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A Conversation With Limited Partners, Part One: Categorical Denial

Rob Day: July 2, 2013, 7:55 PM

In this column, over the next few weeks, we'll be increasingly speaking to the limited partner ("LP") community: Pension funds, endowments, corporates and others who are the major source of funding for venture capital firms. The upcoming "NextWave Greentech Investing" conference by Greentech Media has already brought in a lot of participants from the LP community (you haven't signed up yet? why not!) and is aimed at encouraging a broader conversation across LPs as to when and how to get back into the sector and the megatrends it's taking advantage of. So we've been spending a lot of time recently getting the LP perspective on where the sector is right now.

As such, I had the opportunity to spend a couple of days with LPs and other fiduciaries last week, to specifically discuss energy investing topics as part of the east coast RFK Compass conference. Which, by the way, is a terrific event, they've done a great job of bringing together thoughtful LPs and creating a safe space for open conversation. 

One thing that struck me about these LPs at this conference was the extent to which many of them are feeling negative pressures to divest investments in fossil fuels, but not feeling the positive opportunities inherent in the same trends.

To take a step back: The Divestiture movement is an emerging effort to get university endowments and pension funds and other LPs to eliminate their investments in fossil fuels, directly and indirectly. It's especially strongly felt at university endowments, but I've seen it asked of large government employee pension funds as well. It's analogous to previous efforts to divest from investments tied to apartheid South Africa and to tobacco.

The push-back on the Divestiture request is of course a) to point out that there's an exceptionally large amount of pension fund capital tied up in SOME way into fossil fuels, so this is a much bigger ask than one might imagine; b) it's unclear where the investor should draw the line (is responsible production of natural gas really a net-negative for the environment, if it's cannibalizing dirtier fuels? many think not); and c) to suggest that objections can be more powerful inside the shareholder meeting than outside.

My intent is not to get into that debate here.

But what struck me is that all of this is really predicated on a couple of negative assumptions: That divestiture is about returns tradeoffs. And that divestiture is about categorical shifts.

First of all, let's talk returns tradeoffs. The portfolio theory of being an LP suggests that any limitations on the LP in terms of where they can invest result in lower returns. And this makes sense in theory. If you could choose from among the entire universe of investment opportunities, then any impingement upon those available choices results necessarily in lower returns. Why? Because there will be some superior returns among the boxed-out segments or asset categories. If your goal is to produce superior risk adjusted returns and someone tells you you're not allowed to invest in a quarter of the available managers because of some restriction or another, you'll be shunted into a smaller opportunity set and therefore risk lower returns.

It's a solid theory. But in reality, which pension fund managers thoroughly evaluate all available investment options available to them? In my mind, the theory breaks down on this assumption. Since you can't possibly cover the entire universe of investment opportunities equally thoroughly, then there's a more important filter in terms of where you're looking. This supercedes any selection bias forced by a sectoral screen, and opens up the possibility of positive effects from changed priorities. But importantly, sectoral screens also aren't the only solution, which brings us to our second point.

Which is: Divestiture pressures don't have to result in categorical shifts. They don't have to result in outright rejection of all fossil fuel dependent industries, but instead they can help unlock other sources of value by identifying inefficiencies and more strategic value differentiation even within industries.

There's been a lot of research done to suggest that, within any given market category, the environmental leaders outperform the laggards. I saw it at my old shop way back when I started my career, and I continue to see it in additional research today. I believe this applies in the investment universe as well as down at the individual portfolio company level (where most of this research has been done). 

One participant in last week's conference declared, "Over the long run, externalities will be priced in." And this, I believe, is true. But let's not be sanguine about this fact. "Over the long run, we're all dead" would be the appropriate rejoinder to this sentiment. Just because eventually externalities such as the societal damage of coal, etc., may end up being priced into the market, doesn't mean alternatives are necessarily a good bet today. It's unclear how or when even "inevitable" shifts will happen, and I sympathize with LPs who now have to take a perspective on timing this long-term dynamic. So I'm not here to argue that it makes sense for all LPs to assume, for instance, a particular carbon price when evaluating investment opportunities.

But that said, LPs are affected not only by returns expectations, but by risks. And across investment categories, climate change and other related factors now represent an external risk that at some unpredictable point might become internalized in the portfolios of managers that these LPs back. Thus, LPs should hold managers accountable for how they're assessing and dealing with this risk. Even for LPs who cannot or choose not to divest from fossil fuels for whatever defensible reasons, the divestiture movement could serve as a wakeup call to view their manager selection through a sustainability lens.

When I was starting my career, working with Fortune 500 companies helping them identify profitable and sustainable business opportunities, we developed a perspective that there are actually four different ways that such a perspective could unlock shareholder value. Only the first of which was "right to operate", i.e., worries about being denied ability to operate thanks to public reaction or regulatory crackdown or other negative pressures. Yet, this is where the Divestment movement is mired right now, from the LP perspective. 

What we showed was that positive screens -- "how can you take advantage of rethinking your operations, business or market" -- also yielded strong shareholder results. Sometimes very significantly so, by unlocking business model innovation. And that requiring the thought experiment ("how can we take advantage of sustainability trends, instead of just reacting to them") was the way to uncover such improvements.

