I’ve been avoiding putting together a list of predictions for 2010 (more on that later) but just couldn’t resist suggesting that 2010 could well be a breakout year for weather risk management. All of the conditions necessary have finally started to come together and with the worst of the 2008/2009 hysteria behind us (without passing judgement on the future direction of markets), companies (and hopefully individuals) will start to wake up and respond to the risks and opportunities inherent in weather variability. I wouldn’t be surprised if weather risk was one of the top three risks faced by the vast majority of (non-financial) corporations, perhaps even the most important risk in some cases, and of the same order of magnitude as liquidity, foreign exchange, commodity and interest rate risk – all risk categories for which massive global markets in risk pricing and transfer exist. Weather in this regard remains significantly underdeveloped:
(via Ben Smith, First Enercast Financial) For example the Department of Commerce estimates that more than $1 trillion of U.S. economic activity is exposed to weather. Even if a small fraction of new risk is hedged through derivative contracts, 2010 will be a very good year for these markets.
The massive costs incurred in much of the northern hemisphere over the last few weeks due to heavy snowfalls and cold temperatures are just one more example of how important a factor in economic outcomes weather risk can be. For example, just take the exceptional – and uninsured – costs incurred by local authorities and airport operators across the UK for snow removal, sanding, salting, loss of revenues, etc. Previously, a manager of a company (or government entity) who suffered an exceptional weather-related loss could shrug their shoulders and plausibly say “it was out of my hands.” In a way that would be impossible if for example their organization suffered a massive loss because their buildings or equipment perished in a fire and they were not insured. In that scenario, shareholders or taxpayers would be incandescent with rage at the incompetent risk management of the managers. Not managing weather risks is no different in substance (now that appropriate weather insurance and derivatives are increasingly widely available), only remaining so in perception as awareness lags.
Of course I am biased, having invested in Weatherbill, which is at the vanguard of transforming weather risk markets:
(via J. Scott Mathews, WeatherEX LLC) The weather market was built upside down, which is quite a feat, even for financial engineers. What we mean is that it started on the wholesale level without any retail underpinnings. It started out like a castle in the air…The changes coming in 2010 for the weather derivative market will be keyed “from the bottom up.” Solutions companies such as Guaranteed Weather and Weatherbill who bring management choices to “ground level” risk holders are helping to complete a strong base to keep that castle from crashing on us.
The difference between weather derivatives (Weatherbill.com) (or any other new risk management tool) and say books (Amazon.com) is that risk management tools need to be ‘sold’ – there is a learning curve, however shallow; and while most people instinctively understand and can conceptualize their weather risks, their survival instincts – honed by decades of doing business with rapacious financial services firms – and fear of ‘getting their eyes ripped out’ means that they are understandably cautious when considering using weather risk management instruments for the first time.
This is where Weatherbill’s business model I think is particularly well adapted to the opportunity: on the one hand, they have a very modern (open) approach to pricing: anyone can go to their website and play around in their pricing ‘sandbox’. Try doing that ten years ago when you wanted to price up a complex FX or interest rate option. Basically it was build your own model or keep sending pricing request to your favorite sales person (who would then have to go beg the trader for a price, and in addition to the regular parameters, the client’s identity, the salesperson and the trader’s mood would also be imputed into the price. That is of course if he felt like making one.) On the other hand, (and this is something that has evolved over the past couple years) Weatherbill has aggressively sought out distribution partners – insurance brokers, industry platforms (eg travel sites), etc. – as trusted providers to their respective customer bases, they are ideally positioned to help their customers manage their weather risks by leveraging Weatherbill’s platform. I first wrote about this a few months ago, and since then they have signed up a number of new and significant partners.
I love skiing and my family take a season pass at Les Trois Vallees. Obviously weather risk is central to running or enjoying a ski resort. While there are many different types of risk you could look at in the context of a ski resort, in the interests of simplicity (ease of understanding/customer acceptance) and maximum pain relief, there are two risks that I would have loved to have had an embedded hedge for in our season ticket (and I suspect the same would go for someone buying a week-long pass for their holiday, in fact they would probably be even more sensitive/appreciative.)
Not enough snow to ski risk: ie not that the snow is great or this or that…the basic risk that the pistes are closed. For most modern ski resorts this is actually a function of temperature and not precipitation, as they use snow-making machine to lay down a base. Temperature risk is much easier to measure and price (than snowfall) and has much lower geographic variability ie you don’t need a weather station on every piste on the mountain.
Rain risk: ie the only time it is absolutely unpleasant to ski is when it is raining. Also, rain typically doesn’t help the existing snowpack, making skiing after rain often unpleasant as well.
