Fortino Capital: Why we invest – and will be expanding – in B2B software-based start-ups
Fortino Capital: Why we invest – and will be expanding – in B2B software-based start-ups
By Jacques Bughin and Duco Sickinghe
Our current focus
At Fortino Capital, we’re becoming well-known for being linked to B2B software – most often B2B SaaS. This focus is generally driven by three important factors: the market, the European tech ecosystem, and relationships.
But let’s look into that a little deeper. First, SaaS is where the market has been headed. As Marc Andreessen noted in his famous, 2011 “Why software is eating the world” interview with the Wall Street Journal, recent years have shown a major “softwarisation” of our economies, wherein most leading companies have been leveraging digitisation to become market leaders.
There is more to this than meets the eye, though. Even within the ICT space, hardware has been losing ground to software, and more complex software has led to a simplification trend in hardware. The revolution in the car industry illustrates this perfectly, looking at its infamous new player Tesla. The stock market is now pricing Tesla not as a car but a major smart mobility platform. Its new car models may even shrink to just four components (versus more than 50 in most traditional cars), while Tesla’s software functionalities will be doing the exact opposite – i.e., continuously expanding to do new smart tricks, from recognizing traffic signs to driving autonomously.
This software intensification also means that software capabilities will only keep growing, offering the most capable start- and scale-ups a fantastic opportunity for making inroads in business. Regarding those “would be winners”, we at Fortino are well-equipped to support both financially and with our active, expert operational and management support.
Second, we focus on B2B as it features industrial sectors that sustain the production and assets of our economies. There is a myth that Europe doesn’t have enough “local” talent to play a strong role in high-tech. As a European entrepreneurial finance player, we would disagree. Since our inception in 2012, we’ve witnessed a solid competitive edge in Europe, based on a blend of a) industrial and engineering talents, and b) solid data/software skills.
In fact, using the concept of relative competitive advantage, the European Commission’s Joint Research Centre (JRC) recently found that Europe has three times its fair world share of patent activity in Autonomous Robotics, and, in more good news for our area of focus, up to 2.3 times its share in (mostly B2B) AI services.
Finally, there is a lot more to B2B than the technology. B2B businesses require a longer lead time, better technical knowledge, and more sustained client relationships than B2C. We support software companies that excel in B2B, which will furthermore be able scale a large client base in a more limited amount of time than B2C. With a natural, fit-for-purpose SaaS model, those companies will be tomorrow’s key enterprise darlings that we aim to serve in our portfolio.
More of the same: Benefiting from the next frontiers
Our focus on B2B software has provided us with a major opportunity to date, and we believe that most of the mega-trends we’ve been seeing will only strengthen our focus. In fact, among all the trends to have recently emerged, we believe that software is one that keeps being reinforced.
Consider Covid-19, for instance. Covid-19 has boosted digitisation but has also led to a major shift in working from home. By extension, it has led to a major workplace upgrades and further automation. In fact, part of our recent decision to invest in Peers was based on the support the company provides for workplace transition to automation by predicting the job-related skills employees will need to make this shift effective.
Sustainability is another trend on everyone’s lips, and yet another set of investments we are close to reporting on. But here again the key is not only green IT but, specifically, IT for green. These GreenTech start-ups within our portfolio are building the core taxonomy and data-supported insights to help companies pivot successfully towards a greener play.
Another – and we believe crucial – trend is the rise of artificial intelligence. While the current narrative is that Europe is lagging despite AI’s major source of technological upside, the narrative may miss the subtilities that makes AI a powerful play for Fortino. We know this “inside out” because of the sheer quality of the entrepreneurs and investments we have recently made in the likes of ReaQta, Oqton, Zaion, and again Peers, that leverage AI to put themselves at the innovative edge of their respective industries.
In general, we’re looking at doubling down on AI because of the following strong beliefs:
- “AI has yet to scale” – This narrative hints at our tendency to overestimate the impact of technology in the short-run. We believe that this time, however, it could be different for two reasons. First, the differences in productivity between AI-patenting and AI-virgin firms is often two- to three-times what has been observed in past technologies. Even better, recent studies suggest that the uplift in performance thanks to AI is especially favourable to small- and medium-sized enterprises – Fortino’s target market.
Second, the cost/performance of AI has significantly increased in the recent years. Consider, for instance, image recognition. Using ImageNet as a case study, image detection has grown from 80% accuracy in 2015 to 99% today, or nearly perfect and at least better than human eye. Meanwhile, machine learning training time has gone down from an average of about 6 minutes in Q4 of 2018 to less than one minute by Q1 2020. At the same time, the training cost for deep learning algorithms has gone down from more than $1,000 5 years ago to less than $10 today. Those are massive improvements, but the importance is that the performance/cost ratio makes AI more competitive than any other alternative.
For this reason, we believe that AI has become an economic opportunity.
- “AI still has to prove itself as a GPT” – A GPT is a Global Purpose Technology, or one that can affect all industries. The belief behind this narrative is that most of successful AI cases are concentrated in a few sectors, such as high-tech services or service industries, such as finance.
In reality, the last few years have demonstrated that many sectors can be significantly shaped by AI. For instance, there have been significant breakthroughs in healthcare and pharmaceuticals, where they have had a dramatic effect on the economic structure of those sectors. In healthcare, diagnostics and smart automation have the potential to stop the sector’s secular inflation in our economies without restricting access to services. In pharmaceuticals, it has proven to have a major impact on drug innovation, let alone the time to market for vaccines.