As far as I can tell, few LPs are viewing the Divestiture movement -- much less broader sustainability pressures -- in this way. It's still a reactive exercise, and still viewed as a negative screen. 

We'll talk more about other implications in future columns, but the one big implication of this for LPs is this: Even if you're not going to deny yourself entire categories because of Divestment and sustainability pressures, you should still look to favor some managers over others within any categories and sectors, on the basis of evidence they've soberly assessed these pressures themselves. Managers who've got a thoughtful perspective on climate change and likely regulatory impacts, etc., have at least thought it through. Even if they then invest against these factors (for instance, I've seen some thoughtful energy project firms recently invest in both solar project finance AND coal-fired powergen production) it's an educated judgement call they've made. They're considering the risks and the tradeoffs. And that ultimately reduces LP risks.

So while the Divestment debate rages on, it should be a prompt to LPs to apply climate risk-mitigation strategies across their entire portfolio, in a more discerning fashion. Within even seemingly extraneous categories (real assets, real estate, etc), using this lens can help differentiate between long-term thoughtful managers and riskier-than-advertised firms. And certainly in direct-hit categories like venture capital and especially energy project finance, it can be an invaluable screen for seeing which managers are viewing long-term trends appropriately and who's ignoring them. That's true even if the answer is to back a manager who's heavy into fossil fuel projects; just knowing they've asked the right questions is a risk-mitigating move.

I don't see a lot of LPs viewing their world this way right now. It's all about categories, not differentiating managers within categories. And thus Divestiture is seen as a threat to returns rather than an opportunity to boost returns. We'll talk in the next column about cleantech as an alternative category in which to put capital with equivalent returns. But for today, just note that even without shifting any asset allocations or category allocations, simply reacting to Divestiture pressure by using it as a lens by which to view managers and their risk-mitigation strategies, can yield dividends for portfolio managers.

And sign up for NextWave today!

Some Thoughts on Cleanweb Business Models

Rob Day: June 24, 2013, 10:00 AM

It's great to see a significant upswing in entrepreneurial and venture capital interest in so-called "cleanweb" business opportunities. Regular readers of this column will know that I am a fan of the strong business and environmental potential from the application of web-based business models to resource efficiency. It skewers the popular misperception that "cleantech is always capital intensive and takes a long time to commercialize", and can have a significant impact.

However, all cleanweb startups are not created equal.

With the rise of the category, I've seen a rise in the number of cleanweb startups pitching venture capitalists with somewhat muddled business models. Just because a startup idea is based on a web platform doesn't mean it will scale quickly and become a lucrative exit for all involved, after all. Maximizing the value of cleanweb for entrepreneurs and investors is easier said than done. And in particular, I've noted many entrepreneurs rightfully recognizing the importance of building a cool product, but not recognizing the additional importance of building defensibility into their business model.

You can't blame folks for some confusion. I've noted that whenever people talk about why a site or an app is successful, they focus on the user experience, and on branding. Even the most dominant companies in the tech sector talk about "the experience of the product" rather than how their business model has captured customers (which is where they really make their money). Yes, user experience and branding are vital success factors, not to be minimized. But they are "necessary, but not sufficient" success factors for cleanweb startups. We can all easily identify an app or website that we really liked and that even built a good brand but that we don't visit or use anymore. What makes some web-based business models scale quickly and become hugely valuable assets even while many others languish?

To answer this, let's take a look at some of the current crop of emerging cleanweb "early success stories": AirBnB, Waze, car-sharing services like Lyft and Sidecar, etc. Make your own list. What do they tend to have in common?


1. The companies designed business models with strong network externalities.

Put simply, they designed from the beginning a model where every new user makes the asset more valuable for every existing user. And vice versa. The simplest examples of this type of "virtuous cycle" are C2C marketplaces ("everyone goes there because everyone goes there"), but there are other ways to go about building that kind of self-reinforcing dynamic. Data can be a valuable tool toward building this kind of sustainable advantage as well, if the data is very actionable and easily collected from users (think about Waze's crowd-sourced traffic predictions) for example. And in talking with many cleanweb entrepreneurs, they get this concept.

That said, I continue to see a lot of cleanweb entrepreneurial efforts that haven't really figured out what this concretely means for them. No, it's not that the cost of customer acquisition goes down because more people have heard of you. That's branding/PR and is very replicable -- do you remember what the hot iPhone app was in January? Me neither. And no, it's not that you establish a reputation as an "alternative" opportunity for the few who want something different from the herd. That's a recipe for building some kind of artisanal marketplace or tool that's only cool because so few people are using it. That can be a very fun business to run, but would appear to have a bit of a low ceiling and thus not a fit for VC.

Be very purposeful about how you build network externalities into your business. 


2. Startups may not even consider themselves "cleantech."

Labels are always in the eye of the beholder. One thing that's been true of the cleantech sector from the beginning has been that proponents like me have claimed companies as belonging to the sector even when the entrepreneurs at those startups may not have been motivated primarily by cleantech considerations.

But that's fine. What it really points out is that successful cleanweb startups will most likely not have economics-only value propositions. When people flock to a product or an app, it's not because of the potential for 10 percent to 15 percent energy savings (for instance). The best solutions have a lot of other benefits as well. Gamification motivations. Time savings. Enhanced comfort. Simple pride. Whatever the case may be, the successful cleanweb startups strategically include those other benefits and emphasize them. They may even be the primary motivations, with the revenue model being targeted marketing, and nothing to do with energy savings. 

