Umair Haque should charge admission for his thoughts, but I disagree with a recent post where he takes a solid left and sanctified right on venture capital. Charlie O’Donnell has a shorter response than mine. Umair implies that vcs are ignoring risky business plans. Either that or he is suggesting the impossible - for venture capitalists to wait for the plans that create new industries. Don't invest otherwise. Be even more selective and boycott today's entrepreneurs.
Why are venture investors failing to seed new industries and markets? : Where one pioneer invests, a slew of imitators follow, and so tremendous amounts of cash are poured into the same business design or market space - ad exchanges, social networks, and blogging/vlogging platforms to name just a few recent fads. Why does President-elect Obama have to invest a likely trillion dollars to renew, well, pretty much the entire industrial base of the economy - to seed new auto, energy healthcare, education, finance, and agricultural industries (to name just a few)? Because today’s crop of apathetic, risk-averse venture investors didn’t.
Umair's logic implies venture capitalists are choosing an investment over another because it has less market risk. Venture investors don't accumulate 20 or so deals and then at year's end choose the less risky ten. More business plans are rejected due to small addressable market and too much competition rather than big idea PowerPoint risks. Vcs have immense faith in the powers of sales and marketing.
Vcs are investing in incremental innovation for a reason; it's produced strong returns. It is tough to doubt incremental innovation when you see transistor per chip count move from 5k to 700M+. People thought vcs were doomed in the early 90s, but what followed was strong vintage returns. Some people are looking at the massive amount of commercial success that fed off the transistor and concluding there is nothing out there now which could fuel comparable change. The R&D of the internet started before we got the c in vc in '79. Note, most industry creation has come from military R&D which is considerably smaller these days. Solar cells could be the next wave and should not be discounted just because they are taking longer than the transistor to reach commercial viability. Terahertz imaging, human-computer interaction/design and nanotechnology are other examples. I think Umair is remarkable-tizing recent return history. All innovation is incremental to some degree. You cannot generalize across this stuff on a two-times-two-equals-four basis.
Looking at vintage returns since '98, vcs are assuming significant risk and some taking their humble pie with it. IT and biotech took awhile to gain profitability momentum and still have room for significant improvement. Biotech is 30 years old and monoclonal antibodies only started recently delivering and 99/250 public biotech companies currently have less than six months cash on hand.
Big idea bplans are scarce. Vcs are moving to later stage investing not for risk averse reasons, but because they have more assets under management. It's unreasonable to expect A rounds calling for $20M+. Most ideas cannot put this much capital to work that quickly, and the dilution would be unsuitable to management. However, many entrepreneurs believe they can do more with less and so don't forecast needing much extra financing past a first round. Follow on rounds need to forecasted more effectively. This financing mentality is an expectations gap, otherwise being referred to as a funding gap. Refining this model would encourage entrepreneurs to think big.
Vcs need to put more dollars to work per investment to effectively manage portfolio companies, which has orientated some vcs to more capital intensive (riskier) business models. If there is capital intensity, better it be tied to first mover risk versus capital intensity relying on product substitution. The magnitude of product variance is directly proportional to consumer willingness to change habits. There could be new industries and markets that have been funded but are under Teflon. Pioneers are more apt to go stealth.
Vcs have a responsibility to put their investors' money to work real time. Vcs are not market experts and so build social capital in order to identify opportunities. Many vcs come from the biotech and IT which defines their trusted deal flow to those industries. There is proactive company building, take Book Byers at Kleiner talking about their new bi-defense and pandemic fund. "If large companies are working on part of the problem and doing it well, then we don’t do that. We may do a couple of startups where we just can’t find anyone working in one of these areas." Yes, there are lemmings out there and an increase in risk reducing strategies, for example on the biotech side investors who invest in drugs for market validated targets. However, even for those of us guilty of making lemming investments, this is not a portfolio level strategy.
What is the systematic cause for shortage of radical bplans? Production became so expensive and complex that it muted optimism to try to build big new things. Large companies have become intimidating super powers. Companies' standard setting induced people to fall into formation. Culture has come from commerce.
Social networks and blogging tools will not get us out of the recession, but they are a platform to create a more informed consumer. Empowered, disciplined, balanced, and informed consumers could have saved us from the current mess. Reinventing news media from these new voices will go a long way to convincing the public that many Americans do care about issues.
The venture economy is failing investors, entrepreneurs, the economy, and society.
Umair is belittling the physics of other people's money. Vcs are responsible to create returns for their investors (limited partners). Limited partners' shareholders and customers are the public. All interconnected, all boiling down to personal responsibility. Creative destruction resulting in unprofitable companies is only valuable to consumers.
Yet, the trailblazers of making radical responsibility economically viable are non-profits and social businesses - not venture funds, who have been deeply reluctant to explore the economic possibilities of responsibly powered business models.
I agree. A lot of the world's problems are avoided by geography, involve commons such as water and lack demand due to poverty. We need to capitalize new asset classes and link foundations, private investors and nonprofits.
