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How outsourced R&D drives Enterprise IT

Posted by Chad O'Connor  November 21, 2013 11:00 AM

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Business technology is undergoing a massive overhaul. Over the next decade, cloud computing, mobile, data analytics and new security technologies will completely transform existing IT systems. But who is bringing these disruptive technologies to market?

The major legacy IT incumbents such as IBM, Microsoft, Oracle and Cisco are some of the largest and most profitable companies in the world. They have built themselves to tremendous scale by delivering broad solutions and services to the biggest IT buyers, enjoying very healthy margins along the way. But, in doing so, they have become too big to effectively innovate in emerging technology markets. Focused on enhancing their existing and “bread-winning” products and services, it goes against the grain to disrupt their businesses with revolutionary new approaches. This dynamic is well-documented in Clayton Christensen’s Innovator's Dilemma.

In fact, less than one in five global companies deems itself “very effective” at breakthrough innovation, according to a Bain Consulting survey. At current scale, it’s difficult for tech giants to grow faster than the overall economy, but shareholders demand more than the typical two to five percent growth each year. Furthermore, for these companies to stay relevant and maintain their market positions, they need new product offerings. The demand for growth and innovation creates tremendous pressure for IT incumbents, which aim to achieve both mandates though the acquisitions of smaller, emerging companies.

In essence, tech giants don’t create innovation – they buy it. Big pharma companies have been doing this for decades, but in recent years it’s the enterprise IT incumbents that have relied upon mergers and acquisitions as much as they do research and development to drive growth and stay relevant. Even Google, long considered one of the most innovative and imaginative companies in the world, uses acquisition as a key driver of growth. Consider:

  • In the northeast there have been 1,284 M&A transactions in enterprise IT since 2008, worth nearly $30 billion.

  • In the same timeframe, the top 10 acquiring companies (IBM, Microsoft, Oracle, Cisco, Dell, HP, EMC, Google, Symantec, and Intel, according to SEC filings) in the U.S. spent more than $155 billion in M&A on enterprise IT.

  • Cisco, Dell, and Google all have spent more on M&A than R&D in recent fiscal years, according to SEC filings.

In addition to cash-rich balance sheets, the major players also have strong account relationships with the largest global customers. This translates into a model where promising new companies in emerging technology markets become attractive targets for the legacy IT players to acquire and push through their power distribution networks, helping them to both grow and stay current with new offerings. Given their established scale, the incumbents can also accelerate the delivery and adoption of new technologies once they are proven effective and reliable, often growing the acquired business faster than it could on its own.

The opportunity is also ideal for leading venture-backed technology companies, which have proven to be the fast growing innovators that can capitalize on shifting markets and can expect M&A interest once they gain meaningful traction. Our experience has been that the most innovative and well-managed will also have the option to go public. IPO activity has been heating up this year, with 57 IPOs recorded by the end of Q3 2013, more than the number of IPOs at year-end in both 2012 and 2011.

The outlook continues to look promising for new companies. “Venture-backed companies – particularly in IT – are attracting increased interest from strategic buyers, weighing all options, and holding out for better terms,” the National Venture Capital Association said in a statement in October.

So long as financial markets demand growth, innovative venture-backed tech companies will be important engines for cash-rich legacy technology players. When executed well, this outsourced R&D model is a clear “win-win” for both entrepreneurs and incumbents.

Matt Fates is a partner at Ascent Venture Partners in Boston. The firm specializes in enterprise technology.

This blog is not written or edited by or the Boston Globe.
The author is solely responsible for the content.

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