In March of this year, venerable Silicon Valley VC firm Kleiner Perkins Caufield & Byers announced it had ‘earmarked’ $100m (€64.2m) for worldwide investment in companies being created on Apple’s iPhone/iPod touch platform. The iFund is a partnership between KPCB and Apple, which will provide the firm with ‘market insight and support’.

KPCB is one among several VC firms tying up with platform providers, including the UK’s Eden Ventures and Salesforce.com with their Million Pound Challenge for companies developing on Salesforce.com’s Force.com platform; and Accel Partners, The Founders Fund and Facebook with their fbFund for Facebook application developers.

Investor interest in new platforms is understandable. As KPCB Partner John Doerr writes on the fund’s website, ‘A revolutionary new platform is a rare and prized opportunity for entrepreneurs, and that’s exactly what Apple has created with the iPhone and iPod touch… we think several new significant companies will emerge as this new platform evolves’.

In introducing AppFactory, their independent initiative to fund Facebook app developers, Bay Partners – another well-established Silicon Valley VC firm – make a similar point: ‘Facebook, in essence, became the social Operating System. Historically, the creation of an operating system, or platform, has led to a new economy which includes a marketplace of applications’.

It is also clearly in the interest of platform providers themselves to encourage development on their platform. This is the reason why Microsoft, Sun, Qualcomm, Nokia, Oracle and others run extensive partner programmes. Furthermore, platform providers often put their own money down to encourage early adoption of their platforms.

For example, Google Gadget Ventures is making $5,000 (€3,200) grants to Google Gadget developers worldwide, with the chance for winners to receive further seed investment of $100k (€64k) from Google. In Autumn 2007 Amazon.com ran the Amazon Web Services Start-Up Challenge to encourage development on top of its utility computing platform, which offers startups on-demand computing, storage and other facilities. The winner of the challenge received $50k (€32k) in cash, $50k in Amazon Web Services credits and an investment offer from Amazon.

For platform providers, spending cash on grants and seed investments to yield greater platform adoption is understandable. What is more difficult to understand is why VCs would put their own money on the line in these exercises. To generate returns VCs seek out the highest-potential startups – so why restrict prospects to just a narrow slice of the startup universe?

fbFund works much like Google Gadget Ventures, providing grants of $25k (€16k) to $250k (€160k) to Facebook application developers; however, the $10m (€6.4m) investment pool comes not from Facebook but from Accel Partners and The Founders Fund. The grants are open to companies globally so long as they have not already received VC funding; in return for the grants, Accel and Founders Fund receive right of first refusal for VC investment in the winning companies.

Eden Ventures’ challenge is set up as a competition rather than a fund; entries from UK and Irish entrepreneurs must be submitted by 7 July 2008 and the winner will have the chance to negotiate with Eden Ventures for an investment up to £1m (€1.3m) in exchange for at least a 20% equity stake.

Apple, Facebook and Salesforce.com are assisting KPCB, Accel & Founders Fund and Eden Ventures, respectively, with their investment screening processes. This suggests one reason for the creation of such vehicles on the part of VCs. The strategic insight offered by the platform provider coupled with “official endorsement” during the early stages of an emerging platform may be enough to counteract the downside of tying up funds for such a narrow purpose.

Furthermore, in the case of fbFund, Accel Partners and The Founders Fund are investors in Facebook itself - so they stand to benefit should the fbFund encourage overall adoption of Facebook’s developer platform, regardless of whether or not individual grantees succeed.

Two questions linger, though. The first is whether there are enough quality businesses being built atop these new platforms to warrant so much investment interest. fbFund, for instance, rejected all applicants from its first round of submissions in January 2008.

The second question is whether platform-specific funds are necessary or even advantageous for making investments into the most compelling startups developing on those platforms. Take the case of Camrivox, a Cambridge-based startup developing on Salesforce.com’s Force.com platform. The company’s products allow businesses to integrate their telephone equipment with Salesforce.com, so that when a call from a customer or sales prospect comes in their record will be automatically displayed on screen. Before Eden Ventures and Salesforce.com were taking submissions for their £1 million challenge, Camrivox had already raised £2.5m (€3.5m) in VC funding from CREATE Partners, Cambridge Capital Group, NESTA Ventures, IQ Capital Partners and others.

Throughout the current Web 2.0 boom, Microsoft and Yahoo! – joined by Google, TimeWarner’s AOL and News Corp - have driven the Internet M&A market and provided exits for numerous VCs and entrepreneurs. This weekend, however, Microsoft withdrew its largest-ever acquisition bid - for Yahoo! itself.