Using Weatherbill to hedge their risk, Les Trois Vallees could offer a ski-pass that reimbursed me for every rainy day and for every day say less than 80% of their runs were open due to lack of snow. In an age of increasing climate uncertainty (or perception thereof) I am 100% certain this would help them market (and sell more) season tickets. And for week-long tickets, it would be a great marketing tool for advance sales (with significantly positive cashflow benefits), and great for improving the user experience. Imagine a vacationer whose week in the Alps is ruined by 5 days of torrential rain…getting their money back on the lift tickets (irrespective of whether or not they braved the elements) would go a very long way to having them consider giving it another try next year.
Of course this is but one example, I’m sure all of you can think of hundreds more. In fact it might be harder to think of services or businesses that are completely immune to the weather. So really, what are you waiting for? Start hedging!
This week NEA announced the close of their latest fund at $2.5 billion. That seems like a lot of money for one venture fund, although perhaps if the intention is to focus on (highly capital intensive) clean tech and/or biotech they will be able to deploy this amount effectively. Of course NEA, founded in 1978, has a long and successful track record, with I imagine many long-standing relationships with LPs and excellent ‘brand recognition’ within the universe of potential LPs, and so it is hardly surprising that they are able to raise such large funds. After all – especially with respect to institutional investors – the analog to the ‘nobody-ever-got-fired-for-buying-IBM” paradigm operates in their favor.
A couple years ago, when I first started thinking about what would become Nauiokas Park, a good friend told me that private equity was all about raising capital, not investing it. Of course I understood what he
…private equity is about raising money, not investing it.
was saying, but thought he was using hyperbole to make the point that raising capital was more important than just a means to an end (investing.)
Now I understand that however cynical it may sound, he wasn’t trying to be clever: the way the institutional marketplace for private equity (including venture capital) is structured is all about raising capital and only incidently about investing that capital.
For better or worse, the year-end is typically a time to step back and take stock, to reflect on the year that was and the year to come. And indeed I have been thinking about what we could have done better or differently last year and what we need to focus on in this new year. And the short answer is we need to spend less time thinking about the economic and industrial landscape, developing our investment framework, sourcing potential investments and nurturing our existing investments, and more time soliciting potential investors: pitching our skills, our approach and the opportunity we believe exists to people and institutions that will determine whether or not we can turn our vision into reality. And like any start-up, we are going to have to be hard-headed about how we approach this as the proverbial runway is running out. As they say, there is a fine line between tenacity and obstinacy. I want to try to stay on the right side of that line.
Of course, once the lightbulb goes on it becomes obvious that raising money would be the most important talent of any prospective private investment firm: your LP’s, shareholders, investors are your customers (and not your portfolio companies.) They are they ones that ‘pay the rent’. They consume your service which is to invest their capital. Ah but the better the service, the more customers you have and the more successful you will be, right?
Well not exactly. In investment management generally it is very hard to determine a priori the quality of service one is likely to receive, which is why so often prospective investors – be they retail or institutional – fall back on historical performance to make their judgements. This reliance on historical data is clearly imperfect. However, when considering (many types of) hedge fund or mutual fund, given the typical investment horizon and liquidity profile, a consumer of these services can at least adjust relatively dynamically if they make a mistake. The effect of this is to reduce the psychological barrier to ‘taking a risk’ on any particular investment manager in these asset classes. But given the long time horizons and relative illiquidity in private equity, investors cannot exit a decision easily and so are (even more) inclined to stick with well-established firms and are less open to considering newcomers.
Basically “track record” is the box that needs to be ticked. And is much more important than having a coherent, well-researched and plausible investment thesis. After all, if you have the money, the deals come to you. But a track record in private equity is hard to come by quickly. (And it needs to be the ‘right’ kind: the first time I was told (by a prospective investor) that having been a founding investor in two multi-billion dollar companies didn’t ‘count’ because I wasn’t “a professional investor” when I made the investments was frustrating and somewhat irritating I have to admit.)
A company active in a two-sided market provides it’s services to two distinct constituencies. Often times, they provide those services for free to one side of the market, in order to increase the value of the services they provide to the other side of the market. For example, Visa provides consumers a free payments service (and actually often pays consumers to use their service via loyalty programs, cash back, etc.); in so doing they can charge merchants to use their services which have value to the merchants because of the number of consumers who use their platform. In effect, Visa sells ‘access to consumers’ to merchants. In a different context but the same vein, Google sells access to consumers to advertisers.
