Kate's Comment

Thoughts on British ICT, energy & environment, cloud computing and security from Memset's MD

The High-Tech brain drain – We Need The Chancellor’s Help to stop selling our golden geese

Now more than ever in recent history is a time of golden opportunity for British high-tech firms, and by extension for UK PLC. In order to fulfil our potential we need funding though and this is causing a huge problem. On 3rd October 2011, Chancellor George Osborne unveiled a ‘credit easing’ scheme through which he plans to have the Treasury lend small businesses billions of pounds in a dramatic attempt to avert a second, disastrous, credit crunch. I’m skeptical this will actually help small businesses at a time when such support is very important (because it relies on the existing banking system), especially in technology and cloud services, and we need to do a lot more to reap the potential benefits of the connected planet. Here is why and how.

Why small businesses matter

To my first assertion – my scepticism that this bonds scheme will actually help small businesses. Remember that the “SME” category is actually a very broad church. The usual definition is a business with less than 250 employees. There are 1.17 million such private enterprises in the UK generating about £1.29 trillion per year in turnover1.

However, 1.02 million of those are micro businesses (under 10 employees), and such businesses tend not to have the best growth prospects; Britain’s fish-and-chip shops and car garages. The real powerhouse of economic growth is the 204,000 small (10-50) and medium (50-250) sized businesses who have already demonstrated their ability to grown beyond the micro stage. The former account for £470 billion per year (bn/y), the latter for £430 bn/y, further demonstrating their status as the “gazelles” of the economy when compared with those million-odd micro businesses who do a paltry £404 bn/y between all of them.

What I expect is that the proposed measures will help the medium-sized businesses, which is all well and good, but that is only 30,000 companies. The real boon to the economy would come from supporting the 170,000 small businesses which have the most growth potential. However, speaking as one of those businesses (we employ 25 staff) I can report that there is no appetite among banks to lend to such companies without asking the directors to guarantee the loan – impractical for those of us whose livelihoods are their business – and I cannot see this approach changing that since it would rely on the existing banking systems to do that, and the banks remain entirely risk-averse.

Memset: a case example

To give some context so that you don’t think we have struggled to get finance for good reasons; we are an extremely successful multi-award-winning, multi-million pound company, growing at ~40% compound annual growth rate while simultaneously accumulating significant cash – impressive in any economic climate. We have had steady, profitable growth for 9 years and are ranked 7th in our industry of ~200 for commercial and financial strength2. We want to borrow to bolster our own reserves in order to invest in infrastructure and grow even faster with our sights on global exports. The best Barclays could offer, without us guaranteeing the debt with our homes, was a £200,000 loan, provided that we left it on account with them. I kid you not.

Cloud: A golden opportunity for Britain

While this might seem self-serving, I passionately believe is is important for the UK information and communications technology (ICT) industry as a whole, and as an extension to that I believe it is important for UK PLC. Following the demise of financial services, retail and construction as previous “engines of growth” for the country, and a recovery in those sectors looking unlikely in the near term, the country should be looking once more to our strengths as innovators. More than any other sector, ICT has the potential to be a real new engine of growth for Britain.

Further, now more than ever the opportunity is enormous, especially in the cloud space. I pick cloud because it is especially suitable as an export, something which we need in the UK, and because it is the fastest growing area of ICT. Gartner have predicted that the infrastructure as a service (IaaS) global market will grow from $3.7 billion in 2011 to $10.5 billion in 20143. Currently about a third of that is believed to be Amazon Web Services, so there is lots of room for new players.

Gartner also forecast that the global Software as a Service (SaaS) market will be $12.1 billion in 2011, and that market is growing by 21% annually4. If that growth continues the global SaaS market will be $26 billion in 2015. Add in IaaS and an estimate for Platform as a Service (PaaS) at $5 billion5 and the global cloud services market could easily be worth over $40 billion by 2015.

