Here we are in 2012, and while some fatalists are predicting the end of civilization, I’m going to predict another kind of end. This year will see an end to the current avalanche of investing in what I call “app lifestyle” companies, which have little to no hope of ever producing a sustainable business or “venture” return, usually defined as a 10X return on investment.
You’re initial reaction is probably, what they hell is he talking about? Mergers and acquisition activity is up in 2011. The spigot for IPOs has opened up. Valuations are reaching levels we saw a little over a decade ago.
Well, that is part of the problem. The other issue is this: Do these companies really justify these valuations? For the most part I think not. Take a look at the smartphone or tablet you have sitting on your desk, how many apps do you have on it? How much did you pay for those apps? For the most part probably zero, zip, nada.
By last count there are now more than a half million apps on the iTunes App Store and 200,000 on the Android Market. So how on Earth can all of these companies be making money? Short answer… the long tail is wagging the dog. These apps generate enough money for apps developers to live a comfortable life, but they aren’t going to generate a billion-dollar return for any venture firm.
This isn’t the first time we’ve seen a trend of putting money into areas that clearly weren’t sustainable. You go all the way back to the 1980’s when anyone with a pickup truck and a tool box was considered a contractor who the banks couldn’t wait to lend money to. How about all those great ideas that came along during the first wave of the Internet, where apparently all you needed was a website to qualify for millions in funding? You know what I’m talking about: shipping a 45lb bag of dog food when the cost of delivery was $28. Or better yet, try to establish a complex logistics business taking orders online and delivering groceries via trucks and distribution centers nationwide. Yup… all great ideas that went POP!
Because we as an industry seem preconditioned to forget every valuable lesson ever taught to us, or because we have a mindset that ‘it’s different this time around,’ here we are again on the cusp of another predictable industry bubble.
Now I know I’ll get some pushback on this position. People will argue that Facebook and Zynga don’t charge for their service, and look how well they are doing. My response is that these are platform companies. These kinds of companies will always thrive. It’s the thousands that come after them trying to ride the wave with a nice little app that have very little chance of making it. And that’s where we are today.
You may ask if I’m predicting the demise of what I call “app lifestyle” technology companies, then what kind of companies should we be trying to develop? Simply put, companies that address really hard-to-solve business, technical, healthcare, or energy problems.
Personally, I’m looking at companies that have innovative technologies to help build the infrastructure that will be needed to handle the challenges associated with the exponential growth were seeing in Internet traffic and “big data.” In other words, I’m interested in companies that are dealing with issues we will be facing for a long time to come.
The predictions business can always be a bit dicey and I’m sure I’ll miss some. But if the Mayans are wrong and we are all still here in 2013, there is one prediction I feel extremely confident in making. There will be at least twice as many free apps available for your next smartphone, but only a few successful apps companies will have venture returns.
Paul Santinelli has been a partner at North Bridge since 2005. He focuses on investments in open source, software, security, Internet applications and infrastructure, and communications. Previously, he served as director of Red Hat Network.
Mayan calendar photo: NY-P/Shutterstock
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