Successful private equity and venture capital firms “sell” access to dealflow to their investors and limited partners. It is a two-sided market. And so it is natural that network effects apply and rational for investors to be pre-disposed to the biggest, most established players. It is reasonable to think that NEA (and KPCB, Index, etc.) or Blackstone (and KKR, Carlyle, etc.) will see a high proportion of the best deals. So far, so true. But unlike electronic payments or algorithmic online advertising, investing (in private companies) does not scale and so unlike these markets, the law of diminishing returns kicks in much, much earlier. The industry (well, much of it) admits as much: I suspect if you offered the GPs of NEA a $10 billion fund, they would probably demur. Indeed I suspect if you offered USV a $500mn fund, they would probably turn it down. The key point is that for any given private investment strategy (sector, stage, etc.) there is clearly a maximum optimal fund size. For a company like Visa or Google, this is not the case – more customers, more merchants, more searches, more advertisers – it’s all good.
Jeff Bussgang recently estimated that the (US?) population of active VC partners was approximately 1000. I don’t know how many mutual and hedge fund managers there are but I suspect it is at least an order of magnitude higher than this. This seems intuitively wrong: investing in a private company is more work and there are more of them. You have a thousand investors looking at a universe of tens of thousands (or more) of investable private companies and tens of thousands of investors looking at investing in a universe of thousands of public companies…
Paul Kedrosky (and others) have written extensively and intelligently on how the venture capital industry needs to shrink. How too much money, chasing too few opportunities has destroyed returns. The logic is compelling. However I would posit that the problem is not too much money per se, but too much money with too few and homogeneous investors.
Let’s look at these two constraints sequentially (although they are co-dependent to a large extent.) If you double the number of GPs but provide ten times more investment capital, on average the valuations of the investments they make will go up five times (thus significantly compromising their future returns.) Ah but this logic assumes a closed system – ie that both the number and types of investments are held constant, and so increasing the ‘money supply’ drives inflation (and lower real returns.)
Well in a world where the number of GPs is constrained, and most of them come from similar geographic, educational and professional backgrounds, this assumption is likely to be more right than wrong. Indeed it is embedded in the initial conditions above – ten times more capital allocated to the asset class does not result in ten times the number of GPs. And yet the number of investments any GP can effectively manage is by definition bounded (at a reasonably small number.)(Which is of course why firms like Apax eventually exited venture capital and ‘graduated’ to private equity.) Perhaps an even more important gating factor however is the number of potential investments a GP can seriously analyze and consider each year (dozens? a hundred or two?)
And we uncover the Achilles Heel of the (otherwise extremely successful) ‘Silicon Valley’ model: the relative homogeneity of the environment leads inevitably to a collective narrowing of the universe of potential investments that is considered and amongst these, an additional narrowing in the way they are evaluated and considered. ie Everyone sees the same deals and runs the same slide rule over them. And so more capital simply means valuation inflation and ultimately, lower returns.
But what if we were able to disrupt this state of affairs? Having spent the past two years intensively researching the markets we are interested in, I simply don’t accept that the ‘problem with venture capital’ is a bounded set of investment opportunities. I’m sure there is some limit to the number of good entrepreneurs, viable business models and attractive market opportunities but we are nowhere close to reaching it. In fact, it is so far away we can’t even see it yet.
No, the problem is a failure of market design. (The irony being of course if this market design failure were in any other industry, venture capitalists would be aggressively investing in companies and business models designed to correct and take advantage of this failure.) The problem simply stated is too small a number of too many similar venture capital and private equity investors. The solution is more, and more diversity. The question is how?
I’m sure you won’t be surprised to hear that I have a few ideas on the subject, and for my first (and only) New Year’s resolution, I will endeavor to articulate these in a multi-part series I will call ‘Saving Private Equity’. Some earlier thoughts on the subject can be found here.
The more cynical amongst you might accuse me of simply ‘talking my book.’ Perhaps. Probably. A more flattering way to look at it is that I am living my convictions. And the lesson I’ve learned is that we need to focus almost exclusively on fund raising for now even if that means disappointing some of our portfolio companies or missing out on a great investment opportunity in the short term. It’s not fun or particularly interesting but like almost any other startup, without capital the rest is just theory. Time to stop thinking and start pitching!
So my question is when does Amazon.com split its retail operations from its AWS platform business. I’d love to see these priced separately. Actually, truth be told, I suggest Amazon.com is actually three businesses:
Earlier this year I suggested that AWS in particular could well be the totemic representative technology that inaugurates the sixth techno-economic paradigm:
Just as Intel’s 4004 microprocessor was the catalyst for a wave of creative destruction in the 70s and 80s, will AWS prove the same for the 00s and 10s? Probably. We’re seeing it already. And it’s going to disrupt the hell out of the mastodons of industry across most sectors of the economy. Why? Because their cultures and leaders are entirely ill-equipped to face such a fundamental paradigm shift. They know how to play by the old rules. The strategic competitive advantages they built up over decades risk suddenly – poof! – to become obsolete.
