The evolution of an investment theme

IBM has just announced the acquisition of social recruitment business Kenexa for $1.3bn, the latest of a string of 'social' enterprise software businesses to be acquired this year. Other prominent deals done this year are Salesforce's acquisition of BuddyMedia for $689m, Oracle's acquisition of Vitrue for $300m, and Microsoft's acquisition of Yammer for $1.2bn. The first major acquisition of a social business was Salesforce's acquisition of Radian6 for $326m nearly 18 months ago.

Software to help enterprises leverage social media was the investment theme that underpinnedour investment in Conversocial last year and we have been looking for more companies that leverage the same trends. These acquisitions tell us very clearly that the world's largest software companies now clearly understand the benefits of leveraging social in their enterprise software and new startups in these markets will need to cleverly navigate the existing players if they are to succeed. That stands in contrast to the first generation of social software companies who were successful because they blazed a trail.

The evolution of opportunity as this investment theme has matured is similar to other categories. First the trailblazers define a new category and initially they are viewed with extreme scepticism and many people are convinced they will fail because their business model is unsustainable and/or people won't want their products. By the time the trailblazer is successful there are typically many entrepreneurs working on derivatives of the core idea. Their startups are characterised by lower business model and market risk than the first generation, but much higher competitive risk. If the investment theme is any good there will be multiple successful startups in each of the first and second generations, but after that the opportunity is typically largely over. If the investment theme is weak then success is likely to either be totally elusive, or confined to one or two of the trailblazers.

In the case of social software all the evidence suggests that the investment theme is strong and there will be more winners in this space, but the next generation will work hard to differentiate themselves from their forbears by specialising in different process areas or distinct verticals. Conversocial, for example, is focusing on customer service for companies with a direct to consumer business model, an area where none of the previously acquired startups (or indeed larger software companies) has put much effort. For those that haven't followed the sector closely, Kenexa is focused on recruitment, Buddymedia and Vitrue on marketing, Yammer on internal communications and Radian6 on customer insight.

Ecommerce has gone through a similar evolution – starting with the simple idea of selling stuff of on the web, with books as the first category, to filling out all the other, more difficult categories (clothes, jewellery, etc.). Following that derivative ecommerce business models have become popular, predominantly flash sales and subscription business models, and these in turn have seen successful trailblazers like Vente Privee and Lovefilm followed by second generation players in other verticals and geographies – like Graze and Sports Pursuit from our portfolio.

Ironically, social networks themselves were a much weaker investment theme. Despite heralding huge changes in the way we all go about our lives there have only been a few decent exits in this space and Facebook and arguably Twitter are the only large sustainable companies have been created.

(Nic Brisbourne is partner at DFJ Esprit, one of Europe's leading venture capital firms.  The post has been reproduced with the author's permission from his blog, The Equity Kicker.)