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06/04/2005

Conflicts and Cash: Industry Analysts and Start-ups

The popular impression of industry analysts is that they are the unbiased oracles of technology truth.  Their clients, mostly Global 2000 CIOs, pay them handsome sums to serve as a kind of digital consiglieri in charge of vetting new technology vendors and products.  Such is the power of these industry analysts, that when they recommend certain technologies or products, vendors typically rush to issue press releases touting the endorsement as though God himself had declared them a preferred IT supplier to heaven.

What’s less well known about these industry analysts is that many of them do a booming business in “sell side consulting” to the same vendors that they are supposedly objectively evaluating on behalf of CIOs.  If one is willing to write a large enough check, any vendor, be it a start-up or major corporation, can become of client of most these industry analysts.   As clients, vendors often get direct and frequent access to the same analysts that evaluate them.  These analysts not only provide advice on how the vendors might improve their products to make them more attractive to CIOs, but also give advice on competitive positioning and market trends.

Conflicted Advice
Clearly, this is a situation pregnant with a couple of major conflicts-of-interest including:

  1. Conflict with duty to provide objective advice to CIOs:  When evaluating vendors’ products, if some of those products are from vendors that are also paying clients, the analysts face an obvious conflict of interest: if they give their clients’ products a bad review, they risk losing their business.
  2. Competitive conflict:  Because of their demonstrated influence with technology buyers, many vendors give industry analysts highly detailed product presentations and disclose typically confidential information such as actual customer names, sales, and product road maps.  Should the analyst later find itself in the position of consulting to one of the vendor’s competitors they face another obvious conflict: how does one provide advice on competitive positioning and market trends without relying on, either directly or indirectly, the information that they were given under another premise by direct competitors.

If you ask the analyst firms themselves about these potential conflicts they are all likely to A) deny that they even exist or deny that they succumb to them B) point to various rules and regulations they have put in place to make sure that these conflicts do not “pollute” their core research processes.  Granted, there are some progressive analyst firms that tackle these conflicts in an open and straightforward manner but many firms seem to pretend that they don’t exist.

Pay to Play
On the flip side, ask any marketing director at a high-tech company these days and they are likely to tell you that they clearly perceive this space to be a “pay to play” opportunity.   From their perspective, if you are willing to pay, you have an exponentially better chance of getting favorably coverage and exposure from an industry analyst.  If you don’t pay, you might as well spend your energy elsewhere.

This is not such a big deal for large established technology firms as their marketing budgets are easily large enough to pay at least the minimum fees required by most industry analysts, but it is an incredibly difficult decision for a start-up that has precious little marketing dollars to begin with.

Many of these analyst firms aggressively solicit consulting business from startup firms because they know that startups in particular often need endorsements from respected third parties in order to help skeptical corporate buyers overcome some of their concerns about dealing with a young company.  Most of the firms are careful to avoid explicit “quid pro quos”, but the message from their salesmen is usually pretty clear: if you want get our attention you are going to have to pay us.

Prisoner’s Dilemma
This kind of soft blackmail is particularly galling for a startup when it refuses to “pay to play” but its competitors do not.  Invariably, a few months down the road a competitor is touting some luke warm endorsements of their products from the same “unbiased third party research” firm that hit up the startup and it’s clear the only reason the good ink is flowing is because the money is too.

As a case in point, I recently visited the website of a competitor to one of my venture investments.  Their website was touting in a press release that their product had been named a “cool technology” (whatever that is) by a respected industry analyst.  The same website also included a dead give away that they were paying that same analyst: there was a joint conference call upcoming between that analyst and the startup (something that is usually part of “the package” that vendors buy from these firms).   There was no disclosure of any kind of payments from the vendor to the analyst, but why should there be as such disclosures are not required.  (Of course there’s a chance this vendor is not paying the analyst, but I’d be willing to make a substantial wager that they are).

As a former Wall Street analyst, I actually have a lot of sympathy for the individual industry analysts that have to write these reports and deal with the conflicts of interest.  They face a very similar situation to what I faced when dealing with investment banking clients and having observed them interact with their salespeople in a couple of meetings I can see that many of them are uncomfortable with the assumed but unspoken benefits of paying their firms.

Disclosure Is A Beautiful Thing
That said, I also think that at a bare minimum these firms owe it to their corporate/CIO clients, to the press, and to themselves to clearly disclose in their reports and speeches when a vendor that they mention is actually a paying client.   Asking industry analysts to simply note when a vendor they mention also happens to be a client is not a huge imposition and it gives people a “heads up” that there’s at least the potential for a conflict of interest.    Wall Street analysts have been required to do this for years and it hasn’t proved to be a burden.

I don’t believe in more drastic regulatory steps because those are typically counterproductive and would likely reduce the quality of research over time (just look at Wall Street), but disclosure is simply more information, and more information is never a bad thing when it comes to research.  In the absence of such disclosure, I think that industry analysts are really running the risk of becoming Elliot Spitzer’s next victim, something which even Wall Street analysts would surely advise against.



Top 10 Warning Signs that Your Vendor Is Paying Off Industry Analysts

1.    They receive lame awards like “Cool Technology” or “Up and Coming” from Industry Analysts.
2.    They host conference calls with supposedly objective industry analysts
3.    They have a booth at an Industry analyst’s technology fair/conference.
4.    They are the only start-up in the magic quadrant.
5.    They prominently feature industry analyst logo on their website.
6.    They have written a glowing research report specifically on a start-up.

I stopped at 6 in the hopes that other folks could come with the final 4.  If you have a suggested “Top 10” reason please just create a comment below (or send me an e-mail) and let me know.  I will repost the completed Top 10 later.

June 4, 2005 | Permalink

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