. It is a buyers, not sellers, market

6. Large organisations, capable of taking a unit loss, enter the market. Some startups exit, having burnt through all their funding, others are acquired at bargain basement prices (so VCs don't do so well either)

So some startups will survive; those with impeccable timing, expertise and a clear exit strategy from day one, but the vast majority will go to the wall, for most standards-based markets are essentially commodity markets, characterised by low margin, severe competition and lots of red ink.

Examples of commodity markets abound in the technology industry, including communications standards, as well as 8 and 16-bit microcontrollers, where standard functionality is required (timers, interfaces, etc) and every dollar and cent makes a difference.

Wi-Fi

A recent example of a commoditised market is Wi-Fi (IEEE-802.11a/b/g):

• 2000-2001: the cost of an 802.11b chipset (baseband/MAC and RF) was ~$25-30, falling to $16 in 2002, mainly due to the large number of 'me-too' offerings (at least 20 companies were active at this time)
• 2003: the cost for 802.11b declined to $6-8 as products based on 802.11b/g were released, along with increased competition from Taiwanese vendors
• 2004: $4 forecast, as 802.11b is superseded by more secure, higher-performance, dual-band solutions (802.11a/b/g)

The ASP decline tells one story. For a complete picture, lets look at the shipments. In the 2002-2003 timeframe, there was an 84% increase in shipments, but an 8% decline in revenue. Prices collapsed faster than shipments rose.

Source: TechKnowledge Strategies

802.11b-focused startups were hit by many competitors entering the market at the same time with very similar offerings, initiating a price war. New versions of the standard came out quickly and the final blow was cost-killer competition from Taiwanese vendors, including Acer Labs, SiS, Via, Realtek and Zydas. Some startups bet on the fact that the Taiwanese vendors would not be able to perfect the RF technology, and thus be unable to provide a complete solution. They were proven wrong - mastering a standard takes time, and reducing cost takes determination.

A similar scenario had previously played out with Bluetooth - watch out for Uweeba (ultra wideband) as a forthcoming attraction in commodity chips.

A greater squeeze occurs when the functionality is integrated into a higher-value device, e.g. integrated into a microprocessor or support logic, where a reduction of overall system cost is paramount. Intel has pursued this strategy with interfaces including UART, parallel port, Ethernet and is well on the way to integrating Wi-Fi. When this happens, the market shrinks for those vendors who can only offer point solutions. So, shelf life for a standards-based startup is limited. How then, does a startup maximise success in the market in order to achieve a good exit?

There are three key ingredients to this recipe:

• Focus on the BOM (bill of material) and higher margins at the beginning
• Use patents and proprietary trade secrets as a defence barrier
• Consider market timing, and prepare for an early exit, building the business to be sold (BOBS)

Focus on the BOM - and your margin

If pursuing the development of standardised functionality, one has to look at the overall BOM cost - baseband, RF, power supply, etc, examining the scope for cost reduction -everyone else will be doing the same. What are the degrees of freedom?

1. Reduce cost base: this requires consideration of device technology used, test, assembly and packaging, as well as inventory and distribution. Reliability, performance and cost have to be traded off. Many parameters are dictated by the end application environment (e.g. wide temperature range for automotive and industrial applications), but what is mandatory is a sharp focus on cost reduction with suppliers.

2. Integration into a higher-value device or subsystem: this will require a partner, e.g. an IDM (integrated device manufacturer), and they will require the technology in a form that allows integration. This step is unlikely until the market is proven.

Focusing on the first area, the scope for cost reduction is wide:

• Design (EDA tools and design outsourcing)
• Foundry (shuttle runs)
• Test, assembly and packaging
• Distribution (direct sales, reps, distis & channel incentives)

Patents & proprietary trade secrets

Patents have been used as a method to reassure potential investors, but it has been argued by entrepreneurs and investors, including John Laurie, that patents are not a startup's best friend. They require deep cash pockets to defend, and the data is in effect published into the public domain, allowing competitors to spend time studying it, and devising a workaround and potentially a improvement.

In the case of a commoditised market based on open standards, care must be taken when participating in the standardisation process. It is good to exchange ideas and come up with a solid standard allowing interoperability. It is also a good thing to have some 'secret sauce' that enhances the capability of your product implementation. This should not be a part of the standards discussions. Care must be taken to avoid applying for a patent on know-how disclosed at standardisation meetings! A balanced approach would be to patent certain functions, which are then pooled with other third party patents for the standard, but not to patent the 'secret sauce', or contribute it to the standardisation process.

Market timing

It is vital to hit the market within six months of the standard being finalised. A marketing push at this time, headlining the fact that you are 'the only game in town', and that you have useful 'secret sauce', will generate lots of interest with both potential customers and investors and potential acquirers.

Timing is key, and requires a certain degree of risk, before the standard is published. Almost nobody meets the full spec but market savvy startups always get into the limelight ahead of the curve. Care must be taken not to over hype, as this could backfire when a competitor product highlights your shortcomings. The best defence, and it has been proven before, is to be one of the early ones to the market, make an aggressive push in the market, with the backing and understanding of VC partners, who are willing to bet the company on being a leader in the chosen space. All too often, this is not disclosed upfront, when negotiating the early rounds and results in a self perpetuating cycle of self defeat, whereby there is insufficient capital for an aggressive market push, including a lower price, ahead of the production efficiency curve.

Standards-based startup survival: food for thought

So what's The Chilli's take on standard-based startups?

Investors

• Don't have too many 'standards-based startups' in your portfolio; it's expensive and risky
• Concentrate on one or two standards and put the best team on it.
• The investee company will need an accelerated funding ramp-up to catch market share before ASP (read: margin) drops: the first six months after standardisation are key, for product release and a significant marketing push
• Concentrate on a limited number and help them negotiate with suppliers to take the cost out of the overall business

Entrepreneurs

• Consider partnering to reduce costs at the expense of some loss of control (risk)
• Team needs to consist of seasoned negotiators to preserve margin, and savvy operations managers to deliver the volume.
• Find various routes to market - distributors, ODMs, new geographies - it's a tough market, so be imaginative. Don't be afraid of getting on the plane, as the best volume markets are in the East
• Focus on TCO (total cost of ownership) or the BOM; don't limit your chances by focusing on a specific device, unless it's a defensible niche (but remember the Taiwanese eventually attacked Wi-Fi with RF devices)
• Ensure your business plan has a list of potential M & A partners and timescales, indicating a successful product release at six months, and the companies likely to acquire you to enter that market

Comments on this story? Send an email to the editor at Editor@TheChilli.com

© Chilli Publishing Ltd 2004

11FEB2004