The central concept in this new option is that of the Spot Price, which we determine based on current supply and demand and will fluctuate periodically. If the maximum price a customer has bid exceeds the current Spot Price then their instances will be run, priced at the current Spot Price. If the Spot Price rises above the customer’s bid, their instances will be terminated and restarted (if the customer wants it restarted at all) when the Spot Price falls below the customer’s bid. This gives customers exact control over the maximum cost they are incurring for their workloads, and often will provide them with substantial savings. It is important to note that customers will pay only the existing Spot Price; the maximum price just specifies how much a customer is willing to pay for capacity as the Spot Price changes.
Spot Instances are ideal for Amazon EC2 customers who have workloads that are flexible as to when its tasks are run. These can be incidental tasks, such as the analysis of a particular dataset, or tasks where the amount of work to be done is almost never finished, such as media conversion from a Hollywood’s studio’s movie vault, or web crawling for a search indexing company. For most of these tasks their completion is not time critical and as such they are ideal targets for additional cost savings.
Before I go any further, let’s just say it’s pretty exciting to see vision become reality even if in this case I’m only a distant spectator. Markets in anything. Digital markets. Themes that go back to the founding mission statement of the Park Paradigm:
(December 2005) The technology of the digital age is driving an unprecedented explosion in the ability to create markets in anything. Trade anything. Not just physical goods. Not just financial instruments. But ideas. Events. Outcomes.
The emergence of these kinds of markets will – over time – impact how we view and interact with the world in all aspects of our personal and professional lives. They will fundamentally alter the current world economic and social paradigm.
Chris Swan calls them virtual resource markets and correctly points out that, at least for now, the market is “closed” – ie users cannot trade their capacity amongst themselves, however I suspect that it is just a matter of time before such a market is organized. But what would be even more useful (and exciting) than a closed market on Amazon EC2 resources, would be an open marketplace for on-demand spot computing resources. ie A marketplace which is agnostic as to where the compute resource comes from, so long as it is a robust and more or less uniform resource.* However for this to be useful for the end consumers of this computing commodity, the ability to switch automatically and seamlessly from one cloud computing source to another based on price and/or availability would be crucial. Indeed this would be the key value driver for anyone hoping to operate a compute resource exchange. Sure the price discovery and transaction mechanisms would be necessary but these are relatively trivial to build and hard (in isolation) to monetize. The real value creator for any exchange (just ask the CME) lies in clearing and settlements. (For the non-financial amongst my readers this is the back-end of the trade, fulfillment essentially.)**
Note, however, that this feature is not market-based pricing. Amazon determines the spot price and can raise that price enough to gain back capacity at will, at no real cost to itself. There is no competition. There is no commoditization. There is just consumption of what is not being used.
The truth is, real commoditization of infrastructure services–or any other cloud service, for that matter–isn’t in the best interest of Amazon or any other service provider.
Regardless, commoditization can’t happen without open standards that allow easy portability and interoperability of data and code, as well as security, control, service-level assurance and compliance systems. Those standards are coming, but it is impossible to predict when they will arrive. I only hope Amazon embraces them when they do.
I’m not sure I agree with his view however that commoditization isn’t in the best interest of Amazon. The underlying asset is ultimately relatively undifferentiated (a compute cycle is a compute cycle is a compute cycle) which is in fact the definition of a commodity. If you are a provider of a commodity – unless you can maintain a monopoly or a cartel – it is in your interest to create as big and vibrant a marketplace as possible. Supply creating demand. And particularly if you fancy yourself the most efficient, large scale producer of said commodity (as I’m sure Amazon does), all the more reason to want a big, liquid market of consumers. It is the exchange and clearer that want to create lock-in, not the producers. To be fair, for the moment AWS is both and indeed this is the point James is making I think, but I would be surprised if they had the intention (hubris?) to think this is anything but a transitionary arrangement.
Of course, as a traded market in this critical 21st century resource develops over the next decade and beyond, the business opportunities abound. Better yet, many of them are well known and can quickly be adapted (from other asset markets) to apply to the compute resource market. It’s not a business yet, but it only took a few hours before the first ticker tapes(here also) began to appear for EC2 pricing:
An entire ecosystem will surely emerge – exchanges, prime brokers, risk management derivatives, algorithmic trading… I’m sure there will also be some interesting second-order opportunities. Linking spot computing prices with spot electricity prices. Selling green compute cycles (ie powered by renewable energy sources only.) Allowing anyone to sell compute cycles into the grid (think SETI@home meets micro-generation). The mind races.
