It would be easy to be pessimistic about the current state of the cleantech innovation sector. We’re under attack by politically motivated facts-and-patriotism-be-damned foes; there’s clearly a shakeout happening in several sectors such as upstream solar; and more and more VCs are abandoning the sector (just over the past week, I heard of two more cleantech-specific VC firms that are shelving plans to raise new funds). These are not fun times, to be sure, and these are very hard times for early-stage entrepreneurs in particular.
But it’s important to recognize what this period really represents: the inevitable period of investor 'over-pessimism' following an innovation-driven period of irrational exuberance.
Whether it’s the Gartner Hype Cycle or Shiller or this Federal Reserve Board newsletter, experts in innovation-driven investments have spotted a recurring pattern in which investors often overreact to periods of innovation and expect unrealistic (and ultimately unachieved) levels of return on investments. "This will change everything!" they decide, and pour capital into it with the anticipation of future investors hopping on the bandwagon after them, rewarding them handsomely for having been earlier on the scene.
This is clearly what happened in the past decade of cleantech venture capital. The amount of capital put into various upstream solar, biofuels, battery, automotive, etc. startups was unprecedented and, in retrospect, was never going to result in consistent sector-wide returns (how many billion-dollar solar panel manufacturers can there be this decade, realistically?). Fueled as well by expectations of federal climate legislation finally passing, irrational exuberance was in full effect.
And what happens in such cases? Even in the best of times, results can't match such high expectations. And when the dawning realization also coincides with the worst macroeconomic correction in nearly a century, phhhhbbbbbttttt. (That sucking sound you just heard is the sound of most limited partners withdrawing their support from the sector, followed by a mad dash for the exits by generalist VCs.)
But that doesn't mean huge value wasn't just created. Look at the history of other such innovation-driven bubbles -- railroads, radio, automobiles, television, and of course telecommunications in the 1990s. In all of these cases, there was a period of correction where investments fell off dramatically, but then over the long run, these innovations became a platform for dramatic additional innovation and economic growth. In other words, the buildout of next-gen infrastructure has tremendous long-term benefits for follow-on investments and innovation, even if those who funded the initial pulse of infrastructure build-out might not have prospered themselves. Today's internet riches wouldn't be possible without the investments made in computing and communications in the 1990s, for example. "This will change everything!" is in fact correct, but that doesn't mean the investments in whatever "this" is will create strong direct returns.
So what happened in the past decade's solar and biofuels bubbles? The stage was set for dramatic cost reductions and production capacity. Ten years ago, we were thinking about how revolutionary it would be to see solar panel prices as low as $2 per peak watt. Today we're seeing thin-film vendors making large volumes of panels for less than 80 cents per Wp -- and falling.
The investments made by we overexcited investors worked, in other words. Oh, not for us and our LPs, in many cases. But certainly for the markets. Now, from solar to lighting to energy efficiency to batteries, we're seeing low-cost offerings that have compelling economic value propositions for customers, and are ready for primetime.
What does history suggest is about to happen, then? A renaissance downstream that drives an inflection of growth in demand.
These periods of irrational exuberance in technology innovation are followed by periods of investor over-correction and pull-back. It typically lasts a couple of years at least. And it's not unhealthy: Clearly, just doing more of the same type of investment as in that first wave won't generate returns, and as those sectors get somewhat saturated with innovation and/or overcapacity, it's unclear there's a compelling near-term market need in any case.
But then what happens is a rebound as a next wave of innovation -- typically market innovation, not technical innovation -- builds off of all this available innovation and capacity. Solar panels are cheap and plentiful? Great, how can I take advantage of that? LED lights are ready for primetime? Great, how can I sell them more effectively? This is why large corporates have gotten much more serious about diving into the sector, even as VCs have backed off: they see this pattern too, and selling stuff is what they know how to do.
In other words, after a significant pulse of technical innovation happens, there must be a period of overcapacity that drives down prices (and thus, investor returns) in order to enable the downstream demand growth that leads to a market revolution.
I know it's a hard period for early-stage cleantech entrepreneurs right now, as sources of capital have dried up. But I firmly believe that such downstream businesses -- be they services, or applications -- built on the increasingly cheap and plentiful upstream innovations will launch the next wave of really productive market traction for the cleantech sector, and be very profitable besides.
Investors overreacted with irrational exuberance to a wave of cleantech innovation seven years ago. They built the platform for the next wave of profitable business model innovation. Now these same investors are gun-shy, and are overreacting pessimistically. But that next wave is upon us. And I am confident that within a couple of years, those same investors will be rushing back in to fund next-gen applications ("cleanweb" and other) and scalable services built off of the infrastructure they lost money on originally. Owning access to the customer and low customer acquisition costs will be the next success metrics, not cost per Wp or per gallon or per kwh.
This is why I so soundly reject those who describe cleantech as necessarily being capital-intensive and hardware-oriented. That's the last phase. That's backwards thinking. That's narrow-minded. The next wave won't be tech-oriented. It will be commerce-oriented and application-driven. And it will make a lot of money for those with the foresight to anticipate this historically inevitable renaissance.