Figure out what people are willing to pay for. Emphasize that. You may be motivated by environmental concerns, and if so that's awesome. But figure out what aspects of your business model delight users and double down on that -- it may have nothing to do with cleantech at all, at least directly.


3. They build in high switching costs.

One of the "cleanweb" businesses I see with the most potential (and they may not even consider themselves a cleanweb company) is Nest. Once you've got one of those thermostats installed, you're unlikely to uninstall it. Which therefore means it becomes a very important and defensible platform for a lot of additional user engagement. 

That's an extreme example because it's a physical installation of a product, but anytime you've got a business where you're deeply integrated into the user's existing systems, it's tough to unwind. What the more successful cleanweb startups have in common is that, once you've gone through all the trouble to get integrated into their system, it's a pain to switch over to an alternative site or app. 

Loyalty programs can help, but in my humble opinion they're a bit overplayed (I have no idea what Waze's points do for me). But there are other options available. Quality-control processes, for example, where to be allowed into the system you need to get vetted and build a displayed reputation. Monetary accounts where you've parked money or otherwise just connected it to your wallet. 

Basically, people have a lot of systems they already rely upon. Their wallets, their contacts database, their home or building automation systems. Whatever it is you can interact with that they depend upon, make it easy to set up and hard to relinquish.


4. They have thought through the interactions with the physical world.

Cleanweb startups, as with all cleantech startups, are inherently entangled with the physical world. You're helping people transport themselves, lodge themselves, or change how the buildings they're in operate. The interaction between the physical world and the web world needs to be seamless, and have as few moving parts as possible. And this is really hard. But the cleanweb startups who succeed seem to do this really well, and continue to make it a priority going forward. Arguably Zipcar's system for unlocking cars was as important to their early success as anything else, because a more difficult system would have created friction that would have driven customers away.

Along with focusing on the online user experience, it's as important to focus on the offline user experience. And don't be afraid to productize it.


5. They've tended to be consumer-focused instead of B2B.

To date, the fastest-scaling cleanweb stories have been B2C or C2C. At least as standalone cleanweb businesses have been concerned. I find that curious.

On the one hand, I do see lots of efforts by larger B2B companies to build cloud-based interfaces into their offerings, as a means of capturing customers. Which suggests there's nothing inherently consumer-oriented about cleanweb applications. So perhaps there's a bit of a selection bias among cleanweb entrepreneurs that we're seeing, which would explain things. And furthermore, I do increasingly see emerging B2B cleanweb entrepreneurial efforts that I think hold a lot of promise (and, of course, at Black Coral we've even backed one). In my opinion, B2B cleanweb businesses might be a highly lucrative and yet thus-far relatively untapped entrepreneurial area.

On the other hand, there's something about consumers being more willing to engage with and even embed an application into their lives relatively quickly, versus how slowly corporate customers tend to move. As individuals, we hear about a cool app, and we download it and try it. But trying to get a corporate purchasing department head to do the same thing is more difficult. When you do get it to happen, it raises the switching costs significantly, which is good. But it suggests that a good strategy for B2B cleanweb efforts is to emphasize offerings that individuals in the workplace can try and adopt and eventually get familiar with, rather than go straight to the corporate-level sale. At least for early stage startups trying to break in.


6. They've really thought through how they're going to collect, analyze and use data.

At some point in every cleanweb investor pitch, the entrepreneur mentions all the user data they're going to be collecting, and asserts that it will be valuable. Hand-waving ensues.

Just because it's there doesn't mean you'll figure out how to use it. The best efforts in cleanweb treat data like the weapon it is: They hone it. They devote significant resources to making it ready and useful. They know exactly how they're going to use it when the opportunity presents itself. 

There are lots of ways people have found to deploy rich data sets for a competitive advantage. It can be core to the entire business, by offering a crowdsourced solution. It can be used for targeted marketing. It can be used to establish new industry standards. It can be used to help underwrite financial products. Whatever the case may be, no one will simply pay you for your data just because it's there. It needs to be specifically applied and demonstrably valuable, to users, other customers and eventual acquirers.


The above thoughts are really intended for cleanweb entrepreneurs who think they are going to be a fit for venture capital, and vice versa. As with everything else, there are going to be some great (and potentially personally lucrative) business opportunities in the cleanweb space that shouldn't take in venture capital. And in fact, even high-upside growth opportunities in the cleanweb space can go pretty far without venture capital in many cases. Many of the most compelling cleanweb efforts get their MVP out there pretty quickly and start figuring out all of the above, before ever raising a venture capital round. So not all of the above thoughts will be applicable to all cleanweb entrepreneurs. Take them for what they're worth.

Cleanweb represents one end of a broad spectrum of interesting cleantech entrepreneurial opportunities, and is especially popular right now., which is awesome. I look forward to seeing more iterations on this theme, but I do think we all have a lot to learn from the early ongoing efforts in the space. So please let's all keep adding to this thinking. 


