Big Blue's Johnny Appleseed

A lot of big technology companies operate venture capital arms--but the biggest of them all doesn't. When it comes to its investment strategy in start-ups and emerging technologies, IBM says it is adopting a different tack. Instead of making direct venture investments into young companies, IBM takes a more circuitous route by making selective investments through a fund-of-funds approach. During the past four years, IBM's Venture Capital Group has invested in more than 40 venture capital funds. It has a close working relationship with more than 80 VC firms, including Accel Partners and Walden International.

The group began just as the dot-com bubble was about to burst. The idea was to tap into innovation outside IBM's four walls. It's a strategy that's been paying dividends, according to Deborah Magid, who this year will help place more than $20 million of IBM's cash into funds that other venture capital firms control.

Magid, the director of the company's strategic alliances department, says both sides benefit from a symbiotic relationship: IBM provides cash and knowledge and can act as a sounding board for VCs and their portfolio companies. For their part, the VCs offer a looking glass into the latest trends and technologies because of the companies in their portfolios.

And some of these VC portfolio companies eventually end up becoming IBM business partners, which, as a group, has contributed a third of IBM's overall revenue.

We have invested directly into companies, but we rarely do it.

The $29 billion that IBM business partners generate includes revenue from products or sales that IBM did with one of its partners, as opposed to on its own.

Magid recently talked with CNET News.com about IBM's investment approach and how it fits with the company's wider business and technology strategy.

Q: Why did IBM's venture group decide to be an investor in venture capital funds, rather than make direct investments itself?
A: One of the things that was happening to us in the mid-'90s was that new companies would be born, and we would read about it in the papers later. But we'd never get a chance to be part of their infrastructure, because we were not part of the infrastructure decisions. It meant that we were kind of on the sidelines of the ecosystem, so if we wanted to be in the middle of it, we had to have a much tighter connection with what was happening.

Do you ask VCs to keep an eye out for the types of companies that would fall into a category IBM is particularly interested in?
If we are looking to fill a gap in our portfolio, we'll talk to the venture firms we know about finding a good match. They can help us make the connection and strategize about how we can grow the relationship. And one of the places where that works really well is when a company is still in stealth mode, or when it is just being formed.

What is IBM particularly interested in investing these days?
In a number of areas. Some of them are certain markets and technologies, and some are market segments. For instance, we are interested right now in the small to midsize business market. Other examples are more on the technology side.

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For instance, we still very much believe that Web services is a technology that will be important in the growth of IT over the next few years.

Are there certain segments within Web services that you are asking VCs to take a closer look at?
What we are really looking at now are more applications that take advantage of Web services to do something specific. So, if you can take technology like Web services, put it together with some insight about a particular type of business domain or industry domain, and get something new, then that's very interesting to us right now.

What other categories are you interested in?
We are interested in what is happening in the data center: things that automate computing, the allocation of computing resources--and the management of those resources.

Can you give me an example of a specific company for which IBM was a very early investor, and you received a substantial business relationship out of it?
Sure. There was a company called Cyanea Systems, which we met before it had shipped a product. It was in the early stages of testing and had some prototypes running that we looked at. It monitors the health of running applications--from the application view down into the systems environment. One of Cyanea's founders had worked at Charles Schwab and knew a lot about how complex and difficult that problem was. He spent some time thinking about how to address troubleshooting, monitoring and tracking running applications.

This was very important to our WebSphere business, because WebSphere is an application server and manages heavy transaction loads. So, the ability to get a view into the applications--as they were running on top of this environment--was very attractive. We worked with the company, while they were piloting and testing their software, and helped integrate it into our own environment. Now, we are able to go to market together, with Cyanea as a business partner and with a much stronger offering.

If a VC firm does not really want to participate in a third or fourth round of funding in a company that you want to continue to support, will IBM make a direct investment, or will it find another VC firm willing to take that step?
We have invested directly into companies, but we rarely do it. If a business executive felt that it was important for the development of an IBM strategy, then it might be done. But that decision would not be made by the same group that makes the investments in VC funds.

I can only think of one case--a couple of years ago--in which a young company was producing something that we clearly knew we needed, but it was not something we wanted to own at the time. We wanted it to become a successful business partner, so we put a little bit of money directly into the company to cement the relationship and show that we were behind it. We wanted to help it be successful, but, as I said, that was really not our typical model.