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In the Globe
special report: high-tech boston
10 trends that may lead to a comeback

Tough lessons

The past 18 months have offered a crash course in the harsh realities of entrepreneurship

      SPECIAL REPORT

High-tech Boston

Boston's next buzz
Following leaders in rival cities
Test driving local gadgets
The Boston boomlet era
Tough lessons for entrepreneurs
Future Forward contest

No matter how old you are, life in Boston always seems to follow the same rhythms of the school-year cycle of its legendary collection of colleges and universities.

And though virtually no company starts its fiscal year in September, for many this is the month that feels like heading back to start the next year, after the predictably all-too-short interlude of summer.

For most, it is not shaping up as one of the happy years. There aren't many local companies feeling like giddy start-up freshmen with their first Visa card. There are even fewer feeling like seniors headed toward the graduation ceremony of an initial public offering. Wall Street has shut down the IPO diploma mill that, from 1998 through mid-2000, churned out one new deal after another but has plunged 90 percent from its peak.

No, this is a year that for most area high-tech companies feels a lot like a sophomore slump - or an angst-filled junior year when fleeing to a semester in Europe suddenly looks quite appealing.

``The expectation that everyone in the building can be a millionaire does not exist anymore,'' says Bob Dalias, chief executive of WaveSmith Networks, a 100-person Acton telecommunications-gear start-up pushing to get its first product out the door by Christmas.

Compared to a year or two years ago, when venture capital seemed to rain down on anyone with a half-decent Internet, telecom, or data-storage concept, Dalias said, ``The message today is much more specific: Show me why anybody cares.''

Given all the other sectors of the area economy, like financial services, health care, and biotechnology, Greater Boston as a whole does not seem to have been driven quite so high nor laid quite so low as other high-tech hotbeds like Silicon Valley, Austin, and Seattle.

But there has been abundant pain, from the flameouts of a half-dozen Hub online retailers and Web consultants, to hundreds of local layoffs at tech stalwarts such as Lucent Technologies, Cisco Systems, and EMC Corp., which once had seemed invincible.

And the predictions of endlessly increasing revenues that once drove share prices for companies like EMC, Sycamore Networks, and CMGI up to the sky have evaporated, along with tens of thousands of dollars in stock-option wealth that sweetened the prospect of 80-hour workweeks.

But the world has not ended.

The bar for raising venture capital has been raised dramatically. Still, precisely focused start-ups are raising tens of millions of dollars each month.

Technological innovation has not ground to a halt. High-tech profits have not dried up entirely.

There are still some local companies earning A's and B's. But they've just found that school has gotten a lot harder.

Here's a look at the landscape and outlook in several of the area's leading tech sectors:

VENTURE CAPITAL

For the first time in several years, venture capital is without a Holy Grail. No shiny new technology is sparkling on the horizon, beckoning investors with the promise of limitless potential.

This drab scenario is historically normal, venture capitalists groan. The inordinate fascination that emerged in the late 1990s with e-commerce, fiber optics, and wireless gadgetry has faded into a quieter, bookish sort of diligence. Razzmatazz is out; VCs are looking for practical companies that can help their customers save money.

``A few years ago, we were talking about improving revenues,'' said Leigh Michl, managing director at Ascent Venture Partners in Boston. But it was hard to prove to potential customers that a piece of software could help them sell more product. In many cases, the pitches were simply too rosy.

``The kind of stuff that gets our attention these days demonstrates cost savings,'' Michl said, ``and tangible productivity increases.''

The slower economy has brought entrepreneurs and venture capitalists back down to the gritty earth. Bottom line: a product with a big price tag that doesn't pay for itself relatively quickly or wow buyers will have no takers. Thus the spate of unsexy deals in the realms of customer service systems, wireless infrastructure, and switches that let broadband companies offer better service to people who are willing to pay extra.

Others are betting on data storage, on ways to make cell phones and other handheld devices deliver more information faster, and on the next wave of components that will make computers more efficient and powerful.

Chris Baldwin, a partner at Charles River Ventures in Waltham, said data storage is ``the paper of the modern office place.'' He added, ``Every time you make a plane reservation online or send an e-mail, you're creating an electronic record.'' All companies eventually have to spend money on storage, he argued.

While some VCs claim the tepid economy makes for low-priced investing, others say the environment is grim. Fund-raising by all by the largest firms has dropped significantly, returns are down, and the stock market is in the dumps.

Ascent's Michl puts it bluntly: ``Every trend is quite negative for entrepreneurial ventures and for venture capital.''

Not everyone agrees, at least in public. But for the handful of opportunists left standing, the pack mentality is receding, said Josh Lerner, a professor at Harvard Business School and co-author of books on venture capital. He doubts we'll see another concentration of investments in one or two industries for the foreseeable future.

``Wherever the money is going to go, it's probably not into telecom or the Internet,'' he said.