Finally, AI is disruptive, meaning that it will be used extensively for both competitive and protective purposes. Even in sectors like social media: AI-powered company ByTeDance became a tens of billion USD start-up with the title of the ‘most valuable start-up company in the world’ in 2019 as it successfully managed to enter and later dominate the global market for short videos, and this despite the prevalence of major players such as Facebook or YouTube.
From this, we believe that AI holds significant demand adoption potential.
- “Europe is losing out on the AI opportunity” – At present, the US and China each count about 30% of worldwide AI enterprises, with Europe only holding just half of that. But Europe isn’t sitting by idly: policy-wise, EU nation members have recently put together a synchronised plan that transcends each member country’s individual AI strategy. Furthermore, comparing Europe, not on the level of AI enterprises, but on refereed scientific publications, shows that Europe is much better placed than expected, and is on par with the US. The key is therefore that, for Europe, most of the boost is public institution-driven, as opposed to enterprise-driven.
Second, while it is known that Europe has more high-value-added B2B and manufacturing assets, Europe also has a comparative advantage in robotics and automation (24% of patents and firms). However, it also appears that Europe is pulling ahead of competition in hosting AI services (22%). This is pretty good news for Europe, as evolutionary economics teach us that technology starts at the infrastructure level, to then scale to services and bring the most profit and value.
Finally, the European AI talent pool is not only growing strong but is already seen as a clear advantage in the eyes of AI-tech giants such as Google, Microsoft, or IBM, who have all invested in their AI-based laboratories in Europe. Currently, large, US, AI-based firms have located 20% of their centres in Europe, for only about 1/3 in the US.
For this reason, we believe that Europe has assets to play in AI and that its current specialisation may help support the next wave of AI deployment.
- “AI is a large tech companies’ game” – This narrative is based on the fact that today, large tech firms hold a large concentration of AI resources and will thus be the ones to shape how AI develops, including some of the related standards of AI ecosystems, if any.
Still, the belief does not – at least not fully – match reality. As it so happens, AI start-up funding has continued to expand aggressively, while we calculate that, by last year, 20-25% of unicorns were AI-based start-ups. This is a remarkable multiple relative to the share of start-ups being created, bearing in mind that AI technologies only saw their major breakthrough 3 to 5 years ago, or less than the average time it takes for a company to become a unicorn.
Also, as not all companies will have the capabilities to build and manage their AI factories, a market is being built upon the delivery of automatic AI solutions. This market may hinge upon large, open-source libraries such as the Google-powered TensorFlow, but the market is also being served by a broad array of successful start-ups, like DataBricks, Snorkel, or H20.ai.
And then there is the fact that Europe has a surprisingly large amount of young AI companies (up to 30%, and less than 5 years old). This contrasts with China, for instance, where barely 10% of their AI companies are new-born. This diversity of small firms may become a real asset to Europe in a few years when the ecosystem becomes more connected through the Digital Single Market.
From this, we believe that AI is not closed, and that a variety of successful start-ups will emerge, leveraging AI both as their power source or as AI platforms/solutions/applications suppliers.
- “Software 2.0” – The final narrative is not about the success of AI, but more about its implications. At its most extreme, if AI is indeed pervasive and disruptive, can it also “eat” software, making a large part of software start-ups obsolete?
One vision is the so-called “Software 2.0”, wherein data and neural network architecture machine learning models would replace human coding as the source code. But even if this trend is already somewhat visible, most Software 2.0 projects are still currently failing. Instead, we believe that AI will not (fully) replace full software making, but will act as a complement, to turbocharge better software – e.g., by automating code generation for some modules, or automated debugging and intelligent testing.
Because of this, we believe that AI will further power SaaS, and that the two are a great match of reason.
Putting it all together
As we said at the beginning, the three general pillars to our focus on B2B SaaS are: the market, because of industry “softwarisation” across all sizes of businesses and accelerated by several non-market trends; the European tech ecosystem, because of its high, worldwide share of sought-after engineering talent, patent activity, and AI services; and finally, because of the tighter and longer relationships between B2B businesses, as opposed to B2C.
As with all forms of investing, though, we “keep our heads above the parapet” to monitor trends and try to pick out the new trends on the horizon. In our opinion, the most significant of these present and future trends is AI for B2B SaaS. And if there is a moral to this article, or a message we’d like to get across, it would be exactly that: that we believe there is still a much more important AI revolution to come, and that it should be embraced as a powerful theme for future investments.
Already, AI plays a growing role in our own software-based strategy. Take, for example, ReaQta, who specialise Cybersecurity and named as a Gartner Cool Vendor for their innovative AI/Maching Learning approach. Or there’s Oqton, recently acquired by 3D Systems, specifically for their AI approach to manufacturing. There is also Peers, who apply AI to generate individualised learning trajectories to improve employee skillsets, and Zaion, who dominate the European conversational AI space.
If anything, these companies demonstrate how broadly AI can already be applied. But again, we mention them here to showcase our philosophy and practice, as well as our plans for future attention.
If you’re a Europe-based B2B SaaS company looking for advice and potential investment, we can help. Get in touch and let’s get the conversation started.