On April 10 last year, the Federal Government introduced its $76 million Building on IT Strengths (BITS) incubator program, which funds the development of 10 incubators spread across the country. Incubators are development firms that organise the seed funding and necessary business services to prepare a start up company for further funding. BITS is arguably one of the few initiatives of the current Department of Communications, Information Technology and the Arts (DCITA) to be well received by the IT and communications industry.
Almost 12 months later the various incubators are reporting a level of enthusiasm that is lacking in the rest of the IT sector. The launch of the BITS program was sidelined in the press by the tech stock crash which has re-aligned expectations about the value of technological innovation. But with Government support and a re-invented venture capital market hungry for good ideas, opportunities still abound for those entrepreneurs with an eye for gaps in the market.
Lex McArthur, chief executive officer of the BITS-endorsed Australian Distributed Incubator (ADI), is currently involved with 16 startups and was involved with a further five in his previous position at Melbourne IT's incubator for electronic commerce. McArthur has seen the overall level of investment drop since the tech stock wreck as investors have become more "risk alert". On the entrepreneurial side however, enthusiasm has not waned dramatically, although entrepreneurs have become much more realistic about the value of their ideas.
"What an entrepreneur once thought was worth $3 million may only really be worth $1 million," McArthur said.
Geoff Thomas, managing director of the Playford Centre, a three-year old incubator set up by IT services company EDS and the South Australian Government, believes there is still a lot of money up for grabs for quality entrepreneurs.
"There is still a lot of venture capital around, but they are looking for more mature, better quality deals," he said. "We are still seeing good products and good models. The deals haven't dropped off, it's just the stupid deals have dropped off. Twelve months ago anyone with an idea got funding."
Thomas also believes the methods of raising funds have undergone a significant change. With large multinational vendors such as Intel, Hewlett-Packard and Sun Microsystems snooping around the market for innovative ideas, Thomas believes selling out to an established company will become more prevalent than going it alone on the stock market.
"Floats are out of the question," Thomas said. "Our advice is that you've got to be in it for the long haul. You can't have a model that involves spending cash for a prolonged period of time.
"You should look to trade sales rather than listings. There is still interest from the large vendors, they see these startups as the engine rooms of ideas and are keen to get involved if it suits their solution set."
Kamal Sarma, managing director of BITS-endorsed BlueFire Innovation, believes the tech stock wreck has meant most entrepreneurs must remain in incubation for longer periods of time, as prospective investors want to see profits earlier.
Regardless of the changes to the market, incubator principals say the advice they give entrepreneurs has not needed to be adjusted. This is because the advice revolves around what is good for the company in the long term rather than the conditions of the market in the short term. But what incubators are beginning to highlight to their entrepreneurs is the importance of a solid channel strategy once products are ready for market.
"Distribution is fundamental," said ADI's McArthur. "The way you go to market is absolutely critical to your success. Most of the weaknesses we see in IT business plans [are associated with] coming up with an effective pricing model and an effective distribution channel."
ADI staff have all had experience with their own startups and have therefore had some experience with distribution. The incubator also calls on external consultants to give specialist advice on these issues.
"There is a lot involved in working these things out and avoiding channel conflict," McArthur said.
Playford Centre's Geoff Thomas agrees. "Entrepreneurs under these schemes are always lacking one or more of the key skills needed for business success," he said. "Most can identify a market and develop a good product. But it is not always obvious what the best channel to market should be."
Because the Government funds the majority of the incubators' operations, it is no surprise that those in the IT incubation industry believe the DCITA made spectacular headway into IT innovation when it implemented the BITS program.
Playford Centre's Thomas commended the fact that the incubators are spread across the nation to many areas where development had been seriously lacking. In a state like South Australia, a geographically isolated region with a first-rate education system, developing products, like software, which require no effort to export is an ideal opportunity.
"The Government is doing what Ireland and Israel did so well a few years ago," said BlueFire's Sarma. "They have tried to make the right environment for innovation, now it's up to the private sector to get on with it."
Although McArthur believes the DCITA's commitment to incubators hasn't been equalled anywhere else in the world, he would like to see the Government make a few minor changes to other areas of investment to bolster seed funding. McArthur believes the Government should create a new class of superannuation funds (normally invested in property, venture capital and the like) specifically for seed funding like incubators. "It is an end of the market which is often seen as risky, but research shows the right investment in a seed company yields a much greater return."
Rob Forage, managing director for BITS-endorsed Item3, believes DCITA delivered a program needed in Australia for many years, and advocates the same scheme being applied to other industries. "A number of other areas, like biotechnology and advanced manufacturing, could really benefit from a targeted incubator scheme like this. If this same vision was applied in other industries, our whole economy would be much better off."
With the BITS scheme still less than 12 months old, it is hard to evaluate its success in the short term. But several other incubators, such as Australia's Technology Park in Redfern, Sydney, and Melbourne IT's incubator for electronic commerce, have already yielded success stories which the new breed of incubators hope to mimic in the near future.
Few of the BITS-funded incubators are willing to divulge their predictions about the next killer application that they are seeking from entrepreneurs in the market. Although both the Playford Centre's Thomas and ASI's McArthur are pinning much of their hopes on wireless application development and Internet infrastructure, all believe that thinking in terms of the "next killer app" is not the role of the incubator.
"We are looking for good technology with worldwide potential and good people," said ITEM3's Forage. "Our goal is to develop a sustainable business. So each deal has to be analysed on its own merit."
Similarly, BlueFire's Sarma knows that if he is working on the "next killer app", so is somebody in Israel, Ireland or Bangladore.
"The next killer app could be anything, but it has to focus on two key things," said McArthur. "It has to address both the timely and costly nature of doing business. There could be thousands of applications, because time and cost is what businesses are always looking to cut."
McArthur uses the example of Australian technology developer Bullant to illustrate. Bullant addressed the amount of time it takes for a query to enter and exit a database with information. It is a simple technology, but one that can be applied to a variety of Internet-related scenarios, giving it worldwide appeal. Subsequently, the developers have been warmly welcomed by some of the world's largest vendors such as Sun Microsystems and Intel.
"We always have to look for things that will have a dramatic impact in the near future," McArthur said. "Our role is to attract the attention of venture capital funding, so in many respects we are guided by what the VC community is looking for. If they are looking for wireless and infrastructure, for example, so are we."
According to ITEM3's Forage, the quality of entrepreneurial ideas has actually increased since the tech stock wreck. His peers agree. McArthur points to successes in fields such as biotechnology as an example of the Australian tendency to try the things nobody else would consider, an odd benefit to being geographically isolated.
"Australians are getting more innovative," BlueFire's Sarma said. "We have realised the world market is not so far away any more. The success stories are fuelling the entrepreneurial appetite, as they can see what is now possible."
But both Thomas and Forage agree Australia has a lot to learn about turning innovation into dollars. "The only weakness Australia has is that in places like the US, they are good at turning research into money," said Thomas. "Here we are good at turning money into research."
"Australians are inventive and creative, but it's hard to say we're innovative," said Forage. "A lot of people confuse invention with innovation. Innovation is the reduction to practice of invention. Australia can invent, but we aren't good at capturing the economic rewards. That is what the BITS scheme is trying to address: I expect the economy to have some high-quality companies growing as a result."