Virata - A Case Study
August 2007 (The New Business Road Test)
If you dialled up your high-speed DSL connection today to bid on that special something on eBay, then your data probably passed through a Virata chip. If you bought a book from Amazon via a DSL connection, then you probably used Virata hardware and software. If you checked your email using a high-speed DSL connection, then it went a lot faster because of Virata.
Virata, a British company that grew out of technology developed in the research labs of Cambridge University, provides communications processors and the relevant software that enable the world’s telephone companies to compete for the growing demand for high-speed digital access. But getting there wasn’t easy.
With roots dating back to 1986, Virata was an offshoot of the Olivetti Research Laboratory in Cambridge, UK where Andy Hopper and Hermann Hauser had been leading research into a new technology called Asynchronous Transfer Mode (ATM). ATM had what Hopper and Hauser thought was an important advantage over other competing technologies: it could simultaneously handle voice, video and data transmission over local area networks (LANs) and wide area networks (WANs), and it did so at high speed. With technology valued at $6 million and seed capital from Olivetti, 3i and private investors, Virata was spun out of the Olivetti lab in 1993. With premises in Cambridge, UK, it was given a chance to make its name developing and marketing equipment for LANs.
Ethernet, an older LAN technology that dated back to the 1970s, was not well suited to video and voice, since these time-dependent applications required information to be delivered in a constant stream. Ethernet separated data into packets that were distributed through different routes and reassembled at the receiving end. Ethernet worked fine for data, but not for voice or video. Garbled conversations or jerky images were the result.
A better mousetrap
Hopper and Hauser thought the need for voice and video would grow, so their new company soon began marketing video servers, switches and network interface cards that together comprised a complete ATM solution for LAN networks. Their ATM25 switch was the fastest in the world at the time, operating at 25 megabits per second compared with the 10-megabit products that the Ethernet providers offered. In 1994, with its new headquarters and sales office in California, to tap what was expected to be the first market for this new technology, Virata was off and running.
Like many technology companies, however, the cost of developing the technology outpaced the meagre early revenues. Thus, in 1995, with ATM all the rage in the venture capital community, Virata secured a first round of venture capital led by two prominent Silicon Valley firms, Oak Investment Partners and New Enterprise Associates, raising another $11 million for about 30 per cent of the company. As Hauser put it, ‘Venture capitalists are basically “sector lemmings”. When a sector is as hot as ATM was at the time, venture capitalists have got to have some ATM investments. We had one of the best ATM teams in the world and we had a product that was outstanding compared with all the other switches on the market’.
With others developing similar technology, Virata staked its competitive advantage on its ability to enhance the software functionality of its ATM products. Unfortunately, however, by late 1995 it was clear that, in the words of Virata’s Vice President of Marketing, Tom Cooper, ‘The dog was not eating the dog food – not just Virata’s brand, no one’s brand’. As one of Cooper’s former colleagues from Hewlett-Packard pointed out, ‘Tom, your problem is that you have a technology in search of a problem. No one has a problem yet!’. Tom’s former colleague was right. The vast majority of traffic over LANs was data, not voice or video. Multimedia networking simply wasn’t a mainstream application just yet.
But an absence of a real customer need was only part of the problem. Companies like 3Com, whose livelihoods were invested in Ethernet technology, were not about to let some upstart technology eat their lunch. These companies had deep pockets and large numbers of customers who had made significant investments in Ethernet networks. These customers were happy to pay for upgrades and enhancements as further developments in Ethernet technology occurred. Even though Virata’s ATM switches ran at more than twice the speed of Ethernet switches – at twice the price – customers just were not buying. ‘It was the classic better mousetrap phenomenon’, said Cooper. The better mousetrap, however, is not always the one that sells.