Welcome to the sixth paradigm.
* like a bond futures contract, one could imagine allowing any compute resource fitting a certain minimum specification into the “basket” of deliverable resources; typically in this scenario there would be a “cheapest-to-deliver” resource in the basket which presumably would get allocated first.
** I can’t help but wondering if the amazing technology developed by our portfolio company CohesiveFT couldn’t be adapted or re-purposed to form the core fulfillment engine of a compute resource exchange. The fact that they are Chicago based and their CEO/Founder is ex-O’Connor makes me wonder even more!
A couple of months ago, I had the privilege to have been invited to speak at eComm 09 in Amsterdam. I have posted on this previously but recently the video of my talk was posted and perhaps will make it easier to understand my accompanying presentation. If you can spare 20 minutes (there is an additional 10 minutes of q&a at the end) and are interested in understanding how Nauiokas Park defines our opportunity space, please have a look as it is probably the most succinct expression of the worldview we bring to investing and analyzing potential investment opportunities.
And here is the presentation again, in case you would like to follow along as you listen to the video:
Well-built developer platforms are the future of every industry. (-ReadWriteWeb)
Note: Their is a small glitch around 7:40 where the video skips over a few seconds; funnily enough (for the conspiracy theorists out there) this is exactly where I say that had ZSIN’s existed, the extent of the disasters that occurred in the mortgage securitization markets would have been at least an order of magnitude smaller…)
A phrase popularized by the late Charlton Heston in his crusading role as the poster boy for the NRA. But I’m surprised it hasn’t yet been officially adopted by more old economy industry groups as a rallying cry to marshall support to save and protect their dying business models. To the bitter end.
An Ontario court has shut the door on attempts to create new web sites to repackage real estate listings using data from the Multiple Listings Service system.
In a ruling released Monday, Mr. Justice David Brown of the Ontario Superior Court said Toronto real estate broker Fraser Beach did not have the right to provide broad public access to MLS data through a web site he helped create while working for BCE Inc. division Bell New Ventures in 2007.
The decision comes after the Toronto Real Estate Board (TREB) shut down several attempts in recent years to create new web sites allowing members of the public to sort MLS data – including an operation started by Mr. Beach.
That the Canadian Real Estate Association would want to protect its MLS data is entirely reasonable, indeed it is a very valuable dataset. However one would hope that they would take this as a wake-up call and start thinking very hard about developing a new business model around this data. One that reflects the modern realities of a fully connected, digitized economy. Perhaps they are. To be honest I have no idea. So acknowledging that this is pure unadulterated speculation, I suspect they aren’t. I suspect like the newspaper, music, bookselling, banking, etc. sectors before them, the main focal point of their efforts is to keep the bloody genie in the bottle. At least for long enough for the old hands to ride off into the sunset and let the next generation deal with it.
It’s a shame really, because on paper – as for most incumbents – not only do they have the most (everything) to lose when the paradigm shifts, but they are also by far the best positioned to maintain a leadership position so long as they adapt (in time.) Inertia, installed base and brand recognition take care of that. Basically they’ve got a strong hand. But time and time again it seems that these kinds of companies and institutions can’t help themselves but to overplay it. Taking another card while holding two Jacks kind of thing. Admittedly it would be hard work for someone to build up a competitive offering to the MLS from scratch, but I suspect not impossible. I don’t know what the public information access laws are like in Canada but if they are similar to those in the UK for instance, a smart entrepreneur might mimic the route taken by Zoopla and bootstrap prices starting from public sales records. And even if they do manage to maintain a data monopoly, they and their member agents will be faced with an increasingly angry client base who won’t readily accept being held hostage by secretive data trolls.
If I were a Canadian real-estate broker, I would be leading the charge to flip the MLS and traditional broker roles on their heads. Having read this excellent post on the future of my profession, I would understand that my customers are (mostly) not looking to do away with me but to get real value from my services and insights and conversely will become annoyed and resentful if they get the feeling they’re just paying a toll to a glorified data monkey.
The way a broker creates value in a world of abundance (vs a world of scarcity) is fundamentally different. Someone forgot to tell the record companies. Let’s not make the same mistake again. Save a real estate broker: free the data.
I thought I’d play a little markets jeopardy with the headline to this post. The question of course is: “what would happen if Google stopped mucking around and just came out and said it?” Said they were going to take their massive dataset, brilliant algorithms and (hire) all the smartest people in all the lands and offer a free service to “do anything anyone anywhere might conceivably want to do.” That should be enough to cast a pall over even the most profitable or promising companies. Sell everything (else) and buy Google, right?