The saga may not yet be finished, since Microsoft could renew its bid after Yahoo!’s share price deteriorates and after disgruntled investors pressure the company’s management (Yahoo!’s top two institutional shareholders are already publicly fuming about the botched deal). Whether the Microsoft/Yahoo! merger is realised or not, one thing is clear: the discussion has sidelined two major acquirers of Internet startups.

Microsoft has been an extremely active acquirer on both sides of the Atlantic, purchasing European Internet startups such as Israel’s Kidaro, Norwegian enterprise search company FAST, The UK’s Multimap, and French mobile search company MotionBridge. Yahoo! has played an insignificant role in European Internet M&A to date, but is a key player in the US.

A platform business at heart

There is now press and analyst speculation that the nearly $50 billion (€32.2 billion) which Microsoft was prepared to pay for Yahoo! will go instead towards other acquisitions. The most commonly cited target is AOL, which TimeWarner appears willing to offload and which would provide the nearest approximation of the scale in the online advertising business that a merger with Yahoo! would have achieved. Yet smaller businesses have also seen their names thrown into the discussion: PaidContent suggests that online services like Facebook, Twitter or Digg are now possible acquisition targets for Microsoft.

These latter options are unlikely, because at its heart Microsoft is a platform business, not a content business. Like other technology platform businesses, from Oracle to Qualcomm, Microsoft’s business model is to ensure the dominance of its own software by making that software an essential part of other developers’ business models. This holds true not only for Microsoft’s Windows and Xbox platforms, but also for the company’s online advertising network, which is only as successful as the money publishers make using it.

Microsoft has clear ambitions to challenge Google as an online advertising network, and though Yahoo! would also have given Microsoft the US’s most popular web portal - Yahoo! web properties are more visited than Google’s in that country - the main driver for the proposed acquisition was for Microsoft to quickly build substantial scale in the online advertising business. Microsoft’s largest acquisition to date, the $6 billion (€3.9 billion) purchase of online advertising firm aQuantive in May 2007, provided Microsoft with a foothold but left the company with nowhere near the market share of Google, Yahoo! or AOL in either search or display advertising.

Furthermore, Microsoft has already tried smaller acquisitions in the space. Besides aQuantive, Microsoft acquired a slate of advertising companies over the past two years, including Israel’s YaData; the US’s AdECN, Massive and DeepMetrix; and France’s ScreenTonic. Yet what Microsoft needs now is scale, and Yahoo! and AOL are the only two players who can provide it.

Yahoo! preoccupied

As for Yahoo!, the potential merger has imperiled the company’s status as a major Internet acquirer. Firstly, Yahoo!’s engineering culture, reinvigorated 3 years ago through a series of critical acquisitions including del.icio.us and Flickr, has been crucial to the success of its more recent acquisitions. That culture is now at risk; as Om Malik points out, morale is undoubtedly low at Yahoo!, which will make retention of key employees a problem. Despite holding $2.61 billion (€1.68 billion) in the bank, Yahoo! will face inevitable challenges and potentially lawsuits from investors over the handling of the Microsoft offer, making immediate acquisitions difficult.

The silver lining is that neither a combined Microsoft/Yahoo!, a combined Microsoft/AOL or an independent Yahoo! are truly a match for Google’s online advertising business, particularly in search advertising. Any of those combinations would still necessitate the roll-up of additional online advertising networks, such as Germany’s Adconion Media Group, as well as the acquisition of innovative providers of advertising technology, such as Israel’s Kontera Technologies or Luxembourg’s wunderLOOP. Though neither Microsoft nor Yahoo! are likely to pursue smaller acquisitions in the short term, given time either could re-emerge as a buyer for European Internet startups.

Audience measurement is a critical component of the advertising ecosystem. Advertisers want to know who they are reaching when they buy advertisements, regardless of the medium. Those selling advertising space or time do not always themselves know how many users are listening or viewing. In broadcast media, such as radio and terrestrial television, the broadcaster has no way of knowing how many people are tuning into a signal once it is beamed out.

One company dominates the field of audience measurement: Nielsen. The company began measuring US radio and television audiences in the 1940s and 1950s; US advertisers still rely on the company’s metrics. Nielsen has a strong presence even in countries where audience measurement is overseen by industry bodies, such as the UK. In that country, TV ratings are managed by the Broadcasters’ Audience Research Board Ltd. (BARB), a non-profit organisation owned by a group of UK broadcasters and by the Institute of Practitioners in Advertising, an ad industry trade group. BARB contracts with several third-party research firms to perform the actual audience measurement, however. Chief among them is Nielsen, which handles ‘metering’ (measurement), data collection and data processing for BARB.