By 1996, morale at Virata was heading south. Virata’s CEO tried to rally his troops, arguing that Virata was just slightly too early with its technology. He believed that, ‘When this market takes off, Virata will be a leading player and will ride on its successes far into the future’. Fortunately, there was continued faith among investors that ATM was a technology for the future. After all, ATM was a better mousetrap. As a result, Virata obtained another round of $13 million in June: $3 million from the original investors and $10 million from Oracle, whose CEO Larry Ellison had invested in another of Hauser’s companies some years earlier. Ellison had faith in Hauser and it took only a 30-minute meeting to seal the deal.
Stay the course or change direction?
With a fresh injection of cash in hand, Virata renewed its efforts to sell its line of network products. Significantly, and as a result of connections built earlier in his career, Tom Cooper had had some success in licensing the software and semiconductors used in Virata’s LAN equipment to companies interested in Virata’s technology for applications in quite different areas. One recent approach had come from Alcatel, a French communications equipment company.
Alcatel was pioneering asynchronous digital subscriber line technology (ADSL), which it thought might make possible the upgrading of old-fashioned twistedpair copper telephone wires to handle the growing interest in broadband applications. Alcatel wanted to use Virata’s ATM LAN products as part of its ADSL demonstration, license the technology, and perhaps build it into its own hardware devices. These devices would handle high-speed data in the so-called local loop – the ‘last mile’ of copper that reached from telephone companies’ facilities to their subscribers’ homes and premises. The market for high-speed data applications like DSL looked promising even in 1996, and Virata’s technology was worth a look, Alcatel thought.
Some at Virata were intrigued with the forecasts of rapid growth of online ADSL subscribers and wondered whether this market might be a more attractive one than the LAN markets Virata had been pursuing. But Virata’s CEO would have none of this thinking: ‘It would be disastrous to divert our attention to the licensing market as you suggest’. The company soon found itself split into two camps and, barely one month after Virata received Ellison’s cash, the CEO left the company.
In the summer of 1996, the Virata board asked Charles Cotton, the general manager of the Cambridge operation since mid-1995, to become COO and acting CEO. Cotton’s charge was to determine which direction Virata should take in the short term. Pulling his team together for a late summer strategic retreat in California’s Napa Valley and fuelled by the California sunshine – and some of the world’s finest wines – Virata management decided to pursue both directions concurrently, at least for the time being. It was too early to know whether the licensing strategy – or DSL itself, for that matter – would bear fruit, and it remained unclear whether the networking market might turn profitable. Although networking sales had grown to nearly $1.5 million per quarter, the direct selling and distri- bution costs exceeded the gross margin. Virata was burning cash rapidly and more would be needed soon.
That same month, Alcatel won a large contract with four regional Bell operating companies in the USA to deploy its DSL architecture. This broadbased deal covering a significant portion of the American telecom terrain focused the market on ATM-based ADSL solutions. At last, there was a light at the end of Virata’s tunnel. By 1997, Virata had licensed its technology to other telecom suppliers and to Com21 Corporation, a leader in bringing high-speed data capability to American and European cable television operators, who also saw the potential for an ATM-based solution for their applications. Notwithstanding these deals, Virata’s licensing revenues were still very small.
As the company pursued both the licensing strategy and the networking market, the Virata team remained badly divided. A new CEO – the third in just 15 months – was convinced that networking products – not DSL – were the bread and butter of Virata’s future. The licensing business was just too different and required different skills. Licensing deals were sold to original equipment manufacturers (OEMs) that would add Virata’s software technology and chips to their own products. Sales cycles were certain to be long and there was no assurance that the extensive selling effort required would actually result in purchase orders. The licensing business would also hitch Virata to the DSL wagon, and it was by no means clear that DSL would win the battle with other competing technologies.
