1. The Pace of Innovation and Adoption is Frighteningly High across Digital Media Ecosystem
Massive consumer adoption across social and ecommerce is certainly helping new companies scale faster and cheaper. 2011 started what we think is an interesting phenomenon where companies start and hit reasonably large scale in the same year.  Take eCommerce for example. Wine flash sales business Lot18 is on track to do north of $20 million in revenue in its first year of business. And recently launched daily deal design site Fab.com is generating over $6 million in monthly sales just a few months after launch.

Consumers also continue to explore new, more focused social experiences. Foursquare continues to gain tremendous traction as a location driven network, despite comparable features embedded into a variety of experiences such as Facebook. Pinterest, a new interest based social network, gained all of its traction in 2011, growing users by over 40x in the last half of the year to become one of the most trafficked social networking sites on the Web. Innovation is also clearly moving beyond B2C. Categories such as payments, data sciences, and large end markets with large, traditional incumbents such as healthcare are seeing considerable influence from new technologies and models.

Square, an innovative alternative payments technology currently geared towards small businesses, launched in late 2010 and has already reached considerable adoption, activating over 800,000 merchants and processing well over $2 billion in payments on an annualized basis.  The Company completed a financing round in the summer of 2011 at a rumored value north of $1 billion, about six months after launching.

Nothing smells more of innovation than an accelerator program. In early 2011, Rock Health launched a seed accelerator for entrepreneurs building health-related startups and has since funded nearly 30 companies. 2012 should be interesting year for the healthcare industry, which is arguably the largest in the U.S, but has been relatively resistant to new software and business model led innovation.

We expect the pace to only increase and broaden out in 2012 as software and science led models continue to challenge incumbent models and barriers to creation and adoption disappear.

2. Mobile Goes Everywhere – Latest Battleground and Area of Innovation Across Large End Markets
2011 was a big year for mobile adoption. The investments made in the past five years in network, hardware and software began to bear fruit as consumer up take in smart phones and tablet devices grew substantially in the year.  Although consumer gaming continued to grow in scale on mobile, the attention has turned to how mobile will impact user behavior in the offline world.  2012 will be transformation year for mobile, led by heavy investment and focus from industry giants in digital (Google, Amazon, eBay), Payments (PayPal, Visa, Mastercard, Amex), Promotion (Coupons.com, WhaleShark), and Social (Facebook, Twitter, Yelp). Location driven user experiences as travel, entertainment, shopping should start to fundamentally change for us all in 2012.

3. Big Data gets Bigger
Data science was a key area of focus in 2011.  The scale of data being generated by enterprises today from both offline and online channels is staggering, opening up new opportunities for technology and expertise in turning data into actionable intelligence. In September, Opera Solutions raised $84 million from SilverLake Sumeru and others double down on the opportunity. And a few weeks ago, Mu Sigma raised $108 million from General Atlantic and others for a similarly positioned offering. A personal favorite, Urban Science, has brought data science to global automotive OEMs and dealers to help drive better marketing decisions and higher revenue.

Social data is also exploding on the Web, creating new opportunities and insights for a broad range of companies. Networked Insights raised $20 million in September to build out a marketing platform that relies to mining massive data sets of users and conversations to help brands determine how best to allocate advertising budget.  And companies like Recorded Future are mining thousands of social and editorial data sources to try to predict events for interests such as completive intelligence and financial trading applications.

If 2009–2011 was about gathering data and providing an analytic framework to view it, 2012 will be much more about deriving predictive insight from the data. We think that the data driven investment and M&A thesis should only get louder and more “verticalized” in 2012 as new data sources on the Web scale.

4. Traditional Industry Leaders Continue to Lose Their Way
Traditional industry leaders seem to continue to take a largely traditional, financial metric driven approach to investing in or acquiring new, digitally driven businesses. This strategy certainly didn’t pay dividends in 2011 as evidenced by the lack of significant M&A in the year. We believe that the M&A game in digital has permanently changed. Companies like Google, IBM and Adobe have developed an M&A strategy that is much more focused on team, technology, and long term vision than near term financial criteria.  And this has allowed these types of players to think of value very differently than traditional leaders.

Size and scale matters in M&A. And the new buyers are only getting stronger. The graph below illustrates the difficult situation traditional industry leaders face in the digital M&A market.

MICRO predictions for 2012

1. Changing of the Guard amongst the Internet “Titans” this Year.  Similar to the S&P 500, some companies go in and out of Internet Titan status and some stay in for the long haul.  2011 saw a few companies officially enter “Titan” status, most notably Facebook, Twitter, LinkedIn, Zynga, and Groupon. Yahoo and AOL both relinquished their status as they continue to find their way on the Web. Companies such as Google, Amazon, eBay and Amazon have and will remain long term residents in the category.  2012 should bring in a whole new wave of multi-billion businesses into the mix.

