Identify a Large and Growing Market

Neustar was a 1999 start-up that grew in a few years into one of the dominant communications data services providers in the United States and Canada, because it provides indispensable telecommunications services to industry and consumers. It offers many services, but its foundation service is to allow telephone subscribers (wired and wireless) to keep their phone numbers when they change service providers. Anyone switching from Verizon to AT&T, for example, can keep the same phone number, thanks to the Neustar service.

Just knowing that this need existed for tens of millions of consumers should have made any great entrepreneur take notice. Switching numbers was a major pain point. And even more exciting, the federal government mandated in 1996 that carriers had to offer this service.

Neustar built the business to serve that need. Today, it manages the network (and database) that automatically routes a telephone call to the right carrier and the right destination. This service is offered on multiyear contracts with the carriers, at prices set at contract signing. Neustar has been the sole provider of this service in the United States and Canada, but the contract is subject to potential competition because it is periodically renewed. In 2014, it produced, with other services, annual revenues nearing $1 billion and had a New York Stock Exchange value in excess of $1 billion.

The story of Neustar shows the importance of developing a good value proposition that forms the basis of a new business and guides its development. The value proposition can be simple, but it provides a guideline for defining what a new business should offer and why it will be valuable and hopefully world changing.

The vision that guided Jeff Ganek, founder of Neustar, was the conviction that a company could generate enormous business value by controlling and monetizing proprietary and comprehensive data that enables data and telephone communications. His vision—that this data was the source of the value of the company—stood in contrast to the business model of the industry at that time, which was to own the hardware that controlled infrastructure. Today, the vision that data is of tremendous value is well understood, and data is monetized in thousands of companies.

Ganek became convinced that no matter how the industry might change as it moved from analog to digital technologies, telephone numbers and associated information would be extremely valuable because they were key to reaching most people and businesses. He was also convinced that despite the boom in digital communications and the explosive impact of the internet on data traffic, new ventures had to avoid becoming dependent on expensive infrastructure hardware for their revenues.

Ganek had deep experience in the industry—and this is a major point for any entrepreneur. If you or your leadership team members don’t have experience in the industry you’re targeting, you are deeply at risk. No amount of talking to customers will give you sufficient knowledge to learn the intricacies of a complicated ecosystem. Think of this ecosystem as a jungle. Would you embark into the jungle without intimate knowledge of the pitfalls you might encounter? You wouldn’t survive very long.

Ganek’s experience in the industry conditioned his thinking. He started his career in marketing at MCI, the first company founded to bypass the AT&T monopoly by providing interconnections using microwave links rather than cable. At MCI Ganek got an education in the financial perils of the communications industry because of its capital intensity, particularly as it meant competing with big players.

Being entrepreneurial and realizing that the industry was opening up because of new technologies and government action, he considered a number of possible ventures, including providing private communication services by leveraging satellite communications. In fact, Ganek approached Warburg Pincus with a venture idea in 1995. We discussed it but concluded that the prospects for profitable operations in such a service were low because of emerging competition from big companies. But we parted friends. The value proposition just wasn’t there. Not finding an opportunity for a new company, Ganek left MCI and joined a new division of Lockheed Martin that developed services leveraging its communications infrastructure.

Identify the Right Differentiated Technology

Looking for a new business to manage within Lockheed Martin, Ganek became aware of the number portability mandate in 1996. He immediately thought that it presented an interesting business opportunity that Lockheed Martin should exploit, because it had the resources to complete and manage such a project. But he needed to find the right technology to prepare a contract bid solicited by the regional Bell operating companies (RBOCs) to provide the number portability service. And he needed to find the right technical expert. He found Mark Foster, a brilliant engineer who had consulted with the RBOCs on number portability. Ganek convinced Foster to work with him to prepare a bid in competition with other bidders, such as IBM.

Ganek and his team would need to address major problems to provide the service. The RBOCs did not have systems in place to automate the switchover. Business processes and technical infrastructure, such as billing and call routing information, had to be transferred manually, a process that promised to be fraught with delays and errors. To make up for this deficiency, the contract bidders had to guarantee that the infrastructure for enabling local number portability would become the responsibility of one or more independent companies. These companies would be selected with clear mandates as “neutral” service providers.

Under Ganek’s leadership, Lockheed Martin won one of two contracts awarded by the US telecommunications industry under the aegis of the Federal Communications Commission (FCC). The contract was to design and manage the necessary technology for number portability. Each winner was assigned a section of the United States to manage and demonstrate that it could meet the industry need.

Build a Team with Domain Experience

Thanks to the architecture designed by Mark Foster, only Ganek’s team was able to demonstrate a working, though still imperfect, prototype. It ended up displacing the other contract winner, and Lockheed Martin became the sole provider.

But as a result of the dynamic market, Lockheed Martin eventually had to divest itself of the contract. The company was moving into satellite communications services, and such a business would violate the FCC-mandated requirement that the operator of the number portability service not be in the communications business; only a neutral entity could offer and manage the service. Hence, Lockheed Martin had no choice but to divest itself of the project, and that created our investment opportunity. Lockheed Martin was not giving away the team and the contract. It had invested millions and expected to be paid back, and even get some upside if the program was eventually financially viable.