The techniques used for measuring television audiences have changed little since 1950; in some American TV markets, Nielsen’s only available data comes from paper diaries in which participants log their weekly viewing. In mid-size and large TV markets, Nielsen also uses metering technology which automatically records which station a family is viewing and in some instances who within a household is watching. Nielsen has used both paper diaries and electronic metering for decades.

The introduction of new digital mediums, such as the world wide web and mobile phones, has presented a new set of challenges for audience measurement. Nielsen has responded through a series of acquisitions, buying startups which fill gaps in its offerings. The Nielsen Online division, which tracks Internet traffic and audience behaviour, was built on the back of two of Nielsen’s acquisitions: NetRatings and BuzzMetrics. Nielsen acquired majority interests in both companies during 2006 and bought the remainder of both in 2007. BuzzMetrics tracks online discussion on blogs and message boards, while NetRatings measures online audiences. BuzzMetrics itself was formed through a series of mergers involving Israeli startup Trendum and US startups Intelliseek and BuzzMetrics.

Last summer Nielsen acquired Telephia, a San Francisco-based startup that measures the reach of mobile content, for example the number of mobile games users download or how often mobile users surf the web on their phones. Nielsen launched its Nielsen Mobile division shortly before the acquisition, and Telephia became the core of that division. Nielsen’s acquisitions continue: just yesterday the company announced the acquisition of Audience Analytics, whose software will help Nielsen measure interactive TV and video-on-demand usage on digital set-top boxes.

Which companies might pop up on Nielsen’s M&A radar in the future? Startups continue to proliferate in the audience measurement space. Last week UK-based Magpie raised €670,000 to continue development of its Brandwatch platform, which like BuzzMetrics tracks users commentary on blogs and forums. Several other startups are focusing on tracking audience behaviour in social networks: Xtract, which analyses links between users; Peanut Labs, which runs market research surveys over social networks; and Invite Media, which tracks advertising in social networks.

US-based Mochi Media has developed a metering tool for Adobe Flash files, which complements the company’s primary business as an online advertising network for casual games sites, as Flash is a popular platform for casual games development. Visible Measures, another US startup, measures the audience for online video. Last month the company raised €9.2 million from General Catalyst Partners and Mohr Davidow Ventures.

Nielsen is not the only potential acquirer of audience measurement startups, nor are trade sales the only possible exit for these companies. comScore, a venture capital-backed rival of Nielsen in the internet analytics business, floated last year on NASDAQ. comScore is much smaller than Nielsen, but has close to $100 million (€68 million) in cash on hand and a history of its own acquisitions, from market research firms Q2 Brand Intelligence and SurveySite (acquired in 2004 and 2005, respectively) to the purchase of Jupiter Media Metrix’s assets in 2002, making it a possible acquirer. Lastly, despite Nielsen’s overall size, that company does not yet dominate audience measurement for digital media. As comScore itself proves, there is still room for sizeable, independent rivals to Nielsen; perhaps a company from this latest crop of startups will be one of them.

Library House’s recently-released Q4 2007 Quarterly Briefing showed the quarter to have been a weak one for VC investment across Europe, with the lowest amount invested of any quarter in the past two years. That weakness was even more apparent in the Mediatech sector, where investment dropped a precipitous 52% between Q3 and Q4 2007. Just €121 million of VC money was invested into European Mediatech companies in the period, a stark contrast to the two-year high of €252 million euros in Q3 2007 (see Figure).

The fall in Mediatech investment in Q4 is surprising given Mediatech’s strong showing during the first three quarters of the year. Mediatech investment during Q1-Q3 2007 was up 17% on the same period during 2006. Yet Q4 was so weak that full-year Mediatech investment totals actually fell 0.9% from 2006 to 2007.

The decline in Mediatech investment in Q4 2007 was almost entirely due to shrinking investment into Content and Service (C&S) Providers – a reversal of the first three quarters of 2007. Investment into C&S Providers from Q1-Q3 2007 totaled €372 million euros, up 72% from the same period in 2006. Yet from Q3 to Q4 2007, investment into C&S providers plummeted from €173 million to €49 million – a decline of 72%.

Investment trends within the Video sub-sector are a microcosm of the wider rise and decline of C&S Providers during 2007. In Q2 and Q3 2007, Video startups pulled in several large financing rounds: Joost raised €33.2 million and VideoJug raised €22 million in Q2; and Dailymotion and Metacafe picked up €24.9 and €22.3 million respectively in Q3. In Q4 2007, however, the biggest disclosed European Video deal was RayV, a Joost competitor which received a modest €£5.7 million from Accel Partners.