Many of you are of course thinking no, not right: the premise is far-fetched (not to say ridiculous) and even if you accept it in the spirit of the thought experiment it so obviously is, the conclusion – that they take out every other competitor at the kneecaps – is not a given by any stretch of the imagination. And yet, when Google announced that they were going to launch a free property listing plug-in to enhance their UK maps product, the market reacted pretty much as if Google were indeed Merlin the Magician and just by waving it’s googly wand it could take over any market at will just by unleashing its fierce intellect and sizzling technology on the hapless incumbents. In this particular instance, Rightmove‘s (the leading UK property portal) shares collapsed on the news trading down 10% on the day and c. 15% in all since the story broke. Now to be fair, having traded as low as 156p at the start of the year, RMV shares have had a pretty solid 2009, hitting a high of just over 600p and trading around 550p before the Google ‘news’ hit the market. And since investing (and especially trading) is not about picking the prettiest asset but picking the asset you think most others will find prettiest, I don’t blame any fund manager for selling first and asking questions later. And I have much sympathy for those that think that Rightmove’s market leadership is vulnerable in the medium term; only I don’t harbor much fear that this threat will come from Mountainview. The competitor that Rightmove’s shareholders should be keeping a close eye on isn’t Google, but Zoopla of course. (Reminder: we are investors in Zoopla.) Ah, but Zoopla has a silly name, it can’t be a real threat. Google however…
And it’s not just UK property where I think the mainstream markets and pundits breathlessly get it wrong about Google. In area after area they have proven not to be a very successful or threatening competitor and in other areas their entry has often been a boon for specialist competitors in the segment due to the legitimizing power Google brings to the table. They are able to (implicitly) validate new business models in ways a smaller, more specialist start-up could never dream of, and yet this market validation very often plays right into the hands of folks who, well, know what the hell they are doing.
Don’t believe me? Let’s take just a couple areas where – if you believe the logic in the argument used to justify Rightmove‘s downtrade – Google should be causing wholesale panic and disruption:
Financial Information: maybe I’m wrong but I don’t exactly see Thomson Reuters or Bloomberg shaking in their boots, and yet here is a sector that is tailor made for Google’s engineering, distribution and technology assets, and one where they have had years to refine the value proposition; and yet Google Finance remains essentially a working prototype of a back-of-the-napkin sketch of what a Google financial information portal could become. Umair challenged CEO Schmidt to take up this challenge a couple months ago but I’m not convinced it would be as easy as it looks.
News aggregators: Google News is all we need right? (Perhaps supplemented with Google Reader…) There’s no reason for sites like Digg or Daylife or the Huffington Post to exist. I mean what are these guys thinking: some of them even started after Google News went into public beta. Crazy. Except they actually work, they have customers willing to use them despite Google News existing. But really, how long can this last?
Advertising: I must be joking now. After all advertising is the one market Google owns; the market that gave them their billions that allowed them to hire all the smart (non-evil) people and enter and take any other market at will. Right? Well if you think so, have a look at this recent post from Paul Kedrosky. It’s why vertical search and specialist sites exist. It’s why you (usually) go to Amazon.com if you know you are searching for a book, and not necessarily via Google.
And I could go on. But the point of this post is not to say that Google are useless, yesterday’s game, past their prime. In fact my best Google-fanboy guess would be that they are far from the point of diminishing returns and structural foolishness. My point is rather that they are not – or at least not universally – the ‘destroyers of all economic worlds’; that as they grow to become a company of thousands of employees in dozens of locations they will inevitably have to deal with some of the structural pathologies that this involves, including rising mediocracy and products looking more like camels than horses. Oh yeah and evil too. Yes they are a fierce competitor and certainly there is some risk that they could destroy your business model and take your business with it. But this is far from certain. They are human. They make mistakes. They execute poorly. They don’t always (or even often) win. And best of all, once you’ve proven that you can beat them, they just might buy your company.
Update:
I forgot to send you to a great essay by John Borthwick, thinking about the challenges Google faces going forward and highlighting the structural shortcomings of trying to regulate behavior in the fast moving world of technology, inspired by Ken Auletta’s book Googled: The End of the World As We Know It.
And of course Jeff Jarvis wrote a book about the opening premise of this post (which perhaps Santa will bring me) called What Would Google Do?
Using the tried and tested TED 20min format, it was a great opportunity for me to collect my thoughts into (what I hope was) a coherent overview of how I think technological and economic forces will shape the optimally adapted ‘industrial stack’ for the sixth paradigm. It’s a great summary of the prism through which we look at potential investment opportunities and I hope will help us articulate this more powerfully to entrepreneurs and prospective investors.
