Are the consumer web and enterprise splitting the VC herd?

Dave McClure, the highly successful Silicon Valley Angel/Micro VC investor, published a passionate post about the prosperous future for the consumer web, and criticised other investors for moving away from the sector.

McClure writes:

Recent articles by the WSJ, Fred Wilson, & others are noting a shift in investor interest to enterprise and away from consumer. If true, this is a huge error… at least for entrepreneurs, angels, and smaller funds. There is no better time than the present to build cheap & scalable software-based businesses that make money.

He points out that the business opportunities are far from over because of the simple fact that the Internet continues to grow at a fast pace and still has plenty of room to grow. After all, there are massive economic regions around the world that have yet to come online with the full suite of connection, payment systems, and physical infrastructure for e-commerce that we have in the US and Europe.

“IMHO most VCs switching from consumer to enterprise are clueless about why they’re doing so.”

Here is how I see it.

I’m a big fan of Dave McClure and his work with his 500 Startups incubator and I agree with him that there are still a lot of very good business opportunities in the consumer web sector.

However, I’m also increasingly focused on the enterprise IT sector because it’s a very good market for startups that know what they are doing.

Startups in the enterprise IT sector don’t come from the same stables as McClure’s 500 Startups, or Paul Graham’s Y Combinator. They aren’t filled with fresh graduates in their early 20s. The teams have experience and knowledge from having worked in the enterprise IT sector, and they know the pain points that corporations will pay to have solved.

The enterprise IT market is a $3 trillion global market. Corporations have money and large budgets. There’s still a lot of great enterprise businesses to be created.

McClure writes that it’s very cheap to start a consumer web company, which is true.

You won’t be able to seed enterprise startups for as little as $30K to $80k each, as YC and others do. Enterprise startups need far more capital because they need high value team members that know their jobs extremely well, because they have held high value jobs within enterprises.

Higher startup costs mean that fewer me-too companies are created and ruin the market for everyone.

I disagree with McClure when he claims that these days, it’s, “cheaper to acquire customers than ever before.” The noise level in consumer web sites is high and heading higher.

Setup costs for a consumer startup are low, and a top-ramen and dormitory lifestyle for your team keeps costs down, but marketing costs will increase tremendously.

Sure, some startups will get lucky and score some amazing viral effects that boost their growth at virtually no cost, but it’s unpredictable. Successful businesses have to be built on predictable processes. Startups will have to get serious about their marketing strategy and that means spending serious money.

We live in a free speech society and the more money you have the more free speech you can have. The more attention you buy, the better your chance for success, and the better you’ll obscure rivals, too. Marketing costs for consumer web startups will be higher in the future than they are today and that means more startup capital is needed.

Conversely, IT enterprise markets are far simpler, and it’s becoming easier to target potential customers — mainly because there’s not that many compared with the consumer space.

Social and media technologies are gradually bringing down high marketing costs in enterprise markets. This will accelerate as people learn to use increasingly sophisticated customer acquisition technologies.

Predictable revenues is another nice feature for enterprise IT companies. Once you become an approved vendor to a large corporation, it means steady revenues and a chance to improve them with additional services.

In the fickle consumer web space, you can go from hero to near zero, at a reverse hockey stick rate, for simply redesigning your page, as Digg did.

Since consumer web startups will need a lot more capital because of rising marketing costs, it’s easy to see why falling marketing costs in the enterprise space are looking good to investors.

Coming up: I have a profile of an excellent enterprise IT startup and a great example of the opportunities in enterprise markets. It’s easily the company of the year for me, and I meet with a lot of companies. Find out who it is later this week.