This, too, matches historic norms, Lerner explained. Venture capitalists are known for beating the bushes for good companies, not for just throwing cash at every hot sector and hoping something will stick. Much money has been lost using that gambler's method, and the sting is still fresh.

If life sciences and biotech are this year's hot stories, they have yet to lurch to Internet territory. The sectors reaped nearly 14 percent of all venture funding in the second quarter, or $1.1 billion, more than triple the 4 percent share they saw a year earlier, according to Venture Economics in New York.

Investors say prices for health-related investments have not surged the way Web deals did in 1999 and early 2000. But there does appear to be a growing number of VC firms that claim to be dedicated to the field.

There may be a touch of deja vu there.

BETH HEALY

SOFTWARE, HARDWARE, DATA STORAGE

At first glance, three pillars of the New England technology scene - software, hardware, and data storage - seem to be hurting. Some of the most important software and Internet companies have faded or been acquired, like CMGI of Andover and Lycos Inc. of Waltham, respectively, both of which have announced layoffs and falling profits in 2001. Tech-consulting companies have closed down altogether like Zefer Corp., which recently shut its Boston operation and fired about 300 workers.

Aside from some niche markets like military or medical equipment, big hardware shops continue to move away or overseas. And even data-storage giant EMC Corp. of Hopkinton, a longtime steady performer, has announced earnings disappointments and layoffs.

Despite all the gloom, though, it's not hard to find senior technology leaders who regard the current period as a temporary pause. They point to businesses with outlooks as bright as ever, like applications maker Progress Software of Bedford, which has grown to 1,400 workers. Meanwhile, start-up companies are still being created at a healthy pace, said Joyce Plotkin, head of the Massachusetts Software and Internet Council, a local trade group.

Plotkin said she expects her trade group's membership may decline slightly from the 800 companies that were members last year, but the overall employment at its member companies will remain about the same.

``What's gone on in Massachusetts has been below the radar for a lot of people who track these issues,'' Plotkin said. ``We're still seeing a lot of start-up activity, but they're not getting as much notice as before.''

Boston attorney Rick Lucash, whose firm Lucash, Gesmer, and Updegrove doubled in size in the last three years to 40 lawyers to keep up with growing technology clients, says they're as busy as ever doing licensing, merger, and patent work for high-tech clients.

Among potential corporate customers seeking his services, he said, ``I think there's a decrease in the number but an increase in the average quality.''

The local data-storage industry is centered around EMC, the world's largest maker of data-storage devices, which this year has seen its stock fall around 80 percent because of slowing demand. In response, the company has laid off 1,100 people, or about 5 percent of its workforce. Still, EMC says it hopes demand will begin to pick up again next year, and other storage companies echo that view.

``Longer term, the story for storage still looks pretty good,'' said Mark Canepa, executive vice president at a Sun Microsystems data-storage unit in Burlington, which employs several hundred people. Until demand picks up, however, Canepa says he can't add to his work force. ``No company is doing much hiring, and neither are we,'' he said.

ROSS KERBER

TELECOM AND NETWORKING

Of all of the many ways that Greater Boston loves to think of itself as a world-class community, one area in which it has succeeded is in building a major cluster of telecommunications talent that has attracted billions of dollars in investment over the last half-decade.

The rapid implosion of the telecom boom over the last 18 months has certainly had a big impact locally, with hundreds of layoffs, cratering stock prices, and a steep drop in the once fevered rush of venture capital into the industry. But despite the wreckage, telecom equipment and software remains a major driver of the high-tech economy locally, and Greater Boston and southern New Hampshire remain a key focus of growth and innovation for the telecom industry worldwide.

US telecom's Big Three - Cisco Systems, Lucent Technologies, and Nortel Networks - collectively employ over 8,000 people here, largely due to more than two dozen acquisitions of local startups in the last five years.

All three companies have had to cut deeply, though. Lucent has put its landmark 4,000-employee North Andover optical equipment factory on the auction block, hoping to find a contract manufacturer to buy it, and Cisco and optical giants Corning and Sycamore Networks have all slowed or shelved plans for major new campuses in Boxborough, Nashua, and Tyngsborough.

At the start-up level, the stretch of Interstate 495 from Marlborough to North Andover sports a large telecom cluster, from advanced voice switch maker Sonus Networks of Westford, recently valued at over $3 billion on Wall Street, to growing newcomers like Celox Networks of Southborough, which brought in $80 million in VC money this summer as it continues developing its high-powered Internet services switch.

Sonus neighbor Unisphere Networks, an 800-person company created through a $1 billion acquisition of three start-ups by Germany's Siemens AG, hopes to finally break through the deep freeze for telecom initial public offerings with an IPO this fall after quietly growing its sales to a rate of over $200 million annually.

``This absolutely remains a major hotbed for telecom,'' said Bruce Sachs, a top telecom venture capitalist with Charles River Ventures of Waltham and chairman of the Massachusetts Telecommunications Council, which represents over 300 companies.