I’d love to hear any feedback (good, bad and ugly) from any of the eComm delegates who saw my presentation and hope to continue the conversation with you and others here. You can also follow me on twitter @nauiokaspark.
Thanks to Paul and Lee for inviting me and especially to those of you who took the time to respond to my call for input – it was tremendously valuable in helping me to shape and refine my thinking and in building the presentation; just a few years ago, assembling this kind of distributed brainpower would have been impossible, and I hope I never lose my ‘childlike sense of wonder’ at the boundless possibilities that technology enables.)
Instead, Wall Street needs to be reinvented from the bottom-up: by a new generation of radical innovators, to create thick value, for an authentically shared prosperity.
Building a disruptively better global financial system is the central challenge —and the largest, richest opportunity — for today’s economic revolutionaries. It’s time for Finance 2.0.
Investors, entrepreneurs, and radical innovators of all stripes: it’s time to It’s time to go big, or go home. You’re happy that social gaming is worth billions. That’s nice. But it’s also chump change. Because the gains that can flow from better capital markets are worth trillions.
Finance — not video games, advertising, cleantech, or social nets — is where 10x+ returns lie for today’s venture investors, and life-changing fortunes lie for entrepreneurs.
Hallelujah. Anyone who knows us knows that this is right out of our pitch book. And yet. It’s not easy. And I’ve been wondering why that might be. How much of it is a ‘turkeys not voting for Christmas’ problem? Or is it a question of ‘Lord, make me chaste. But not yet…’? I don’t know, hard to tell. Anyhow I’m sure we’ll get there in the end, but there is so many exciting opportunities and so much potential sometimes I struggle to understand why we aren’t reduced to beating back hungry investors with a stick. I guess the real answer is that we need to spend more time seeking capital and less time investing it. But I tell you that just doesn’t seem right. It should be the other way round, no?
A wise man (not being sarcastic – he really is wise) once told me of a very large private equity firm where he used to work at one time. He said they had a lot of smart and ambitious people. And a few well, Forrest Gumps. The latter took care of investing, while the former focused on the much more important job of raising more and bigger funds. I thought he was joking. I’m now pretty sure he wasn’t. (Note to self: area no. 697 of financial services ripe for disruption: allocation of capital to private equity managers…)
There has been much recent angst in the venture capital world about funds that are too big, and indeed the same debate flares up from time to time in the hedge fund world where many strategies (although not all) have analogous scaling problems (over-crowded trades, positions too big for the market, opportunities too small to ‘move the needle’ of a big fund.) But investors time and time again prefer to take the safe route and ‘buy IBM’. The classic fail-conventionally-versus-succeed-alone trade. Don’t get me wrong, there are some amazing big funds – where as an investor you get to eat your cake and have it too: ie great returns and the ‘safety’ of a tried and trusted organization – but there are also many many mediocre funds who have grown out of their edge and had their business objectives perverted into raising and keeping ever larger amounts of AUM, rather than having the objective of generating the best possible risk adjusted returns. I guess the fund-of-fund structure was one answer to solving the dilemma of how do you scale allocation of funds into many small and/or new managers, unfortunately more often than not, many of these funds find it easier and safer (reputationally not financially) to slide back into allocating to the same old, same old. (And a few bad apples discredited the whole concept by just putting all their money into a ponzi scheme and taking fees for their trouble!) I’ve thought about this a bit, and I must admit I have yet to come up with a clever mechanism that would solve the problem of efficiently (and safely) getting investment capital out into the ‘long tail’. But I’m sure it exists. Especially with the tools and access to information available today.
We also need to fix the supply-side by taking away the naked incentive for asset managers to blindly pursue AUM growth as a priority. This is easy. It was the first thing I said I’d do differently – three years ago – if i ever managed outside capital. It seemed so bloody obvious: management fees pay the cost of running the business, carry or performance fees are the juice. So set management fees at the level of the operating budget. Simple. You would think investors would love this as it reflects the true cost of managing the investments and aligns interests. Sure, it is a bit more complicated than just multiplying the capital by a fixed percentage, but only a bit: the cost structure of an asset manager is not exactly complex – people, an office, some travel, IT (more or less depending on the strategy) and some professional fees (legal, accounting, etc.) Further if there are economies of scale to be had in the strategy in question, these would be naturally passed on to the investors as the costs as a percentage of assets would naturally decline as assets grow, but the managers would be indifferent to this and so aim for an amount of assets that allowed them to create the best returns net of management fees. Indeed this is exactly what Paul Kedrosky suggested the other day. (Once again perhaps we were too early!) We thought potential investors would love this. The reality (so far) is that most have been at best indifferent and in a few cases outright skeptical – “That sounds too clever, why don’t you just stick to 2% like everyone else…” (I’m not making that up!) ie Don’t rock the boat. And that’s a problem, because we’re all about rocking the boat! And I can’t see how we can be otherwise and remain credible when our value proposition is to identify and invest in disruptive business models… (Sigh.)
