There is a common belief, particularly among developing countries, that programming knowledge and a few computers are good enough for starting a software firm. But, according to an annual study of PricewaterhouseCoopers and the National (USA) Venture Capital Association, among venture capital investments, software is reaping the lion’s share: $21.5 billion in 2014, or 42% of all dollars invested, compared with $6 billion for biotechnology and $2.4 billion for industrial and energy companies. Why so much risk capital is needed to finance the launch of software startups is an important question to look into.
One of the commonly cited software startup examples is Rovio’s Angry Birds. Apparently, it’s a simple idea of simulation of basic geometry and visualization. A science graduate with programming skills is supposed to be able to demonstrate this concept by putting in a couple of months of effort. But adding features that would make a large number of people willing to pay to generate profitable revenue was the challenge. Rovio’s communications director Sara Antila revealed that prior to the ‘overnight’ success of Angry Birds, the company spent six years toiling to add ideas and fine tuning them to produce the successful version, after having produced 51 unsuccessful games. Such a reality should be taken into consideration to exploit the wealth creation possibilities from software. Although many developing courtiers are busy organizing idea competitions with the perception that a great idea is going to lead to success. After winning the Nokia and HP mobile game idea competition, Niklas and his friends had to work for 6 additional years spending millions, while failing 51 times, to reach their goal. This need of risk capital financing should be taken into consideration to produce profitable revenue from software centric idea of innovation.
Software intensive innovations now mostly focus on interpreting data produced by sensors of real-life scenarios. Research and Development (R&D) efforts in developing algorithms in processing the data to extract meaningful information is quite substantial. It often takes years of research work to develop algorithms to process images in separating over ripe tomato from just rightly ripped ones. The funding needed to support multi-year R&D effort of highly qualified people is quite substantial. But, once the algorithm is perfected, writing the code for automated execution of developed algorithms is quite negligible.
Israeli software firms are leading equity fund raising. In 2017, Israeli software companies led all sectors in capital-raising, according to the survey, garnering $1.9 billion in 208 deals; as life sciences companies followed closely behind with $1.2 billion raised, an increase of 41% compared with the $850 million raised in the field in 2016. Leading the pack was Sirin Labs, the Israeli-founded, Switzerland-based blockchain firm known for developing a $17,000 secure smartphone for high-end clients, which raised close to $158 million in December 2017. Sirin Labs’ new project FINNEY is blockchain-secured, open-source phone and PC. Bancor, an Israeli startup that developed a virtual currency conversion platform, raised $153 million in June 2017.
Software intensive innovations now mostly focus on interpreting data produced by sensors of real-life scenarios. Research and Development (R&D) efforts in developing algorithms in processing the data to extract meaningful information is quite substantial.
The question could be, did Indian software firms require significant equity funds? The growth of firms in exporting software and technology services in India generating large export revenue is quite impressive. Notable ones are Infosys and Tata Consulting services. But these firms in were struggling to grow in the 1980s. For example, Infosys was about to be shut down before taking off. A very limited supply of risk capital and revenue generated from project based customized application deliveries were not sufficient for their growth. But the scenario rapidly changed in mid 1990s. The growing need of IT professionals to offer software development services like coding and testing opened a new business model. Instead of developing software for generating revenue, these firms adopted the business model of offering IT human resources to mostly American firms. As a result, these firms entered into headcount based linear business models as opposed to generating sales proceeds from the trading of software applications. Such business models required investment in training and physical facility mostly, but there was hardly any need for R&D financing. Due to this unique business model, in the midst of scarcity of risk capital, firms in delivering software development services to foreign clients grew in India.
Another important question could be, despite the dearth of risk capital, why do we observe so many small software firms operating in developing countries like Bangladesh? For example, in Bangladesh, there are more than 200 software firms. These firms are small and with about 30 professionals, they remain small. With the impression that coding, high-level software design skill, and the knowledge of database were sufficient to develop software, many aspirants started such ventures. With basically very little risk capital they enter the market. As they could not afford to undertake R&D in developing high value software applications, they often imitate stripped down versions of available business applications. Due to low willingness to pay among a small number of customers for such applications, they often fail to generate a healthy revenue to finance operations and R&D. To deal with the real-life scenario, they often engage in project based customized business application delivery. On one hand, the cost of delivery of those customized applications is unaffordable to target customers. On the other hand, the generated revenue is not sufficient to finance the operation and growth of those firms. As a result, despite the possibility of engaging a growing number of graduates into knowledge intensive software application development, the dearth of risk capital often keeps such a possibility untapped.
Database centric simple business applications have very limited untapped opportunity for software innovations. Many of the software startups are looking for innovations in the area of machine intelligence, crypto-currency and other algorithm intensive applications areas. Some of the underlying technologies like image processing, machine vision, neural network or blockchain have been researched by academic communities across the world during the last 30 years. Many of those technologies have the potential to support meaningful innovations serving critical applications. These technology potentials have been drawing the imagination of startups to take very high value software innovations to the market. For example, automated perception of environment leads to realization of autonomous driving cars, opening the opportunity of making roads safer as well as more productive. Similarly, detection of anomalies in medical imaging by software creates the opportunity of making modern medical services more affordable as well as accessible. But to exploit these and many other innovation potentials, underlying technologies need to be improved further. Due to competition, startups need to make that improvement within a far shorter period than the time that was taken by the academic community to show the potential. To do so, startups need to engage high caliber professionals in a rich work environment. Such necessity requires a large sum of venture capital finance, as commercial revenue flow lead time often will be several years down the road.