2. The M&A Buyer Landscape is in a “tweener” Stage, Creating Warning Signs for Digital Businesses.  A large gap is forming in the digital M&A market between long term strategic buyers (the “new buyers”) and financials driven, short term focused buyers (“traditional buyers”). New buyers consistently take a long term view on the business and team and are willing to apply multiples based on those views. New buyers fall into two camps: Large, highly strategic deal at scale. And small tuck-ins with an emphasis on cultural fit and technology.  On the flip side, traditional buyers have remained financially driven in their thought process and generally don’t have the appetite for larger ($100+ million) deals, irrespective of fit.  Small team driven deals aside, new buyers are only getting hungrier for strategic M&A opportunities that possess game changing characteristics and are clear leaders in their category. The bar is high, but valuations are exceptional for these businesses. Adobe acquiring Demdex and Google acquiring Admeld are just two examples. As it has become clear that traditional buyers can’t compete for those assets (due to size and value), a lower end of the range has formed based largely around metrics such as EBITDA.

Therein lies the challenge. Businesses that have raised north of $30 million of capital typically require somewhere in the range of $150 million to achieve a good outcome. If the business doesn’t develop a strong path to distinct leadership in a growth market, there likely won’t be a home for that company at attractive valuations. A middle ground alternative is currently not available in this M&A market. We expect this theme to play a greater role in funding and exit strategy in the digital sector in 2012.

3. AdTech will Experience a Breakthrough Year in 2012.  In 2011, we began to see companies break away from the pack. We see a continuation of that trend and expect to see three distinct tiers form this year. Tier one players will position themselves as viable niche competitors to Google and pursue M&A and growth capital aggressively during the year. Tier two companies will continue to pursue their niche and continue to chip away at growth and profitability. And tier three players will stall this year and aggressively seek strategic partners. In many cases, tier two companies have raised $30 million in capital and will face the dilemma outlined above. Some tier three companies are in the stage of deciding whether to sell or take significant capital to grow. We think an increasing number of them will decide to pursue the sale path. Some of those will represent good M&A opportunities.
In addition, as we predicted last year, we began to see some flexibility in doing private to private deals, typically a very challenging execution path to pursue. DDS/MediaBank and Tremor Media/ScanScout were two great examples during 2011. Our last prediction in this category is that we believe most traditional display ad networks will continue to lose momentum to emerging channels, technologies and buying methodologies in 2012.

4. Online Measurement takes Center Stage.  The lack of standards has been a limited factor for large brands allocating more $$ online.  Despite breadth of innovation in online advertising to date, last click attribution remains the default methodology for measurement today. Measurement and effectiveness will take on a greater priority in the media buying process in 2012 as a key enabler of brand budget growth.

5. High Stakes get Higher in Payments. There has been lots of noise from very large players around controlling the payment value chain in 2011 as well new disruptive models designed to work around the interchange infrastructure. Incumbents such as Visa have been active acquirers, purchasing companies in new fields like Playspan for virtual goods and Fundamo for mobile payments. We expect Mastercard and AMEX will follow suit in 2012, thinking more strategically about the role of payments in the quickly evolving landscape of local, social and mobile.

6. eCommerce and Content will be Largely Indistinguishable. Curated commerce has been a big theme online in 2011. Companies like OpenSky have proven the value of high quality content in generating purchase intent. Thrillist has proven a similar theory, that trusted content can be very additive to a consumers’ experience when purchasing goods. 2012 will bring a continuation of this theme across the Web.

7. Explosion of the Seed Investor is Altering the Investment Cycle for Early Stage Businesses. Certainly lots more deals, but has quality been impacted and is this phenomenon good for innovation? We won’t add fuel to the heated debate on this topic, but what we’ve certainly seen is confusion from the entrepreneurial community about the right funding and exit path to pursue. We think this only continues in 2012 as “digital” continues to draws entrants from other parts of the economy and as technology removes more and more barriers.

8. IBM’s Digital Marketing Strategy will become more Apparent with a Large Acquisition in the Online Advertising Sector. IBM has certainly been a potential entrant to the sector for some time. Their ambitions towards data driven industries is pretty clear at this point. We think the online ad space is maturing to a point where their role and opportunity is becoming apparent. The real question and excitement will be around how they play with Google.

9. Mobile M&A will Continue to Move across Digital Categories into 2012. 2010 was a seminal year for mobile M&A with large acquisitions such as Google/AdMob and Apple/Quattro. Focus in 2011 broadened out into areas such as location based services and payments. For example, eBay acquired both Where and Zong in 2011. We expect 2012 to be a big year for many areas of mobile such as location based services (both social and commerce) and payments as these technologies develop further and new players come into the M&A picture.

10. We will Continue to see More Innovative SaaS Business Models with Companies Growing up Faster and Achieving even Higher Sale Valuations. This trend is just beginning and it goes back to what we said in the beginning of the newsletter. Ditch the old business models and technologies. The SaaS “genie” isn’t going back into its bottle