One bright spot amongst Content and Service Providers which could see more attention in 2008 is Search & Directory. Investment into this sub-sector rose 211% between 2006 and 2007, buoyed by both vertical and general search engines. Some major VC deals in 2007 involving vertical search engines include: residential search engines Properazzi and Zoomf.com (from Spain and the UK respectively); German gaming search engine Wazap!; and French Enterprise search engine Exalead. 2007 also saw the funding of generalist search engines with a unique spin, such as Russia’s Quintura, which presents search results as a visual tag cloud; and the UK’s True Knowledge, whose software answers natural language queries for facts and information.

Advertising in and around video games is a growing business. The 14 in-game advertising companies Library House tracks have raised nearly $250 million in disclosed venture financing, and Yahoo!, Google and Microsoft have each acquired a startup in the space. The opportunities and challenges faced by these startups vary substantially based on what type of games and which platforms they target. The three major categories of in-game advertising are as follows:

Console and hardcore PC games
The most radical innovation in video game advertising involves inserting ads directly into the 3D worlds of today’s console and PC titles. Realistic titles such as Atari’s “Test Drive” are set in contemporary environments, where gamers would expect to encounter real advertising.

Working with publishers to insert advertising opportunities into such titles requires heavy lifting on the startup’s behalf, both from a business and from a technology perspective, so companies in this sub-group of in-game advertising companies have raised the largest amount of venture funding per company.

Massive, a pioneer in the space, raised $17.6 million before its 2006 trade sale to Microsoft, which was reported to have been worth between $200 and $400 million. Rivals Double Fusion and IGA Worldwide have each raised over $40 million in venture capital to build out their networks.

Those networks are live and reaching gamers: IGA Worldwide, which serves ads into over 50 games such as Electronic Arts’ first-person shooter “Battlefield 2142,” is serving 100 million ad impressions to over 1 million gamers per week.

Despite this, advertising has not yet made a substantial contribution to game publishers’ turnover. In the quarter ending 30 September 2006, for example, EA earned $5 million from in-game advertising – less than 1% of its total quarterly revenue.

The video games industry has high expectations for in-game advertising, however. During that quarter’s earnings conference call, EA’s CEO John Riccitiello said, “I really think when it comes to in-game advertising, the way to think about it is it will be some day a great business. It is not today. Most people involved in the business are investing spending to establish position and it’s just currently not at all at scale.”

Casual PC games
A fast-growing segment of the video games market is casual gaming. The Casual Games Association estimates that 200 million each month play casual games like PopCap’s “Bejeweled” and PlayFirst’s “Diner Dash” online. The model varies substantially from console titles, which attract a younger demographic and a smaller audience (there is a next-generation console install base of only 46 million worldwide, according to VG Chartz).

Real Networks’ RealArcade casual games service, for instance, reaches an audience that is over two-thirds female, with 80% between the ages of 35 and 64. The company operates a hybrid model, where users can trial any game for free – with advertising – but must pay a monthly fee to download games for unlimited play.

Other games services are entirely ad-funded, such as Kongregate. Game developers upload games to the site in the same way that users upload videos to YouTube, and Kongregate shares the revenue from ads shown to its 1.3 million monthly visitors with developers.

Advertising in casual games typically surrounds the game or is run before or after gameplay. In either case, serving ads onto games sites does not require the complex integration performed by console and hardcore PC in-game advertising firms. Startups addressing the casual games advertising market therefore function more like standard online ad networks. Some examples of casual game ad networks are San Francisco-based Mochi Media and Silicon Valley-based NeoEdge Networks. Google purchased AdScape, another San Francisco firm, in Q1 2007.

Mobile games
Gaming on mobile phones is at an earlier stage of its evolution than either console or PC gaming, but already publishers and mobile operators are bringing advertising into the picture, hoping that advertiser-subsidised gaming will allow mobile games to reach a wider audience. Despite substantial improvements in game quality over the last 3 years, mobile gaming has failed to crack the mass-market, even as interest in other mobile data services - particularly the mobile web - is surging.

London’s Amobee and San Francisco-based Greystripe are competing to provide the technology to wrap ads around mobile games. This is no simple feat, since games publishers produce hundreds of variants for each mobile game title in order for their games to run on as wide a range of mobile phones as possible. In building their networks out, Amobee has placed a high priority on mobile operator engagements, and received investment from Vodafone and Telefonica last November. Greystripe, meanwhile, is pushing its own free mobile games portal, called GameJump, and has struck several deals with high-profile mobile games publishers such as Digital Chocolate, Vivendi and Hands On Mobile.