Horizontal Progress vs Vertical Progress

In his new book Zero To One, entrepreneur and venture capitalist Peter Thiel writes:

At the macro level, the single word for horizontal progress is globalization – taking things that work somewhere and making them work everywhere. China is the paradigmatic example of globalization; its 20-year plan is to become like the United States is today.

The single word for vertical, 0 to 1 progress is technology . The rapid progress of information technology in recent decades has made Silicon Valley the capital of “technology” in general. But there is no reason why technology should be limited to computers. Properly understood, any new and better way of doing things is technology.

Elaborating on the theme of Globalization as “horizontal progress” versus Technology as “vertical progress”, Thiel writes:

This age of globalization has made it easy to imagine that the decades ahead will bring more convergence and more sameness. Even our everyday language suggests we believe in a kind of technological end of history: the division of the world into the so-called developed and developing nations implies that the “developed” world has already achieved the achievable, and that poorer nations just need to catch up.

But I don’t think that’s true…most people think the future of the world will be defined by globalization, but the truth is that technology matters more. Without technological change, if China doubles its energy production over the next two decades, it will also double its air pollution. If every one of India’s hundreds of millions of households were to live the way Americans already do— using only today’s tools— the result would be environmentally catastrophic. Spreading old ways to create wealth around the world will result in devastation, not riches. In a world of scarce resources, globalization without new technology is unsustainable.

As I’ve written earlier, this is a fundamental dichotomy: while advanced economies have the knowledge base and networks to deliver such innovation, the market for such innovation lies in emerging markets.

Achieving higher resource efficiency and developing lower-pollution energy sources presents a considerable innovation challenge – and commensurately, an entrepreneurship opportunity. So far, major startup successes that have emerged from India and China have been adept at “globalization” – they’ve taken proven business models from abroad, and executed those models well in their own markets.

The “technology” successes, especially in non-software or Internet areas, have been few and far between – and there are some very good reasons for why this is so. The question is whether emerging markets can become economically developed by globalization alone. As Thiel writes, this won’t be possible – “globalization without new technology is unsustainable”.

Something’s got to give – either we have technological breakthroughs that enable sustained economic growth, or growth itself will become constrained. China is already facing enormous pollution and environmental issues – sample these news reports:

Air Pollution, Birth Defects and the Risk in China (and Beyond)

The pollution constraint on China’s future growth

Environmentalism with Chinese characteristics

China Needs Industry to Enlist in “War on Pollution”

India is a fair distance away from China – and it’s already “choking on air pollution”. So the question is, where will the innovation come from, and which startups will deliver “vertical progress” to help sustain growth in emerging markets?

EM is lodestar for cleantech investment

Energy and clean technology investing has proven to be disastrous for venture capitalists. Capital allocated to clean tech fell to less than half in 2013 from the $3.7 billion invested in 2012, and new clean tech-focused funds were able to raise less than $1 billion last year, compared to $4.5 billion raised in 2012.

High-profile flameouts like Solyndra, A123 Systems, Konarka, Miasole, Better Place and Fisker Automotive have, appropriately enough, made investors very wary. Billions of dollars of equity has evaporated. Successes, such as Tesla Motors and Nest Labs, have been extremely rare.

Clean tech and energy, once touted as a fecund sectors for entrepreneurship alongside software, life sciences and the Internet, are no longer mentioned in the same league. Risk capital has dwindled dramatically, with prominent venture investors either winding down energy investing teams or retrenching significantly, content only with managing existing investments and not making new ones.

But why has clean technology blown a hole in investor’s pockets?

From questions about the suitability of cleantech for the venture capital investing model, to heated debates about the validity of climate change itself, which became a moral basis for the promotion of clean technology, many a rationale has been offered for why clean tech didn’t succeed in delivering investment returns. There is still no clear answer to why companies led by top-notch entrepreneurial operators and commercializing promising technologies met with spectacular failure.

It could be something more prosaic: clean technology companies and energy innovators have been in the wrong geographical market. Investors have unwittingly violated one of the maxims enunciated by venture capital pioneer Eugene Kleiner, who said; “Make sure the dog wants to eat the dog food.”

Take any metric – energy demand, fuel consumption, pollution, power generation growth, electrical grid development or water demand. Over the last decade, North American and European countries don’t figure on the list of the fastest growing markets for any of these.

Yet, clean technology companies have focused almost exclusively only on these developed world markets. The economies that have witnessed the highest growth in energy- and resource-related consumption are in emerging Asia, South America and Africa. Countries and cities in these regions also top global rankings for being the most polluted.