With spending on telecom gear falling from the frenzied levels of the late 1990s, Sachs said, ``We haven't seen anything different than the pounding that every other area with a large telecom focus has felt, like Silicon Valley or Texas or Ontario, but I think we've got a lot of rich talent here.''

Eric Giler, president of 350-person Brooktrout Technology of Needham, which makes software and devices for bigger companies' phone-company and office-networking switches, said, ``This is one of the centers, if not the center, of telecom talent in the country, on a concentration basis. The industry is kind of bumping along the bottom right now, but there will be a turnaround. Massachusetts is huge in telecom and will be for some time to come.''

Depending on how the industry is defined, telecommunications -including both equipment makers and service providers like Verizon Communications, AT&T and wireless carriers - is generally estimated by state and federal analysts to account for 50,000 to 100,000 jobs in Massachusetts. But it has an outsized impact on the local technology economy in the creation of jobs and wealth.

From 1995 to 1999, venture funding for Massachusetts-based companies in telecommunications and networking equipment soared, from $50 million to $791 million, according to a survey by PricewaterhouseCoopers cited in the Massachusetts Technology Collaborative's latest ``Index of the Massachusetts Innovation Economy.''

Software-oriented companies dominated the VC derby throughout the period, attracting over a quarter of all funds, but telecom's share rose from 11 percent to 21 percent. Though funding began to slow in late 2000, it has not vanished, with companies like Celox, Equipe Communications of Acton, Quantum Bridge Communications of Andover, and SnowShore Networks of Chelmsford landing eight-figure VC deals in recent months.

Massachusetts' history as the home of early 1990s telecom sensations like Cascade Communications, Proteon and Wellfleet Communications, as well as networking operations of long-gone computer makers like Digital Equipment and Wang, helps to account for its continued strength in the field.

Bob Dalias, chief executive of WaveSmith Networks in Acton, a 105-person company developing a data-switching device for big phone companies, said, ``What makes the Boston area so appealing for launching a startup, if you have the nerve and can get the money, is the employee base.''

PETER J. HOWE

E-COMMERCE

E-commerce in New England? Ho, ho, ho - that was Christmases ago.

If we're talking about those Internet pure plays that hoped to revolutionize the retail industry, the vast majority of once hot and not-so-hot players can be found in the our local dot-com graveyard. The ghosts of e-commerce now include Toysmart.com, HomeRuns.com, Shoplink.com, Streamline.com, MotherNature.com, and Craftshop.com.

But e-commerce is not dead; it's just being reshaped by old businesses with deep pockets and surviving pure plays savvy enough to carve safe niches in the tough retail industry. Shoebuy.com, for one, is a Boston-based online seller of footwear that has outlasted Nordstromshoes.com and a host of companies that tried to round one of the most difficult corners on the Web. In Arlington, Museumshop.com lives.

Sales at closely held Eziba.com are still growing due to $40 million in second-round funding, cautious spending, and an offering of high-margin unique gifts. Eziba.com plans to be profitable by the end of 2002 but can make ends meet if this holiday season proves to be a bust, said Bill Miller, chief executive of the North Adams-based digital merchant.

Until recently, Priceline.com of Norwalk, Conn., looked like a ticking dot-com bomb. But now it is one of the few e-commerce pure plays making money. The name-your-own price travel site has been slashing costs and posting higher sales in its car-rental and hotel businesses. As some consumers have told us, the novelty of bidding on hotel rooms, rental cars, and airline tickets is wearing off. But maybe penny-pinching will make a comeback in these stingier days.

What's more interesting is the maneuvering by traditional retailers. Staples and L.L. Bean have clearly staked their claims on the Net. Even women's apparel retailer Talbots, which operated one of the clunkiest apparel stores on the Web, has started clearing its cluttered aisles. Local florist Winstonflowers.com has upgraded its Web site, too.

In the business-to-business arena, it's the same story. There are a few comfortable corners where pure plays can thrive, but for the most part the big guys came and conquered with intimidating in-house initatives or huge industry-driven consortia on the Web.

Trying to track down the local online business exchanges that popped up in the last several years is like playing ``knock, knock, is anybody home?'' In Boston, PaperExchange.com got spirited away, its technology remains purchased by HIT International Trading AG, a European paper trading company. Gofish.com, which hoped to rock the seafood industry, recently ditched the exchange portion of its business after online transactions proved disappointing.

``It was a great idea that just wasn't the idea for today,'' said Neal Workman, chief executive of the Portland, Maine-based company, which still provides industry news and credit ratings on its Web site.

Still, there are a few bright spots for online-only B2B-ers, including e-Wood.com Inc. The Wellesley online auction site for wood and wood products recently attracted $1.25 million in investment.

More compelling, though, are the e-business firms that provide e-commerce software and services, rather than books, fish, and lumber. In this area, watch for pre-IPO businesses like Bowstreet Inc., a developer of software that automates connections and business relationships on the Web. Investors funneled a whopping $140 million in funding in Bowstreet at a time when most wallets had closed.

STEPHANIE STOUGHTON



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