(Source: Cambridge Associates LLC via TechCrunch; The crude annotations are mine.)

Ouch.

There are lots of problems with this 8.4% 10-year rolling average return for venture capitalists in the US.

The big one, of course, is that when VC returns head into the 8% range, institutional investors who might otherwise plow an obligatory 1% into VC firms to cover their “alternative” category, start looking for less risky investments with similar return profiles.

And if those institutional investors start to go away, you end up with smaller VC funds and a big gap develops in the middle of your investment cycle, as it did  from 2001 to 2003 – between the seed investors involved in early rounds and the larger, later-stage VCs, private equity funds and strategic industry investors who might participate in later rounds.

Of course, this should be a temporary problem: This is a rolling average and low returns can’t last for much longer, can they?

Or can they?

2010 is expected to be a year in which several technology company IPOs break the log-jam that has held up VC profits for the last couple of years and pushed the averages down dramatically.

But there is no repeat of 1998 and 1999 on the horizon, and those were years that contributed significantly to outsized VC returns, buoying up the 10-year rolling average. Until 2010, when those years rolled off.

Even if the returns head north again, they’re not going back to what they once were. And those were the returns that attracted the investors and built huge funds.

That leads to a larger question: Whither goeth the VC firm?

Whether the returns go back up a little or a lot, there has been serious discussion about the relevance of VC firms in the modern technology development cycle as the cost of software development, hardware development and manufacturing have plummeted.

Leaving things like pharma out of the discussion (but leaving a lot of biotech in the discussion), the way we innovate has changed and as a result the capital markets are gradually changing as well.

Low cost, agile short-run off-shore manufacturing, rapid prototyping options for everything from software to genemod, just-in-time digital supply chain management, crowd-sourced design and community syndication financing of new designs and products: They’re all starting to have an unforeseeable impact on the way new products and services come to market.

All of those trends mitigate towards lower costs to establish proof-of-concept and the ability for bad ideas to fail faster and for good ideas to succeed faster. That means less upfront capital required just to get products developed and into the market to discover whether the idea is good or bad.

Some commentators are taking this to the extreme and asking whether we really need venture capitalists anymore. Instead,  do a lot of businesses really just need seed investors and then strategic investors and acquirers at the exit?

I don’t buy most of this “no-VC” hype: Rapid prototyping and direct web sales from manufacturer to consumer doesn’t mean you don’t still need capital to do complex engineering and kick off large-scale manufacturing for most products or to buy television airtime for marketing.

But it does mean that if you can test ideas faster and spend less on development and less on establishing and eliminating costly failures, you can push the entire average cost to launch a successful new venture downwards. And that has important implications.

We need VC firms, but those rolling averages are real, and they’re hitting the firms that have invested in bloated ventures or have a bloated model. Those firms will transform or die.

The ones that will survive into the next fund-raising generation will be smaller and nimbler, putting more smarts and fewer dollars into ventures, and they will learn to source deal flow through new and very different means.

The evidence is already here: We’re seeing the emergence of contests, camps and accelerators focused on extremely low-cost, rapid venturing to get products to test markets at lightening speed.

Forward-thinking VCs are using seed investment programs, university partnerships, contests, laboratories, and incubators to participate in the changing innovation marketplace, where the distance from idea to product is ever shorter and success or failure is measured in the time it takes to count the re-tweets.

The firms that survive will be those that raise reasonable amounts of deployable cash, and are the smartest of the “smart money.” These are the firms that focus exclusively on areas where their executive leadership has depth and experience and can bring value to a limited number of investments in an increasingly structured manner and in an extremely short period of time.

In the end, smaller, smarter VC firms are a good thing, even if fewer dollars are definitely not. The higher the proportion of investment dollars that go towards ventures that ultimately produce a successful business, the more competitive our economy will become.

Today, India and China have taken the low-end manufacturing business away and are solidly chewing on the middle. And they’re doing it strategically: China is making investments now with plans to lead the world in solar and wind energy hardware manufacturing.

The only way for the US economy to stay competitive is through innovation, and we have to do it on fewer dollars and in fewer months than we had a decade ago. Not just because of the recession, but because that’s how the competition is gaining on us: They spend fewer dollars to deliver innovation and they’re doing it systematically.

It may be painful in the short term, but letting bad ideas fail faster and good ideas succeed faster, with fewer dollars spent to get the result, makes the innovation process a lot leaner. And that is exactly what we need right now to stay competitive.

But why did they buy it? This article from Information Today seems to analyze it pretty well:

Gale Reaches for More End Users With Questia Acquisition

A salient point from the article:

Barnes [Executive VP of Gale] says that HighBeam is doing very well, and with Questia, the services will reach some 30 million visitors per month. In addition to the synergies of HighBeam and Encyclopedia.com with Questia, Gale will look to integrate Questia with its AccessMyLibrary service (www.accessmylibrary.com), which connects users through web services to their local libraries for access to more than 30 million articles from premium sources. In December, Gale announced a free AccessMyLibrary mobile application for the iPhone.

