VCs warm up to tele-soft
By Om Malik
Redherring.com, December 01, 2000
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Optical networking startups are the darlings of the venture capital community, but the smart money is already moving on to the next big thing -- tele-soft companies.
Tele-soft refers to any piece of software that adds intelligence to so-called new generation networks. The new network infrastructure can be broken down into three layers. The first layer is switching hardware that acts as a bridge between new and legacy networks. The second layer is known as a soft switch, which is like an operating system for new Internet-protocol (IP) based voice networks. And the third layer, known as the service creation layer, uses specialized software in new value-added (and money-making) applications, such as call forwarding and unified messaging, that can be added to voice networks.
Tele-soft companies focus on the second and third layers of the market. If recent news announcements are any indication, smart VCs are looking at tele-soft companies for their next home runs. Optics guru and Kleiner Perkins Caufield & Byers partner Vinod Khosla has already shifted dollars from networking hardware equipment to software that will make today's fiber-optic networks more intelligent.
CATCH THE WAVE
Earlier this month Kleiner Perkins led a $25 million second round in SS8 Networks, a signaling and service software firm based in San Jose, California. That funding came on the heels of Kleiner's lead position in the $39 million second round of IpVerse, a soft switch maker based in Sunnyvale, California.
Not to be left out of the game, Redpoint Ventures has bet on quite a few tele-softies as well, including Rapid 5 Networks and Syndeo. Rapid 5 has so far raised $70 million in two rounds of funding from a group of investors led by Redpoint. Redpoint was so bullish on Syndeo that it put up all of the company's $18 million second round.
A host of other VCs, including Battery Ventures, New Enterprise Associates (NEA), and Norwest Venture Partners, are crawling all over the space. Battery and NEA started IpUnity with $6.6 million, and the company raised another $12 million in a second venture round in August. Based in Milpitas, California, IpUnity makes software that allows competitive local exchange carriers (CLECs) and other service providers to deploy enhanced next-generation services -- such as unified messaging, Web conferencing, and tele-browsing -- cheaply and easily using common hardware and software.
Venture capitalists can't help but be bullish on the soft switch market. The sector will grow from a mere $104 million in 1999 to $4.3 billion in 2004, predicts The Yankee Group, a Boston-based research company.
No fewer than a dozen startups are chasing the soft switch market. Entrepreneurs like Paul Singh, cofounder of IpVerse, say the soft switch push is part of the natural evolution of technology. "If you look at it, the mainframe was usurped by the personal computer and the same thing is happening in the telecom space, where the telecom switch is being dis-aggregated," Mr. Singh says.
CONSIDER THE SOURCE
Naturally, Mr. Singh's a little biased and does not mention the fact that many questions remain about the reliability of soft switches vis-a-vis their hardware predecessors, or the dozens of different versions that are floating in the market and might not be compatible with each other.
Mr. Singh's enthusiasm stems from the fact that IpVerse has had some early wins, gaining customers such as Telocity and Electric Lightwave. IpVerse got its start with a $3 million investment from Norwest in 1998 and has since raised an additional $39 million from the likes of Kleiner Perkins, Battery, and Norwest.
VCs aren't the only ones interested in tele-soft. Earlier this month, Sonus Networks (Nasdaq: SONS) spent $442 million to acquire soft-switch maker Telecom Technologies of Richardson, Texas.
Tele-soft opportunities abound, thanks in part to the changing anatomy of today's networks. Traditional circuit-switched networks were controlled by legacy equipment made by the likes of Lucent Technologies. However, today things have changed and the new networks utilize IP for switching -- the act of moving data and voice between different locations. The old legacy equipment does not work with new networks, which need a whole new breed of equipment and software such as soft switches to work with the old gear.
Soft switches let service providers add new voice services such as call waiting to their networks without depending on a traditional switch vendor for specific features and updates -- all on a server made by the likes of Sun Microsystems that sits quietly in a corner. And the changes can be made in a matter of hours, if not minutes. By comparison, a traditional hardware switch is about the size of a refrigerator, and it takes about 12 to 18 months to add the same functionality.
Since tele-soft applications allow phone companies to add value-added features for which they can charge a lot of money (like $4.99 for simple call forwarding), they are likely to be big buyers of these products.
The recent slowdown of voice-related revenues at AT&T (NYSE: T) and Worldcom (Nasdaq: WCOM) show that making money by selling voice calls is like trying to snatch the World Series away from the New York Yankees. Worldcom executives have made positive remarks on soft switch deployments in recent analyst calls.
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