Anyhow, Umair don’t lose faith, we’re working on it!
I was very kindly invited by Paul and Lee to attend my first ever eComm conference, which will be in Amsterdam from October 28th to 30th.
The Emerging Communications (eComm) Conference & Awards was created to promote and accelerate communications innovation. Telecom, mobile and to a lesser extent, Internet based communications, had been innovation stagnant for far too long. Yet the opportunities for innovation had never been greater. Those opportunities are only going to grow as drastic changes further impact the multi-trillion dollar a year telecom industry.
The speaker line up looks fantastic and I’m the spare tire on an otherwise star-studded panel Thursday afternoon, that is if they still want me after my plenary talk that morning at 9:30:
Platforms, markets & bytes: the economic landscape of the 6th paradigm(?)
In a world where everything can be expressed as 0s and 1s, are the traditional ways of defining sectors and industries (as verticals) still relevant? If not what new business models and industry structures are likely to emerge? Oh and what’s the difference between a bank and a telecom company really?
Now at the risk that tumbleweeds blow through the comment section, proving once and for all that all my dear readers are in fact spambots (but in which case no one will see this and no embarrassment suffered), I thought I’d take a page out of the legendary Fred Wilson‘s book and ask you all for thoughts and comments on this theme that I might incorporate them into my presentation. (Or not!) So fire away!
A couple years ago, I had just decided to try to build what would become Nauiokas Park. I wasn’t entirely sure exactly how I was going to go about it but I had a vision of what it might look like and I knew the market opportunity – to develop technology-enabled disruptive business models in financial services and markets – was vast. Also, Saul and Reshma’s inaugural seedcamp had given me an excuse (or a push) to stop ‘mulling it over’ and ‘get started’ even if I didn’t exactly know what ‘it’ was yet.
One of the first things I did was to start building a database of startups and private growth companies that I thought fell into my embryonic firm’s new investment universe, and one of the first companies I added (on August 29th, 2007 to be exact) was Mint.com. I had first heard of them early that year when they were raising a Series A round and the concept had always appealed to me (and I had always wondered why banks had been so oblivious to it.) I had definitely hoped to be able to take a closer look once I had raised outside investment capital (they were already past the seed stage where I could have contemplated trying to play as an angel) and so it was one of the first companies on our internal ‘radar screen’. Well as they say in the start-up game, it always takes longer than you expect and here we are – one giant financial crisis later – in the fall of 2009 and Mint will now be coming off our radar screen (into our archives) having gone and gotten itself acquired by Intuit for $170mn.
On the one hand, it is exciting to see innovation in the space we are calling our own, succeed and be rewarded. And although I’ve never had the pleasure of meeting Aaron, I would like to congratulate him and wish him continued success with Mint and Intuit. Who knows, perhaps I’ll get to meet him in the future. Maybe when he’s contemplating his next venture? On the other hand, I can’t help but wonder if they sold too soon. I have to insert a disclaimer here – I have absolutely no idea what Mint’s financials looked like – so my view is entirely speculative, but I can’t shake the suspicion that if they had enough traction to get $170mn from Intuit, they had already hit and passed the inflection point and could have aimed at becoming (at least) a billion dollar company and owned the space.
Bittersweet? Well partly for not having invested as an angel but that’s just back-trading, so not really. Mainly it’s because – if the company was for sale – I would have really liked to have been in a position to run our slide-rule over it and, if it made sense, put in a bid, either alone or as part of a club deal with one or two private equity peers. If they have attained critical mass – which it looks like they may well have – it doesn’t take too much imagination (if you live in the sixth paradigm) to see them developing into a multi-billion dollar business over the next 5 years or so. Don’t get me wrong, I understand why management, the angels and the VCs, might find this exit attractive, especially given events of the past 24 months, but I can’t help thinking they’d done the hardest part and instead of letting a winner run, took their profits too soon.
PS If anyone knows where I can find Mint’s financials and projections, I’d love to have a look.
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I guess the real answer is that we need to spend more time seeking capital and less time investing it. But I tell you that just doesn’t seem right. It should be the other way round, no?![Reblog this post [with Zemanta]](http://img.zemanta.com/reblog_c.png?x-id=10483c2d-bbf4-4a59-afd1-59196fc4e09a)
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