Defining ‘Significant’ Cleantech Investment and Deployment

Rob Day: May 29, 2013, 2:00 PM

First off, I'm very excited about a new conference Greentech Media and I are teaming up on. In Menlo Park in September, we're going to host a crowd of limited partners, family offices, entrepreneurs, venture capitalists and other industry participants for the first "NextWave Greentech Investing" event. It's an idea based upon this column I wrote a few months back, and cheers to my friends at GTM for following through on it. Already a bunch of LPs and family offices are registered to attend, which is great to see. Should be a fantastic day with a wide variety of interesting investment theses brought out into the open.

And yes, that means there will be some (constructive) disagreements among investors. We're all working to develop new approaches to this huge macro opportunity, and these approaches are increasingly looking very different from each other. And as I mentioned in my last column, that's okay! We don't yet know which new investment strategies will succeed, we just know we need some new investment strategies. It's a time to question assumptions and past patterns, not rely upon them.

Which brings me to the subject of this column. A few days back I was catching up with a fellow investor I admire, and he said something I've been mulling over since we spoke. He mentioned my thesis in "market reinvention" -- changing how we deploy, buy and consume increasingly cost-effective clean technologies. "But I've concluded," he continued, "that to do anything significant in this sector, we need to spend a lot of capital and take a long time."

My question back at him at the time was simply this: "Define 'significant'?"

But I see his point. We're a long way away from implementing solutions at the magnitude necessary to significantly change the trajectory of our global climate crisis, for instance. And ultimately, significant new technology advancements will be necessary to get there. We can't just "efficiency" our way to zero carbon emissions, for instance.

Let's take solar, for instance. Solar is definitely a feel-good story right now. Installed solar capacity in the US nearly doubled last year, adding 3.3 gigawatts to total 7.7 gigawatts of capacity by year end. By my back of the envelope calculations, that probably results in around 10 terawatt-hours of solar-based generation potential, accounting for capacity factors and such. And rooftop solar not only has been growing by around 60 percent per year, the success of SolarCity and other solar financing players has just further accelerated adoption. It's a big, attractive market for investors.

And yet at the same time, it's just a drop in the bucket. 

Let's put this in real world terms. As of March 2013 there are 52 gigawatts of coal-fired capacity in the US announced for retirement. 45 gigawatts of that is scheduled to go offline over the next three years. At an average utilization of 49%, that implies those 45 gigawatts produce around 193 terawatt-hours per year. So all that solar capacity we've successfully put in to date only adds up to around 1/20th of the capacity of coal-fired plants being retired over the next three years. Much less, the full 322 gigawatts US coal-fired power plant fleet. 

Even looking more broadly to include the much greater wind and geothermal capacity in place (which has only minimally been the result of venture capital investments) in addition to this solar capacity, in the US the total production out of these renewables tallies up to only around 1/20th of the production from combustible fuels.

So yeah, compared to those kinds of benchmarks we've got a lot of work to do in clean powergen to achieve anything "significant".

But that's an incomplete picture. Let me throw a few other data points at you.

  • If solar installation levels in the US grow 40 percent per year (remember, they've been growing significantly faster than that) over the next three years, that 10 terawatt-hours of solar-based generation would grow to 40 terawatt-hours during the period in which those coal-fired plants would be retiring. Solving 20 percent or more of that gap seems significant. And at this point it doesn't require massive amounts of venture capital in long-term breakthrough technology development efforts to get there. It needs VCs moderately funding efforts like financing solutions, customer lead generation tools, cheap inverters, and other installation cost reduction efforts, which then serve as leverage to unlock a significant amount of non-VC dollars to fund the actual implementations. 
  • So far in this column we've ignored energy efficiency. We shouldn't. In fact, building energy efficiency has already been so effective and widely adopted that building energy usage is in steep decline and isn't expected to dramatically rise anytime soon -- in fact it might keep dropping significantly. A reasonable set of assumptions about continued efficiency gains nets out to 62 gigawatts worth of reduced necessary powergen capacity, according to one study. That replaces the retiring coal-fired fleet by itself, and there's potential for much more reduction. And again, while this has been triggered by venture capital investments in some ways, it hasn't required massive amounts of venture capital dollars either to fund long-development breakthrough technology, or to fund the actual implementations. Consumers have been funding their own implementations.
  • Similarly, VCs have partially funded the development of advanced lighting technology that's now poised to save up to 122 terawatt-hours of lighting-specific electricity consumption per year by 2020. That by itself would cover around half of the current announced coal-fired plant retirements. And again, this is already set in motion and will be largely funded by consumers themselves, not VCs.


Yes, these are not full solutions, I'm not trying to in any way suggest that deeper breakthrough tech innovation isn't needed or potentially lucrative. Nor am I trying to play the role of Pollyanna, saying everything's fine and taken care of already -- the above growth does still mean figuring out business model innovations and market solutions to overcome non-economic barriers to customer adoption, as we've discussed here before. 

But I think we can all agree that these existing solutions offer potential impact that is indeed "significant." Solar plus energy efficiency plus wind power is already on a path to making a big dent in the problem, without it taking a long time and lots of venture dollars to come to fruition. It does require a lot of dollars in implementation from project funders and customers themselves, but not an unrealistic amount of venture capitalists' dollars and patience.