Does it make any sense to build windmills in Scandinavia or solar plants in Germany and California, when those regions already have relatively low levels of pollution and are fully electrified? As Europe is discovering, moralistic grandstanding cannot become the basis for innovation. This discrepancy represents a fundamental misallocation on a global scale of both human capital and financial risk capital.

The difficulty of commercializing innovation is compounded thanks to the cultural challenge innovators in developed economies face when working in emerging economies, which also inevitably have very different business climates.

Frequently, the geographical markets that are amenable to innovation in clean technology have regulatory risks and present far more challenging conditions for building businesses, as evidenced by their low rankings in the World Bank’s ease of doing business study.

This is an advantage “virtual world” businesses that are in consumer-focused Internet and mobile sectors have over others in that they have to contend with a lot less friction in developing markets.

Consider China’s situation. Tens of thousands of environmental protests are reported annually, millions of consumers live in extreme pollution and smog is destroying visibility – so it is easier to make the case for higher rates for electricity.

India’s growth has so far been predominantly services-driven. Manufacturing output has collapsed and saw negative growth because of unprecedented economic mismanagement by the current national government. This isn’t socially sustainable – as India promotes manufacturing and heavy industry to employ tens of millions of its youth, it’s inevitable that problems with pollution and environmental degradation will be exacerbated.

These are markets where one needn’t be moralistic about why clean technology is required. As the prospect of unlivable communities and unbreathable air looms large even in the most important urban centers, the economic logic for clean technology is self-evident.

Innovators outside these economies should take them a lot more seriously and find ways to overcome the cultural and business pitfalls of operating in emerging markets. There is also an unprecedented opportunity for inventors and entrepreneurs in emerging markets to build companies in clean technology.

A reallocation of financial risk capital and human capital towards where the clean technology and energy innovation markets are would go a long way towards solving the world’s sustainability challenge – and in the process, would also deliver far better returns for investors.

Originally Published: http://navam.in/1hmJSlU

Challenging Silicon Valley’s Innovation Hegemony

For several decades, Silicon Valley has had a near-monopoly on innovation. The Valley emerged out of America’s deep commitment to higher education and scientific research, combined with the American will to maintain leadership in defence technology. Through the second half of the 20th century, China was disastrously experimenting with Maoism, India was embracing Socialism, a fragmented Europe was rebuilding after the Second World War and the other superpower, Soviet Russia, was persisting with its Communist economic model. The Americans invested public and private capital in fundamental research and development, allowing private enterprise to drive economic growth and entrepreneurial small businesses to commercialize publicly-funded scientific research. America invented the venture capital model to commercialize such research.

It stood out as an oasis in a world where central planning and a state control of the economy was the norm. Owing to a liberal immigration policy, it became a magnet for talent from around the world. Scores of scientists migrated from Europe to America in the throes of the Second World War, including titans like Enrico Fermi and Albert Einstein. Nobel laureates Hargobind Khorana and Subramanyan Chandrasekhar, both of whom completed their college education in India, also made America their home.

The migration of talent from other parts of the world to America continued through the 1960s and 1970s, with the best talent from China and India making the move, thanks to the economic havoc caused by the destructive ideas of Chairman Mao and Prime Minister Indira Gandhi.

In this way, America managed to consolidate the world’s best scientific talent. It then gave them a platform and funding to invent and create. The scientists and engineers who went to America might not all have founded technology companies, but through their work at private research labs, government research institutions, universities and startups, laid the foundations for America’s technological prowess that underpins its military and economic might to this day.

It is important to recognize that this was a historical aberration and cannot be sustained by design — America positioned itself to benefit from the poor choices that the rest of the world made. A reversion to the mean is underway, and the tide has started turning over the last two decades. Besides increased economic and financial integration worldwide permitting capital flows on a global scale, economic reforms catalyzing sustained growth in Asia and the creation of a common market in Europe have fostered economic blocks that can compete with America.

Sector after sector has become more globalized. Venture capital investing, long the exclusive preserve of a clutch of firms on Silicon Valley’s famed Sand Hill Road and till recently heavily concentrated in the United States, is now unmistakably global. Risk capital flows to places that have talented people pursuing breakthrough business ideas — and sustained global growth over the last two decades has set the stage for a need for technological innovation across economies and geographies. The rise of the Asian consumer is creating opportunities for innovation in all kinds of consumer products. Transplanting ideas from elsewhere doesn’t always cut it with the taste and sensibility of consumers in Asian countries. With increasing consumption, there is a glaring need for efficiency in resource utilization and energy use.

Challenging economic conditions combined with more stringent immigration policies in developed nations have made it appealing for accomplished scientists and engineers from developing nations to return home, where in many cases there is stronger economic growth alongside a new focus on nurturing and financing science and technology. This has set the stage for venture capital investing in emerging markets.