Cotton and Cooper, however, were of the mind that Ethernet was going to win the battles and the war for networks, and that ATM – Virata’s better mousetrap – would lose. Licensing looked to them like the better bet. The debates over Virata’s direction became increasingly divisive, and in September 1997, after only five months at the helm, the new CEO departed and Cotton was promoted into the position. As he saw it, the two-pronged strategy was no longer tenable: ‘We were straddling a chasm that was starting to widen. Sooner or later we had to jump to one side, otherwise we risked falling into the chasm never to recover’. His first move was to dismiss Virata’s entire networking product sales staff. The house was bet on DSL.
The new direction required that Virata would have to develop new capabilities in chip design. It also meant that Virata’s customer base would shrink sharply in number, as it focused its efforts on large OEMs. By 1998, three customers accounted for 40 per cent of Virata’s revenues, and its total customer base numbered less than 20. The long sales cycle also meant that cash losses continued.
A happy ending
Fortunately, there was not a day that passed in 1998 when someone wasn’t reporting the red-hot growth of the Internet and its follow-on effect for broadband access. The Internet frenzy enabled Virata to raise, with the help of Index Securities, a Swiss investment bank, another $31 million from existing and new shareholders to fund the company until a planned public offering in 1999. In November 1999, with Virata showing growth in the licensing business – no profits just yet, however, but declining losses – Virata shares started trading at $14 on NASDAQ and jumped to $27 by the end of the first day. Broadband access and the Internet were hot. Virata’s technology was playing a key role, and technology investors wanted to get on board. By early 2000, Virata’s share price reached $100.
What endowed Virata’s long struggle with its happy ending? To be sure, the coming of the Internet age had a lot to do with it. Hermann Hauser’s ability to raise a sorely needed $10 million from Larry Ellison in a 30-minute meeting didn’t hurt either. But, as Hauser recalled, ‘Without a doubt, the thing that carried us through was the quality of the team and all of its connections.’ When Cooper told the story about Alcatel’s interest in the Virata technology at a board meeting, ‘The board seized upon the story and talked to some people that they knew. It turned out that the board had spotted an early trend, and this is where we made all of our money.’
Virata’s connections mattered. Call it luck or serendipity if you like. But Tom Cooper’s connections down the value chain to potential customers in markets not then being served led to the Alcatel inquiry. The board’s connections up and across the value chain – to suppliers and other players in related industries who could confirm what was happening with DSL – enabled Virata to place a very risky bet with more confidence than would otherwise have been possible. It’s been said that lady luck comes to the well prepared. As we’ve now seen, she also comes to the well-connected.
Lessons learned from Virata
Virata was fortunate that a confluence of technological trends created a market – telecom providers seeking to provide dial-up broadband access to their telephone customers – for which its technology happened to be extremely well suited. It’s been said many times that luck can play an important role in entrepreneurial success. Being in the right place at the right time, as Virata was, can turn a struggling company into a blockbuster.
The lesson from Virata isn’t, however, about luck. The lesson is that connections – the right kind of connections – can deliver to an entrepreneurial firm three important outcomes:
Identifying fortuitous trends or changes in the marketplace that the company might take advantage of.
Doing so early, before other would-be competitors can do so.
Obtaining a broad-based assessment of such a development, from a variety of perspectives outside the firm, in order that a decision to pursue it can be an evidence-based one rather than a risky guess.
What kind of connections will your venture want to have?
Connections up the value chain to suppliers who deal with the leaders in your industry and with firms in other industries that might serve as substitutes for the products you provide.
Connections down the value chain to potential customers in target markets that you might serve one day in addition to the markets you plan to target at the outset.
Connections across your industry with competitors – and with firms from other industries that offer substitutes – so that you can gain some perspective to gauge accurately changes in market conditions. When your sales increase, it’s good to know if they are doing so because you are gaining market share or if you are simply benefiting from a rising tide that floats all boats. The same is true when your sales are soft.
Connections across your industry also help you understand its CSFs, an important issue in helping you assemble an entrepreneurial team that can deliver the kind of performance you and your investors seek. These connections can also identify and build relationships with skilled people who know your industry and who – now or later – you may wish to attract to your company.