In short, VCs investing in nearer term business model innovations and "tech-enabled" product/service solutions that change and accelerate how people buy, sell, and implement existing clean technologies are indeed "doing something significant", just as the more hardware-centric deep innovation investors are. Both types of efforts are needed, and both can generate returns. And from available early evidence, right now, we "market reinvention" investors are making returns in a timely fashion with our approach. That, to me, is also significant.

In September, we'll be hearing from investors now tackling a lot of different "significant" solutions via a variety of investment models. I'm really looking forward to it.

A Tale of Two Cleantechs

Rob Day: May 14, 2013, 11:33 PM

Two years ago, I heard today, at the NVCA Annual Meeting the Cleantech session had 200 participants.

At today's, it had around 30.

And yet I walked away very encouraged. Why? Because in a room that probably had something like 200 or so collective years of cleantech venture experience, so many smart minds were focused on the basic question that we're wrestling with these days: "What will the next wave of cleantech venture capital look like?"

The panel session quickly turned into a full-room discussion on the subject, with lots of fodder for future columns (I'll get to them eventually, I promise). But perhaps the biggest takeaway for me from the conversation was Josh Green's suggestion that there will be two separate cleantech categories. "Energy/Industrial", and what I'll generally call "Market Reinvention" (while continuing to think of a better way to describe a wide range of consumption-facing business models and technologies -- suggestions welcomed).

"Energy/Industrial" would be the cleantech that many VCs and others seem to instinctively think of when they think about "cleantech": Hardware innovations, production processes, physical innovations. And this always seems to be what VCs gravitate toward. If you get more than two VCs together in the same room to talk about "cleantech," I guarantee you that within five minutes the conversation will have skewed over into the difficulties of getting venture returns from materials science or bio-chemistry innovations. (It was fun to watch the cleanweb investors like Mitch Lowe from Greenstart smile and go silent when that happened today.) There are a lot of reasons for this dynamic, including that many of the original cleantech venture investors came out of such hard-engineering disciplines, as well as the fact that cleantech markets are inherently about the physical world and thus there's no escaping the significant needs for such physical world based innovations. But clearly, a lot of venture investors, LPs, pundits, etc., tend to have a primary image of "cleantech" as being all about this subcategory, not just sometimes about this subcategory.

And the other category, as regular readers will no doubt recognize, is about business models and system integration (sometimes financial-oriented, sometimes web-oriented, sometimes software and controls oriented, sometimes deployment-oriented, sometimes just plain services). In large part, these are innovations focused on accelerating the adoption of the increasingly-attractive physical innovations and other resource efficiency improvements that the last decade of cleantech venture capital has done so much to bring about. They can create competitive advantage through proprietary IP, but as often they utilize brand, network effects, captive value chains, etc. to create their competitive advantages.

The point of the conversation, as it dwelled on this division, is that these two subcategories are really very, very different. Very different in terms of the skills required by the entrepreneurs and investors; different in terms of capital requirements; different in terms of time to market; different in terms of which strategic partners are critical, and what roles they need to play.

I happen to personally believe (and am investing around the thesis) that the current investment opportunity is in the Market Reinvention subcategory. Because there's a backlog of ready-for-prime-time physical innovations that aren't being adopted nearly as fast as their economic value propositions would suggest, so there are rapid growth opportunities to be found in figuring out how to unleash accelerated adoption.

Indeed, when Cambridge Associates put out a recent analysis of cleantech venture returns, the differences in performance between these two strategies was quite stark. From 2000-2011, they found that the pooled IRRs of bets in "Renewable Power Development" (basically, deployments/finance/etc. downstream of powergen) and "Energy Optimization" (lighting, efficiency, etc) were relatively more attractive at 11.4% and 8.9% respectively, whereas IRRs for "Renewable Power Manufacturing" (at 4.6%) and "Resource Solutions" (at 1.5%) were significantly less attractive. 

But the point isn't to argue that one of these subcategories is better or more attractive than others. That will likely be cyclical. If Market Reinvention is successful, in fact, it will create both increased demand for and more rapid adoption of new Energy/Industrial innovations and thus create the opportunity for superior returns there. It's analogous to when corporate America got to a point of prioritization of and dependence upon new IT innovations that CIOs became prevalent -- when corporate America starts hiring "Chief Energy Officers" we'll all be much better off and physical innovations may find more rapid paths to market adoption and exits. And heaven knows, as a society we need much significant progress in these innovation areas -- a need that may well lend itself to tremendous investment returns for investors with the right strategies and in the right market conditions. 

No, the point isn't to advocate for one of these subcategories or the other; the point is that these subcategories are indeed very different and thus require very different investment strategies and skill sets. In any rethinking of the cleantech venture category (and perhaps leading to some rebranding efforts), it's important to acknowledge these differences, and indeed embrace them.

In short:

1. "Cleantech" is not one opportunity. It is lots of completely different opportunities in completely different markets, built upon completely different technologies. It is more of a lens through which to view a wide range of innovations by entrepreneurs, some of whom may not even consider themselves "cleantech." And that's okay.

2. Not all of these opportunities will be a fit for the venture capital model, with its exceptionally high returns expectations and relatively short time to exit expectations. And the boundaries of that will vary over time. And that's okay. 