Western Europe already has $2.7 billion of the SaaS revenue, predicted to grow to $4.8 billion in 2015. At 23.3%, Western Europe’s market share is growing faster than the global market (ie. we are gaining market share), and most excitingly growing faster than America’s at 18.7% (SaaS growth).

These are serious numbers at any scale, and as a country we are uniquely placed, both literally and in terms of economic cycle, to take advantage of the opportunities for global export of cloud services and the rapid revenue growth that would bring. One could easily envisage us within a few years being a major hub of cloud services, serving the American and European markets.

I’ve seen estimates of Britain’s share of the current global cloud market at about 10%. The source was part of a Chattham House rules presentation, so I cannot share it, but that would mean we have 44% of Western Europe’s market which seems plausible with a little squinting. In that case, if we get our act together and merely hold on to our share then by 2015 we could have $4 billion of the global cloud market. If we grew our market share as well then perhaps we could get to $6-$8 billion by then, which would be about 0.4% of British GDP (though there are a lot of “if’s” in there)! Given that the Treasury only expects GDP (the entire economy) to grow by 1.2%6 in 2012 these are potentially significant numbers. Further, cloud is just one of many exciting technology areas in which we excel, high-tech manufacturing being another. However, that vision will not come to pass unless some things change.

The high-tech brain drain

The problem is that we keep selling our golden geese! I was recently on a UKTI cloud trade mission to Silicon Valley with a bunch of other cloudy entrepreneurs. That illustrious company reminded me that we as a nation are awesome technology innovators; let’s not forget that (despite what VMware’s propaganda would have us believe) server virtualisation was pioneered with the Xen Hypervisor (hypervisors are a key technology underlying compute clouds) under Dr. Ian Pratt at Cambridge University, UK, in the late 90’s.7 Today, Xen is owned by Citrix, an American company, and to my dismay many of my fellow cloud missionaries were intent on seeking US investment – yet more great technical innovation being siphoned out of our shores.

The problem is two fold: First, there is a gap in the UK funding market. Fast growing small businesses (as defined above) usually need cash, but in the £2m-£10m range (roughly 10-50 people for most ICT firms) banks are not lending and the companies are too small to float on an exchange (aka “go public”). This means that those companies have to turn to venture capital, and those institutions almost always insist on a sale in 3-5 years to reap their profits. Those sales are almost always to larger, American firms.

The second part of the problem is culture. I am extremely unusual among my British technology entrepreneur peers in that I have my sights firmly on the big game. My ambition is to take Memset to the global market and have us become the next Autonomy or ARM. That means we eschew VC funding since their goals are far too short-term. My fellow entrepreneurs, however, almost exclusively, believe that the way one does business is the above – get going, get VC funding, sell for a few £m, rinse and repeat (if they are serial entrepreneurs, otherwise sit on a beach I suppose). We need to challenge that culture as well and reignite our faith in our ability as scientists and technologists with outstanding skills in innovation.

An alternative

What I would like to see is Mr. Osborne using those £billions to set up a government-owned bank with the specific mandate of lending to small businesses with a proven revenue model who could accelerate their growth with additional capital. I foresee such a bank facilitating the development of our own “Mittelstand” – the German-owned SMEs that are the powerhouse of the German economy. Such a bank should not be run by civil servants, whose track record is no better than the bankers’, but by private sector professionals with expertise in high-growth SMEs.

Measures to get part-publicly-owned banks to lend (project Merlin) have failed in my view. Further, politicians are still, amazingly, operating under the misapprehension that schemes like the Enterprise Finance Guarantee are working. They are not, and similar complex schemes will just, once again, allow risk-averse banks to hide behind the mechanisms and not actually do what we need them to do: share a small amount of the risk with us, the golden geese, and in doing so allow us to fulfil our potential as drivers of economic prosperity.

Update: Seems I’m not the only one thinking this: “Credit easing plans ‘must go beyond the banks’” – Telegraph

2 Source: Plimsol analysis of the UK Web hosting industry.
5 Most analysts are more upbeat about PaaS’s prospects but I believe the technology is still far too immature, hence a reduced estimate.