That striking homogeneity reflects an almost total lack of strategic imagination by venture players
Innovation is associated with overlooked or underestimated value / cost drivers that make proposed alternatives unattractive. Most really breakthrough stuff is not obvious. A lot of smart people got a free look at the Google deal at a price tag of $1M. Vcs cannot tell an entrepreneur what business to start. The great businesses are started from passion and imagination. Credit belongs to those who are in the arena.
Blake Ross of Firefox said, "The next big thing is whatever made the last big thing more usable". Innovation has been going at the same rate the last 50 years while we have entered an unimaginative era. The blog (a memoir) is the leading art form. Problems are easier to identify these days. Entrepreneurs don't need to think long and hard to find something to be passionate about fixing. Look at most technology out there, it usually has to do with what a product can do versus what it should do. The product is more about having one more feature than the competition. Another factor that has tied us to incremental innovation is that the technology involved in processor, computer, software, and internet has all been layered in shared design, people and most importantly geography. PR's focus on Silicon Valley could be impairing Umair's assessment. The industrial revolution didn't happen overnight.
Homogeneity; you can argue that all the companies are eventually in the same bucket. There are scale and employee incentive economics that limit one company's ability to dominate more than a niche market. Granted, fortune 100 companies have 50 industry business lines on average, but that is a different equation than startup economics.
Venture investors have been free to take hidden action that maximizes their own near term returns - underinvesting in radical innovation.
The scapegoat is startup execution. It’s not necessarily failure in big idea investing. Execution needs a stew of creativity to enable refinement of a business model and supports hiring needs. This comes from a local mix of media, design, film, international relations, fashion, health, etc. We need more diverse entrepreneurial friendly ecosystems like NYC. There are too many startup black holes across the country.
Most vcs accept the orthodoxy that sources of advantage are fixed - and that’s the single biggest mistake they make: Brands are losing relevance; cost advantage is often an illusion; differentiation is too often simply skin-deep; and market dominance stifles innovation and creativity - to name just a few. Yet, tomorrow’s sources of advantage remain largely unexplored - because vcs have been systematically underinvesting in discovering them.
Vcs and entrepreneur often start a business in an underperforming industry, because they think they can do better. Vcs are no different than industry actors who align to the rewards of their system and don't take countermeasures until the model breaks. This is easier mental calisthenics than recreating business advantages. Vcs have refined the model; gone vc gone are the tourist (investing abroad without local infrastructure) or drive by (investing without business model) vcs.
New sources of advantages such as creativity, continuous innovation, execution, collaboration and sustainability are needed. I also agree that some old sources of competitive advantage are less significant. Distribution channels are a less powerful source of advantages, forcing companies to seek other ways of reducing customer power, threat of substitutes and threat of new entrants. However, this does not mean that all tried and true advantages aren't still rewarding such as cost (iTunes) and reputation, differentiation (iPod).
People argue choice paralysis and perfect information is killing branding. Increased search costs and noise actually increase the value of branding. Branding is more accountable for the relation between message and product. The act of conveying expected value is still a representative, albeit less compressed, experience. It is increasing if you define brand as the level of engagement with consumer. It is getting better if you agree that advertisers have to convey unique value with less space (320 x 178 banner ad).
Commoditization of investment philosophies since the 1990s has generated technologies that can best be described as sexy-cool rather than disruptive and meaningful (with a few exceptions). It paved the way for get-rich-quick entrepreneurs that are skilled in feeding the dogs the dog-food, rather than support the real entrepreneurs that have a dissenting view of the world.
Sites like TheFunded are bringing transparency to the industry and encourage vcs to be less detached. It would be great to see a vc do a Bob Swanson and collaborate with academia, government or corporate America to create new industry.
It's great that Umair makes spirited points for innovation. Hopefully my response reads as optimistic, constructive passion versus self serving, get too much from my job description. Pessimism is the new black; it seems can-do USA is gone and there is significant uncertainty. However, with recent events, participatory culture should only continue to grow. We need to improve education and generate more leaders.
To quote actor Wendell Pierce from "The Wire",
"I hope that people will look at ‘The Wire’ and look at the humanity in it, as harsh as the show can be, and understand that there is humanity and that there is shared experience. No matter how far your life may be from these characters’ lives, it’s a shared experience. There’s hopes, there’s dreams, there’s inadequacies, there’s strengths, just like with every human experience. To tap into that (is) to understand the wealth of knowledge we’re denying ourselves and our community (by allowing) such an underclass to continue and thrive. I think about that every time I pass a cancer center. Man, we’re sitting here struggling with cancer, and just think about the generations of great minds who’d probably have the cure for it (but) never got on that right track, were never given the right track. The cure for cancer may be on the corner of Rampart and Ursulines. Some character hanging out there, right there in the Lafitte project behind the cemetery."
"Indeeeeeeeeeed", to quote a character from "The Wire".