3. And even within these subcategories, there will be very different strategies and skillsets required. Smart investors will move away from "checklist investing" as so many of us have engaged with in the past ("I still don't have an advanced battery company in my portfolio, let me go get one of those") and start to focus on particular areas (skill-wise and/or market segment focused) where they have particular access and expertise. And that's okay.

Lest we forget, these are markets that add up to trillions of dollars of revenue opportunity per year that are practically screaming out to be overtaken by new, more efficient technologies and market processes. Clearly, only a subset of this opportunity will be applicable to venture capital returns. But even that subset will be hugely attractive, when we can figure out how to crack it open.

Let's go crack it open.

Consolidation in the Intelligent Energy Sector

Rob Day: May 8, 2013, 8:43 AM

Consolidation in an industry sector can be a good or a bad sign.

The waves of consolidation in the PV manufacturing sector for example, presaged (when it was vertical consolidation to lock up access to demand for panels) and then highlighted the overcapacity in that industry. Much of the ongoing consolidation upstream in the solar value chain at this point is opportunistic consolidation of IP on the cheap. Not exciting at all from an investor's perspective.

But the looming consolidation in the "intelligent energy" (i.e., IT applications in energy efficiency) sector is, I believe, a very different story. One that is positioning the sector to start showing some really exciting growth stories.

There is a paradox at the heart of the building energy efficiency opportunity.

Many venture investors have shied away from the sector because it doesn't lend itself to what they consider "proprietary technology" that has massive scale -- because it is a highly fragmented market, when you get down to ground level. A home in Nevada behaves very differently and has very different energy costs than a home in Connecticut; much less trying to compare either building to an office building in Chicago, or a foundry in Idaho. So the matrix of optimal lighting, HVAC, etc. solutions ends up looking quite different from customer to customer.

And yet conversely, many of the basic solutions do have commonalities; and many customers end up having some of the same space-driven needs in common. That foundry in Idaho does have an attached office that's smaller than, but has similar needs to, that Chicago office building. Those homes both have opportunities to participate in automated demand response programs and voluntary efficiency programs.

As we've discussed here before, one of the challenges for "single solution" vendors is figuring out how to scale up in the face of such a fragmented market. It's tough to navigate through that matrix of potential customers to find the ones that need your particular solution AND have budget, authorization and motivation to act. One solution we've discussed is to cast a very wide net, and harvest the scattered "easy wins" out there.

But an alternative approach is to offer a full solution set. If you have a full suite of solutions, it's more likely that any single customer will have a need you can satisfy. And that's what the looming consolidation in the intelligent energy sector is shaping up to look like. An early mover in this wave, EnerNOC, acquired several ancillary businesses in energy procurement, carbon accounting and wireless demand control for small commercial facilities -- acquisitions with mixed results, but clear intent. And then came yesterday's announcement of Nest's acquisition of MyEnergy. These were acquisitions to provide more completeness of offering to customers who want a single vendor to solve their overall energy issues, not just offer one particular solution. They don't complete that aspiration, of course, but they're pointed in that direction.

While there have been and will continue to be opportunistic acquisitions of distressed assets, of course, I believe this is going to be a healthy consolidation wave in this sector. Why? Because the most strategically-valuable acquisitions will be the ones that customers are already experienced with and are proven out in the marketplace, not distressed assets. Acquisition targets that already have some additional strategic value beyond any proprietary technology, such as customer/user networks, brand recognition, etc. This will be real companies buying real companies, and if done right, will end up with even faster sales growth. And in intelligent energy in particular, it is relatively easier (stress on "relatively") to integrate different offerings into a consolidated single platform for customers.

What this likely means is that we're going to start seeing the emergence of several acquiring platforms that could eventually challenge the incumbent sleepy technology providers in these markets (the Johnson Controls, Honeywells and Rockwell Automations of the world). These acquirers will increasingly look to offer a full-service solution set to a particular category of customers -- utilities on the one hand, and on the demand side likely different platforms for different major categories like residential, retail, manufacturers, etc. Some solutions will be outright acquired, others will be licensed or otherwise brought into the solution set without an acquisition. But for major categories, the offer will be "one-stop shopping" for their energy needs.

Controls providers will be well positioned, if their solutions can be easily integrated into a wide range of other vendors' equipment. Network effects really come to the fore when you're looking to consolidate control of a very fragmented user equipment base onto one platform.

This also likely means that owning the customer relationship, is going to become even more valuable. Those who own the customer interactions are going to want to be such consolidation platforms; startups that can aggregate a significant customer or user base and aren't planning on driving consolidation will themselves become prime acquisition targets.

The rapid proliferation of new, intelligent solutions for the building energy efficiency market has therefore opened up an opportunity for some new, big players to emerge. And for the incumbent providers to also therefore need to drive strategic acquisitions of their own so that their offerings to their customer base also don't develop gaps. 

This feels like the launch of an arms race in intelligent energy, in other words. And investors who are building and selling into it should be pretty excited right about now.

Clean Energy Policy: A Three-Legged Stool

Rob Day: April 22, 2013, 2:35 PM

As I sit here at the jam-packed BNEF Summit listening to Senator Murkowski express her frustration about unrealistic political rhetoric on energy, I'm reflecting upon all the recent discussion among clean energy advocates here in the U.S. about priorities.

