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Why Telecom Service Providers Must Become VCs

Since the financial crisis, venture capital (VC) firms have been actively investing in mobile, social, and over-the-top (OTT) app start-ups, while showing little interest in the core telecom networking sector.

In fact, VC support for telecom infrastructure start-ups has dropped from $796 million in 2009 to just $270 million in the 3Q 2011 to 2Q 2012 period. According to the latest market study by Ovum, they have found reason for new optimism -- but not from where you would expect it.

While VC support for network infrastructure has declined, overall VC investments have recovered -- growing from $20.1 billion in 2009 to $27.8 billion in the four quarters ended 2Q12.

Matt Walker, principal analyst at Ovum, said "A funding disconnect has thereby emerged between network builders and network users. Lots of innovation and venture capital is targeting the network users, such as mobile apps and OTT platforms. However, little of it is directly helping the network builders."

With a weak start-up pipeline, the industry relies more on incumbent system vendors to generate new ideas and products. Their budgets are bigger, but VCs are often better at funding game changing ideas that are routinely ignored by established vendors.

Incumbent vendors internal R&D budgets are now nearly 90 times larger than VC investments in the sector -- that's up from 30 times two years ago. This narrows options for service providers, who rely on both large and small vendors for innovation.

The big vendors also need access to the start-up pipeline, to fill in gaps in their own aging product portfolios through partnership and M&A.

In response to the apparent innovation shortfall, telecom service providers are getting more actively involved in funding and working with start-ups. Telefonica, Vodafone, Verizon, AT&T, KDDI, China Mobile and many others are now funding start-ups directly -- often deploying products in the network or lab ahead of commercial availability.

Others are now joining the growing trend. Deutsche Telekom (DT) was the latest telecom service provider to announce a new push on the venture side, revamping its T-Venture unit to foster purchase of majority stakes and accelerated disbursement of funds.

Walker said "Carriers really need help from suppliers, yet what they face is a vendor market in confusion. Most large vendors are now shrinking and reorganizing, even the Chinese suppliers. Several vendors are modifying business plans and selling assets in order to stay solvent. With the recent VC drought in networking, it’s not surprising that big telcos have become more directly involved in funding start-ups."

Walker points out that, based on data from the PWC/NVCA MoneyTree Report, the Networking & Equipment share of total VC investments shrank to just 1.0 percent for the past four quarters (3Q11–2Q12) -- that's down from about 10 percent in 2003.

The good news is recent IPO and M&A deals do suggest that VCs are looking favorably on the telecom sector once again, when telecom is defined broadly.

That being said, the fact that telecom service providers have taken an active role in stimulating the core networking technology venture capital arena points to an innovation gap that exists in the global marketplace. The upside opportunity is significant for entrepreneurs who can make a quantum leap past the slow-moving legacy vendors who have lost their momentum.

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