For me, that is amazing. Even if I don’t remember who the author is, I’m instantly reminded with a quick glance at the Xobni pane, which sits on the right side of the typical Outlook layout.

How does it do that trick with the photos?

Simple: It checks social networks – FaceBook, LinkedIn, Twitter and many more – for their accounts based on their e-mail address and name, and can log into my accounts and allow me to instantly connect, friend and follow them, right from Outlook. You can also look up their company’s profile in Hoover’s.

This is social networking for the way we really work.

Additional features include a fast mail indexing and search engine, an instant view of threaded conversations as soon as you click on an e-mail, shared e-mails and recipients with the highlighted author, lists of files exchanged, links, and appointments with the author.

In addition, one of the unique and oft mentioned features of Xobni is the stats dashboard, which presents the frequency and times of e-mails received from a particular sender. This is only sometimes useful, but it can be insightful, especially when sending sales and marketing e-mails and trying to catch an important contact in the office.

Xobni basic is free and will only index a single mailbox. The Plus version is about $30 and is what I currently use. The upgrade was certainly worth it to be able to index all of my mail.

Xobni has also introduced a version that integrates with Salesforce and an enterprise version that allows for centralized deployment, management of features and the ability to install customizations.

The enterprise version is a recent addition and I look forward to seeing what integrations they add next.

I know in the past there has been speculation about why Microsoft hasn’t simply bought this company and integrated the features into Outlook. Frankly, it wouldn’t surprise me if they do, and then you’ll be able to get for free the product I just bought.

But I’m happy I’ve got it in the mean time and the price was right.

Xobni just makes finding conversations and identifying authors a lot faster and easier, which makes me more productive every day.

In fact, a good CEO is focused on the numbers, despite the drama involved in starting any new company. He or she will report the numbers to the investors, other executives, and in an “open books” company, to the whole staff, without really thinking about it.

They’re going to publish how much they’ve made at any particular point in time, how much they plan to make and how they plan to do it, especially if the plan has changed. And they’ll broadcast this intention over and over, until it becomes a reality. And if it isn’t painful sometimes, it isn’t real.

The content should change as the plan changes and the numbers change, but the instinct to broadcast should not.

For an investor, a good CEO cuts through the crap and tells you how much you’ve made, because he or she understands that this is, fundamentally, their only purpose in showing up in the morning. You can separate the good CEOs from the bad CEOs by this one trait, whether they’re running a public company, a private company or an early-stage start-up.

This is one of the big filters I use to evaluate executives, investments and start-ups: Is this organization or person focused on the vital numbers or are they focused on playing games?

You can’t do both.

I co-founded Questia Media in 1998 with Troy Williams and Justus Baird. We started the company in a studio apartment on the south side of Houston, Texas.

All three of us had been students at Rice University in the mid 90’s, had gone on to other things, and then come back to Houston to found Questia in late ‘98.

I haven’t been involved in the company in a long time, but it is nice to finally see it sold to a strategic acquirer that provides online tools for education, rather than the string of  financial investors who have been involved in most of the company’s history.

We started the company with a vision to “democratize access to knowledge” by making access to a high quality academic library universal. This is literally how we described what we were doing. It was our reason for existence and we worked around the clock.

It wasn’t a picnic, but we had a high-minded mission that we thought we could realistically achieve, and it was exciting.

There are a lot of stories involved in getting the company off the ground, but I’ll leave those for the book.

The short version is that we started off in a small apartment in south Houston with an old phone, a kitchen table and some computers bought out of my checking account. We used our credit cards for living expenses.

Troy started negotiating deals with publishers to get access to digitally re-publish their out-of-print books, I started writing the software to display and index the books while Justus started acquiring the books and hiring staff.

Within the first year of starting the company, we had caught the attention of Rod Canion, the founder of Compaq Computers, and his roving management team of ex-Compaq executives.

Canion and Co. made initial investments in the company to begin hiring staff. I picked up the initial investment check from his house one afternoon and we were off.

We rented an old house near Rice University, started hiring young dotCom folks, and the company exploded from there.

Olympia Ammon, one of our first employees and VP Publisher Relations, put up posters graphing the number of publishers who had signed deals with us.

I put up posters graphing the prototype software modules we’d finished developing. I kept a black marker handy to track our progress and wrote a lot of prototype code myself.

Eventually, I had a technical staff that involved about 60 people, half dedicated to internal digitization workflow and half dedicated to the online service.

Randy Dragon, the VP Technical Operations for Disney, was recruited to follow me as Chief Technical Officer when I left the company a couple of years later.

Over several years, the company raised around $160MM in capital to continue digitizing content.  It now provides access to 76,000 books, millions of articles, and citation and writing tools for tens of thousands of subscribers.

The company has survived two recessions, the eventual exit of all of the original founders, and many rounds of cut-backs and new capitalizations in order to continue developing the digital library.

While this wasn’t the IPO that everyone had in mind, it does help to guarantee that more than a decade of effort and investment aimed at building the world’s largest, most authoritative, and most copyright-compliant academic digital library is safeguarded and continued.

These are all right on target.

I always read this stuff and think, “Geez, I need to edit my websites…” That’s a definite sign of a useful post.