There's a recognition that in this policy environment, at a federal level this sector won't be able to enjoy all the policy support it should. But upon recognizing this the three major camps of clean energy policy advocates immediately fall upon each other, arguing that their camp deserves the most attention and support.

Advocates of deployment argue for implementing today's energy efficiency and renewable energy technologies at scale, as the best way to affect ongoing carbon emissions and build a stronger sector that can provide fertile ground for future generations of technology. Advocates of breakthrough innovation argue that today's technologies aren't sufficient so it's more important to emphasize R&D for the future solutions that can actually be full solutions. And those of an economic bent still advocate for putting a price on carbon as the biggest overall piece of the puzzle, but they tend to be more quiet these days, with a few stalwart exceptions.

They're all correct. But they all too often insist the other camps are wrong.

We need as much deployment as possible of RE and EE today where the economics make sense, and increasingly they do. The bigger the installed base, the more simple cost curve dynamics drive down prices. And the more people employed and making profits off of clean energy, the bigger voice we have in politics. Momentum matters. Forgoing momentum today to attempt an end-around via breakthrough innovation that solves everything down the road seems improbable, and also unrealistically assumes that a weak market with non-existent channels, etc., could even rapidly scale up such innovation when it becomes ready. And as for carbon tax advocates, it's unrealistic to expect a price on carbon to be politically acceptable if the alternatives aren't evidently at scale.

So I'm encouraged to see the efforts of Sens. Coons, Moran, Murkowski and Stabenow and others to put in place policy changes like MLP treatment for renewable energy that could help unlock deployment capital. These and other policy changes are possible (if still not probable) even in this broken political climate, and could make a significant impact. At a local level, movements to promote PACE and EE financing and feed in tariffs are all also welcome. I love the "race to the top" model for state-level energy policy encouragement outlined in the Obama budget. Furthermore, I've also talked here in the past about non-budgetary ways the White House could do a lot more to focus corporate America on making energy efficiency a shareholder-pleasing priority. If something like these kinds of efforts gets momentum, clean energy advocates of all camps should throw their weight behind it, and not whinge about how their individual camp is being left out.

Similarly, we clearly need to support more R&D spending on clean energy technologies. The Obama budget underlines this need and asks for significant more resources -- this may well not happen when Congress gets around to their own budget versions. But again, it's worth all clean energy advocates fighting for, arm in arm. Even among later-stage deployment folks, the emergence of alternative cheaper energy solutions would only enhance future economics. And to be blunt, as human beings we also need this type of breakthrough innovation, eventually.

Finally, we need a price for carbon. I see deployment advocates and innovation advocates pooh-pooh this basic fact way too often, arguing that a patchwork quilt of incentives for their pet priorities are sufficient. And there's a somewhat defeatest attitude presented along the lines of "oh, Americans will never go for that, so stop distracting yourself with the concept." But let's remember that the climate challenge is at its root a challenge of externally-priced damages. When dumping carbon into the atmosphere is free, no one internalizes these externalities and thus any patchwork of policies will find loopholes exploited, key solutions left out, arguments against "government picking winners", etc. Thus, an overarching policy solution is an inevitability, frankly.

Which is where I take issue with the White House (sorry, Mike and David). I agree that a price on carbon is probably unrealistic in this Congress, and I agree that the President's bully pulpit role will be insufficient to change that fact due to entrenched obstacles, and I understand that this White House is looking for battles they can win right now. But that's such a terribly short-sighted perspective on the President's role. Addressing climate change is going to be a decades-long struggle more akin in its political dynamics to civil rights progress than to near-term economic policy debates. And seen through this lens, the President should take every opportunity to simply utter the phrase "There will eventually be a price for carbon emissions". Just say that. Yes, the President talks about climate change and yes there are some good efforts being done by the Administration such as those mentioned above and many others. But eventually we need a price on carbon. And the President of the United States cannot be cowed into silence on that fact, even if it's politically impossible to push any specific legislation during this particular Congress. Repetition of this phrase, by this President and future presidents, helps shape the expectation that it will happen. It keeps the sense of inevitability that powers long-term political fights. It reminds everyone that, even if it's not a top three priority at any given time, it remains a long-term priority. It's too important to leave to patchwork half-solutions and short-term political silence. And just talking about climate change is not enough. People need to hear that there is an inevitable long-term solution. Or the inevitable keeps getting pushed back.

And along those lines, advocates of clean energy innovation and deployment need to stop their own reticence to engage in this inevitability. I've seen studies talking about how, for instance, dollar for dollar a direct subsidy to deployment results in more deployment than a broader carbon tax. Well duh. If all you care about is deployment of certain technologies, then put your dollars directly into that. But a) this type of argument only serves to illustrate how a broader approach to ALL carbon-reducing options is important, because dollar for dollar internalizing externalities will be more efficient for reducing carbon emissions than any subsidy; and b) a price on carbon can be made partially or entirely revenue neutral, and thus "dollar for dollar" should actually serve multiple economic purposes and have even broader benefit. But that's not to argue that a price on carbon is more important than supporting deployment or R&D -- it's absolutely true as well that if carbon emissions were priced but no support was given to emerging technologies or innovations, barriers to entry and lack of R&D capital would slow down necessary progress.