America has a long lead, but the rest of the world is catching up. It will continue to maintain primacy in Internet innovation in particular because of the spending capacity of the American consumer. The Internet is a platform for consumption, be it consuming information which allows for digital advertising to flourish or purchasing products through Internet-based retailers. America’s consumption power allows it be the breeding ground for global Internet giants such as Google, Amazon and Facebook, and it will dominate in web innovation as long as the American consumer has clout.

New York-based venture capitalist Fred Wilson recently wrote about how the Valley’s dominance could be upended if there was a new wave of technological disruption, far separated from the computing and Internet industry on which the Valley has been built. Wilson said that should Silicon Valley miss such a new wave, it could look like Detroit in a few decades.

Just as a consumer-centric economy allows it to dominate Internet innovation, it also creates an insulation from innovation in non-consumer industries. The world has become a dramatically different place in the last few decades, and such innovations that define the next wave of technological disruption can come from any nation that has a sufficiently large pool of talented people working to solve the big challenges in energy, health care, clean technology and other sectors. That would weaken Silicon Valley’s grip on driving innovation — and further undermine America’s standing as a global power.

Originally Published: http://navam.in/1omJBAj

India’s rapidly evolving technology landscape

Most investors who have put capital behind consumer internet startups trying to build commoditised businesses will lose money.

India’s technology landscape can be characterized as having seen three waves of evolution and growth. The first wave was led by the likes of Tata Consultancy Services, Patni Computer Systems, Infosys and Wipro, who pioneered the outsourcing model based on labour cost arbitrage. These were firms founded in pre-liberalization India and took decades to establish themselves as global brands. The second wave occurred in post-liberalization India of the 1990s, when several IT firms adopted similar business models to the outsourcing pioneers. The small- and mid-sized enterprises that emerged during this period strengthened the foundation of India’s nascent software services industry and today form the backbone of that thriving sector. The third wave can be said to have begun with the advent of the Internet – startups such as Naukri.com, MakeMyTrip.com, InMobi and Flipkart.com who have emerged as category leaders in providing web services.

The common thread to the three waves has been the domination of the services-oriented software and Internet companies, and in recent years, the preponderance of ideas that have worked in the West that were repackaged to suit the Indian context. The fact is India has seen more imitation than genuine product innovation.

India’s technology industry has been dominated by IT and Internet firms, and venture capital investment figures for recent years bear out this trend. Since 2009, VCs have poured over $810 million into 113 deals in the software, mobile and Internet sectors. In contrast, early-stage health care and clean technology companies have received $292 million across 71 deals. It’s also interesting that average deal sizes are larger for early-stage companies in software and Internet than for health care and clean technology – one would have thought that the former is less capital intensive than the latter, and would hence require lesser capital to grow at the early-stage. By some estimates, India’s software and Internet ventures have been raising larger amounts of early-stage venture funding than American clean technology startups.

The data points to a clear mismatch both in terms of funding size and sectoral capital allocation. My hunch is that most investors who have put capital behind consumer Internet startups trying to build commoditized businesses will lose money. Most of these ventures are pursuing unsustainable business models. As if having imitators of American Internet startups wasn’t enough, we’ve seen imitators of Indian imitators of US Internet startups successfully raise funding. These ventures have almost no pricing power and hence almost no profitability. A fund raising arms race is under way, and the vast majority of startups will lose out as capital providers cluster around the top 1 or 2 category leaders.

In a more rational world, India’s VCs would bring together some of the outstanding engineers and scientists working at corporate research laboratories operated by Fortune 500 giants like General Electric, who are conducting key R&D work that is in many cases indispensable to the parent company. VCs should be willing to back stellar teams pursuing big ideas, and should invest capital in ways that harnesses the economics of outsourcing to deliver path-breaking innovation.

The data also tells us that more India-focused venture funds will be forced to look in places other than the tried and familiar Internet and IT sectors. Health care, clean technology and energy are mammoth markets that are relatively underserved and in dire need of early-stage capital, particularly for areas with substantial technology risk. Investors are beginning to recognize this, and several new funds have emerged that are both willing to look beyond IT and are comfortable backing early-stage ventures with $1-2 million.

The emergence of product-driven companies in sectors such as life sciences and clean technology in this decade will mark the fourth wave of the evolution and growth of India’s technology landscape. India’s talent base extends far beyond computer science and IT into fundamental sciences and engineering – it’s only a matter of time before risk capital connects with this talent base to deliver world-leading product innovation across more sectors. In order to achieve outsized returns, investors should skate to where the puck is going, rather than where it has been, to quote ice hockey player Wayne Gretzky.

Originally Published: http://navam.in/1iL99U1