Develop a Compelling Value Proposition and Business Plan

Ganek became convinced that the contract could be the basis of a great new company with a clear value proposition and business plan. The number portability service was going to be hugely popular, because it freed consumers from the tyranny of a sole provider; you could now switch painlessly from one service to another while keeping the same phone number. Furthermore, the business model was based on a small guaranteed payment that was largely invisible to the consumer. In addition, as the sole provider, the new company was initially shielded from competition, while at the same time it could leverage its infrastructure to offer other telecommunications services.

However, Ganek knew that he needed to find the right investor, one who had the understanding and capital to fund such a venture. It would not be cheap to build the new company, particularly because Lockheed Martin wanted to recoup its multimillion-dollar cost.

Find the Right Investor and Board Members

Lockheed Martin mandated that Ganek find an investor that had the financial capability to continue the program by buying the team and contract. He approached Warburg Pincus (and Henry) with the proposal. Working with Joe Landy and Bilge Ogut, we became convinced that number portability represented a great opportunity whose technical risks were justified. In effect we agreed with Ganek’s thesis. The team negotiated a sale price with Lockheed Martin and received approval from the industry groups and the FCC, in a process that took nearly one year. So in 1999, Neustar was born, with Ganek as CEO and Mark Foster as CTO. An effective board of directors was selected consisting of experienced people with business and technical experience in the telecommunications industries, including knowledge of regulatory matters, as well as the investors.

Our investment thesis recognized that Neustar would be in the enviable position of sitting at the center of intercarrier communications in the United States and Canada. We believed it could eventually offer additional services, either internally developed or through acquisitions, that leveraged its exclusive infrastructure. At the time of the investment, however, we did not know what those services might be.

But if the upside potential was good, the risks were significant.

• It would take large investments in software and hardware to enable the service.
• There was no guarantee that enough phone numbers would be ported to ensure profitable operation or a good return on investment.
• Neustar could lose its contract exclusivity if its performance did not meet the industry’s stringent requirements.
• Although pricing was agreed upon, the company’s profitability was not guaranteed by the industry.

In today’s world, very few venture capitalists would fund such a capital-intensive venture. Most investors now seek potential for high return with relatively low investment, and that’s why the software industry has been a primary source for investment. Only top-tier investors would even consider an investment requiring large amounts of capital, because they alone would have the resources, experience, and confidence to consider such large and risky investments in early-stage companies.

Build the Organization and Execute

Neustar had an exclusive contract for a certain number of years that would allow it to establish itself, but only if it executed as needed. The core team transferring from Lockheed Martin included the necessary talent. But to meet the tight requirements set by the industry, Neustar had to hire many additional people, something that challenged its start-up budget.

The company had developed its technology to the point where we were able to formulate a credible business plan. Pricing for services, based on the number of phone numbers ported, had been negotiated for the full term of the initial contract.

But after the company closed on our investment at the end of 1999, we found that the investment needed to complete the technology to the required level of quality was higher than anticipated. Time was our enemy, because the terms of the contract were clear and very challenging. Neustar could not build revenues until the contract terms were met. The company was also fighting time in rolling out new services before competitors using other technologies. However, after the technology was in place, revenues ended up exceeding our expectations.

Manage Success at the Crossover Stage

Because Neustar was launched on the basis of a single contract, there was always the risk of its loss in the future. Hence, we needed to broaden our offerings as fast as possible. Because of the excellence of the team and the value of the core technology, Neustar added new data services that leveraged the existing platform and increased revenue; soon, number portability was only half of the revenues.

As we added services, we recruited new talent to ensure we were offering the proper level of service. This policy was consistent with our belief that the company’s value would increase as we expanded our offerings. The original thesis of the value of data continued to play out: managing essential data in a growth industry can produce a highly profitable business, because it is largely shielded from price competition. As the database and customer base grow, the value of the data continues to increase.

The fact that Ganek had selected the right investor became clear to the management team, because during the first two years (2000–2002), Neustar required an investment of $70 million to finance its operations, while its revenues rose from $68 million to $92 million. But by 2004 the company’s revenues had grown to $165 million, with a profit of $45 million. Infrastructure investments were complete, and the annual volume of numbers being ported was rising rapidly, aided by a 2003 FCC mandate for portability of wireless numbers, as we had anticipated.

With a solid business and excellent management, Neustar was ready for its initial public offering. We selected the New York Stock Exchange with an offering in June 2005.

In 2006, Warburg Pincus exited the investment. Neustar was valued at $2.4 billion in mid-2006. On the initial investment of $77 million, Warburg Pincus received $1.24 billion for its stock, representing an internal rate of return of 56 percent over the 6.3 years of the investment.

Ensure the Future by Maintaining Innovation

Over time Neustar added excellent managers and technologists, and innovation became a driving force. Synergistic acquisitions were made to broaden the offered services. What started as a new communications network to process the routing of telephone calls transitioned to support many other applications, including bypassing telephone switches made inoperable by disasters such as 9/11, which destroyed the switches in downtown Manhattan.

Neustar has revolutionized a major part of the telephony system in the United States and Canada and is a stellar example of the kind of venture we highlight in this book.

Stories of successful ventures are fine as proof of concept, but aren’t in themselves very helpful to the entrepreneur. In the next chapter, we explain how to discover breakthrough venture opportunities.