We are in the middle of an industry-wide revolution in the delivery of software, moving from desktop and client/server delivery to web-based Rich Internet Applications (RIA) delivered from the cloud. And our decisions in the last 60 days put us firmly in the middle of the latest wave of that revolution.

In November, we made the difficult decision to switch platforms for GEOINTELIS from ASP.NET AJAX (JavaScript) to Silverlight. This little episode might be informative for other Web 2.0 startups, and software developers generally.

(We haven’t written much about GEOINTELIS because it is in stealth mode. Yes, I know I just posted about how “Stealth mode doesn’t work.” I’ll post another one on “When does stealth mode work?”… Bear with me!)

This decision wasn’t easy, but it was necessary. Microsoft has announced that they’re ending development and new releases for the Bing Maps ASP.NET AJAX control in favor of the new Silverlight control. In fact, they’ve announced a whirlwind of changes in both their Bing Maps offering and their Silverlight controls over the last year.

The discontinuation of the old control won’t happen immediately, but it does mean that our current development path is ultimately a dead end.

Obviously, this happens periodically to anyone involved in software: Technology moves forward and platforms change.

We’d developed our previous product, ParcelExplorer, on the old control and were in the middle of developing our new product, GEOINTELIS, on the old control.

We could have continued using the old control. We considered launching with the old control because switching paths was going to throw our release deadlines into disarray. But we decided to switch.

We decided that it was worth the cost of switching not only because it ensures that we won’t have to re-develop in the future for the new platform, but also because our product gets a lot of advantages from using Silverlight.

What do we get from Silverlight 3? This is geeky, technical stuff, but worth a bit of explanation to explain the coming revolution in Rich Internet Applications and SaaS.

With Silverlight, there are two major advantages: 1) We get a lot more control over the user experience and presentation of the application; and 2) We reduce the number of potential points of failure and incompatibility between browsers in our application.

First, the User Experience (UX): Unlike AJAX, which is really just an adaptation of a wide range of existing browser-based functions (mostly dependent on whatever JavaScript parser your browser implements…), Silverlight is a whole mini-operating system that runs inside the browser, controlling server communication, most aspects of user interface design and layout, and all user input – like mouse button clicks and scroll-wheels.

This is a big deal. It allows us to deliver a more “desktop-like experience” for users. Hence the appellation “Rich Internet Application” for these kinds of applications.

We can deliver an experience similar to what users are familiar with in their installed desktop software. We achieve much greater control over the map interactions, location marking, pop-up dialogue boxes, right-click context menus, report and document generation, and a whole range of other things you just can’t control very easily from JavaScript.

Second, using Silverlight reduces the overall amount of JavaScript we’re required to manage, improving reliability and reducing the number of points of potential failure. Whenever you can reduce the amount of code you are managing, you reduce the chances for failure.

And by using Silverlight inside the browser, we eliminate the question of differences in JavaScript implementation almost entirely. We don’t have to develop different versions for different browsers. We can rely upon a single application to delivery a single, consistent experience for our users.

As an entrepreneur and technology executive, responsible for the whole enchilada, from product design and usability to ongoing support, maintenance and development costs, all of these capabilities make me smile.

And all of this discussion about Silverlight leads me to my point about the revolution: The emergence of web application frameworks like Silverlight and its competitors (Adobe’s Flash, Flex and AIR, Sun’s JavaFX, and Google’s Gears) makes it completely realistic to replace visually complex, interaction-intensive enterprise client/server and desktop applications with web-based on-demand services.

Adoption of these rich internet application frameworks is accelerating quickly. And Silverlight adoption has grown very fast.

(If you want to know more the future of RIAs, O’Reilly has a whole publication dedicated to tracking this emergence: InsideRIA)

And these desktop software replacements, being delivered to a web browser from the cloud, are inherently easier to manage, faster to deploy, less expensive for the middle market and much more efficiently delivered.

The revolutionary potential of software on-demand has been promised since the dawn of the Internet Age, but we’re finally starting to see some delivery on that promise.

As these RIA platforms become the norm and the development skills and tools proliferate, expect to see a lot more easy-to-use, technically powerful and visually compelling enterprise SaaS offerings in the near future.

There’s a lot of good stuff here and I’d encourage anyone developing a sales and marketing strategy for an enterprise software start up to read this. There are a ton of articles on software sales, but most of them don’t get the enterprise dynamics quite right. This one gets closer.

The items that stand out for me are items 5 and 6: Once you make an initial sale to an enterprise client, you do have to “move in” with the client and become essential to the operation. And, yes, selling new software takes a lot of “swagger.” Every start up organization needs that swagger in its enterprise sales staff.

The only important thing that I think gets consistently left out in many discussions of enterprise sales is the “project sponsor” dynamic, which we’ve found to be incredibly important. Your entire experience with a particular client is likely to be dependent on the strength or weakness of that relationship, and the rising or falling status of that sponsor within the organization. Your understanding of the organization, and their understanding of yours, comes through the lens of that sponsor. Tough, important stuff that deserves a post of its own.