In short, we need all three: Innovation, Deployment and a Price on Carbon. The right answer isn't one or two of these policy areas. Appropriate and comprehensive clean energy policy is a three-legged stool. I recognize that policy advocates are incentivized to be contrarian and thus divisive. And I agree that we can't do everything, so some prioritization is necessary. But please, stop arguing that your leg should be longer than the others. Let's all get behind whichever of the three has a window of opportunity at any given moment. And let's all speak loudly at all times about the importance of all three; now if possible, later if necessary. We're too small of a community to be able to afford being so internally divided and riven with cynicism.



Why Are Utilities Letting Other People Take All the Value?

Rob Day: April 4, 2013, 2:37 PM

The traditional utility model is under threat. Industry leaders like Jim Rogers and David Crane are talking about this publicly. It's becoming harder and harder to make profits managing wires that distribute centrally sourced kilowatt-hours to end customers on demand. The aging T&D workforce, new potential significant loads like PHEVs, intermittent and distributed generation sources, an increasingly complex array of technologies on the demand side and on the grid for utilities to be on top of -- it's not surprising that utilities are finding it a daunting challenge to profitably manage their businesses with their existing wires-based revenue models.

But what I'm surprised about is that utility managers and their boards aren't taking advantage of the unique positioning and branding they have with customers, and their big balance sheets, to tackle other emerging profit pools. In fact, they're letting other players come in and chip away at them, even though they are in a strong position to capture a lot of shareholder value here.

Ultimately, I believe that the wires-management portion of the electric utility business will be used by investor-owned utilities (IOUs) to enable other, unregulated profit centers.

There's already a strong history of IOUs running unregulated subsidiaries. This practice has waxed and waned over the past couple of decades, but I've seen IOUs that have run outsourced billing services divisions, energy trading shops, and even fuel cell businesses. In many cases, those unregulated subs weren't designed to take advantage of the market position of the regulated T&D business unit actually managing wires, etc., but there's no reason they couldn't be if structured appropriately.

Let's look at the business opportunities on the demand side right now. Utility customers are looking to take on energy-efficiency projects, distributed generation installations, inclusion in demand response and ancillary services and other load control programs, backup power and combined heat and power systems, etc. But what holds back these activities from scaling up even faster than they are today? Lack of capex, and lack of buyer information (which vendors to work with, which systems actually work, what other options are there, etc.).

What are utilities uniquely well suited to provide to the customers they literally touch, via managing the wires? Financing of capex, and access to buyer information. How?

Utilities have big balance sheets, thanks to all of their T&D assets. They can tap into that to get very low-cost capital, which they could then offer as financing to interested customers. If done through an unregulated sub, they couldn't maintain an exclusive financing opportunity to customers -- naturally, other third-party financiers would also be hitting up these same customers. But utilities have a primary advantage of likely lower-cost capital because of the balance sheet, and also more accessibility to customers. On-bill financing has demonstrated that it can be dramatically more effective at unlocking customer purchases than third-party leases and other third-party financing -- customers just find it much easier to pay their financing fees on their existing utility bill. It's not another vendor or a new relationship, it's a bill they're already used to paying each month. IOUs could conceivably make significant high-margin, very stable income by becoming a financier to customers for demand-side projects, or, in a lighter form, by charging a fee to third-party financiers who want to offer customers "on-bill repayment" via the utility billing system. Even in a competitive financing market (so as to not take unfair advantage of the natural monopoly of managing T&D wires), utilities could have enough competitive advantages to grow big businesses here.

Utilities, thanks to their brand and existing connections with customers, are well positioned to be a more effective channel for solutions providers. They have the data to be able to show customers how a specific project would affect their energy spend. Plus, utility-approved vendors and systems (akin to Rockwell Automation's Encompass program) would be given more credence by end-users who don't have time to do an exhaustive investigation of all of the proliferating options available to them (which would make it easier for the utility T&D department to better manage all the more variable inside-the-meter load and generation effects). Utilities could even leverage new or existing unregulated service/channel subsidiaries to compete for this work themselves. 

What's necessary? IOUs would need to have a major strategic shift, away from treating the distribution of kilowatt-hours through managed wires as being their primary profit center. They would need to embrace that the grid will be the source of kilowatt-hours of last resort in many cases, and stop trying to make their margin off of the kilowatt-hours thus sold. They would need to embrace that the ability to have that T&D role with end-consumers is worth much more than that, because of the above-named businesses, and bring in strong managers to launch/expand such unregulated subs -- and let them take senior leadership positions within the utility, which as yet never seems to happen. And they would need to educate PUCs as to how this ends up lowering costs for ratepayers, without endangering reliability.

So clearly, it won't happen soon.

But it's going to happen to them if they don't get out in front of it. They need to eat their own lunch before someone else does. And it wouldn't require any major regulatory shifts. So I'm surprised I haven't seen more IOUs starting to talk about a future business model that looks more like the above, rather than just lamenting that the existing business model is in trouble. This could actually be a big win for the shareholders of IOUs, but for now, such shareholders must instead just sit back and watch as other financiers and startups (and increasingly, bigger companies like NRG) take advantage of IOU inaction.