Cleantech Venture Investing Still in its Infancy

On Monday, Topline Strategy be releasing our new report on the trends in Cleantech venture investing. When I first started on this report, I was expecting to find the dotcom bubble 2.0. With all of the hype and reports of phenomenal growth in Cleantech, I didn't see any reason to suspect anything different.

What I found was quite surprising - Quarter over quarter, Cleantech investing for the last four quarters, Q2 2006 to Q1 2007 was basically flat. Furthermore, with just a couple of exceptions, the leading VC firms have been just dipping their collective toes in the water.

What does this mean? From a venture capital perspective, we have barely left the starting gate of a 30 year project to build a sustainable economy and that this project is so different than what VCs have become accustom to in high tech and life sciences that it is going to take a while for them to figure it out.

Our report, chock full of data on who is investing how much in what, provides an in depth analysis of what makes Cleantech different and what VCs will need to do to be successful in the space. While the report will be formally released on Monday, you can download it now from our site.

Verde Energy

If you haven't heard of Verde Energy, you should get to know them. Verde is solving one of the most difficult components of buying a renewable energy system - searching for a reliable, trustworthy installer.

Putting in a renewable energy system, from wind to PV to solar thermal, is like renovating a house - only worse. Like renovating a house, installing a renewable energy system involves finding a contractor who will do good work, on time, and at a fair price. This is never an easy task, but is even harder when with renewable energy projects because the purchaser:

• Is dealing with unfamiliar, emerging technologies.
• Does not know enough people who have installed an renewable energy system that they can ask for referrals - a very common way to find a contractor.
• Does not know where to turn for information (if there is anywhere).

Even Google is of little help. I searched for "Solar Power Installers in Massachusetts" and there was only one solar power installer in Massachusetts in the results. I did get links to the Sun Microsystems website, a non-profit providing solar power in Ethiopia, and an article on a recently installed solar power system in Cambridge, MA.

Verde Energy makes this process a whole lot simpler. The company uses the Lending Tree model to help you find a contractor - you fill out a form describing your project and they refer you to several prescreened, qualified contractors in your area. (For the record, they were also the top search result in my Google search).

In our recent study, What the Solar Industry can Learn from Google and Salesforce.com we identified lowering search costs as one of the key ways that the solar power industry can accelerate adoption. Verde Energy is a critical piece of making that a reality.

Why I Love Carbon Offsets

A few months ago, I seriously investigated installing a 2 kilowatt solar electricity system. I chose 2 kilowatts since that is the size system that would fit on my roof. We have a limited amount of space with the right orientation and access to direct sunlight. Here are vital statistics on the system that I was considering...

The 2 kilowatt system would have cost approximately $19,000 installed and have covered a 10' by 15' section of my roof. I would have received $2,000 back from the federal government when I filed my taxes and assuming I could get them, another $5,500 in rebates from the state. That would have put my out of pocket costs at $11,500. If I financed that amount using a home equity loan, my annual payments, net of taxes, would have run approximately $500 per year, almost exactly washing with the $500 in annual electricity cost savings I would have realized (2,900 kilowatt-hours generated x 17.2 cents/kilowatt hour at Massachusetts's prevailing rates).

On the global warming front, for my effort, I would have eliminated 5,800 pounds of carbon dioxide emissions per year, or 2.6 metric tons. That sounds like a lot, but Carbon Offsets currently run approximately $5 per ton, making the total cost of achieving the same amount of carbon reduction about $13 per year.

This analysis isn't meant as a condemnation of solar electricity. I think it is an important technology that will be increasingly critical as prices fall and it delivers real electricity cost savings. However, a home solar panel project is not easy to do. That is why today, as a way to help the environment, it doesn't hold a candle to Carbon Offsets. In our new report, we take a look at the current state of the market for Carbon Offsets and discuss what it will take to take them to the mainstream. To download the report, click here.

Business Software Ready for the Next Big Thing

In a recent post on Sandhill.com, I argued that as the current wave of SaaS, Open Source, and Vertical Market start ups mature, it will take a major breakthrough on the order of client/server computing or web technology to keep the business software start up engine humming.

Your probably thinking that you've heard this all before. Back in 2001 and 2002, people were predicting the end of business software only to have the sector come roaring back as SaaS, Open Source, and vertical market companies filled the gap. Here is why this time is different.

Consider what happens to technology markets as they mature. In the early stages, the market is dominated by horizontal products that are customized to a specific customer's needs through professional services. As the market starts to mature, the dimensions of competition change to meet the needs of the late adopters. To maintain growth, companies must lower costs to be able to profitably serve this price-sensitive customer group and they must tailor their solution to meet the unique needs of smaller and smaller unserved niches (simplification and specialization).

When viewed through this perspective, the SaaS, Open Source, and vertical market investing wave can be seen as the mature phase of the business automation boom that started in the early 1990's with companies like Siebel, Documentum, and Remedy. When this current wave slows down, there is no obvious successor on the horizon (What comes after the mature phase?). Therefore, short of a major breakthrough, business software investing will slow.

By how much? Our prediction is that business software investing could slow by as much as 30%. Topline Strategy's analysis of business software investments from Q3 2006 found that 59% of all business software investments were SaaS/Open Source/Vertical Market companies offering simplification and specialization as their primary benefits while 41% were companies were offering solutions based on new technologies (such as video over IP and mobile computing). We expect, short of a major breakthrough, that investing in companies based on new innovations will remain steady. However, investing in simplification/specialization plays could fall by half. To get a closer look at the data, you can download a list of all the Q3 business software investments here.

If this post seems like all doom and gloom, it isn't. While we expect business software investing to fall, we expect consumer and mobile investing to continue to soar, more than picking up the slack.

The Founding Myth

If you want to gain real insight into a start up company, ask someone to tell you the story of how the company was founded. Start ups have precious little history and culture and therefore, since these stories may be all they have to bind the company together, they are elevated to the status of myth.

In The Hero with a Thousand Faces, Joseph Campbell deconstructed classic myths and identified a recipe for myth creation that spans cultures. (For those of you who are not aware, George Lucas borrowed heavily from Joseph Campbell's recipe when he wrote Star Wars). Founding myths also have a common recipe:

1. The founder(s) was toiling away in a related, but somewhat different, job
2. He/she identified a problem or need
3. He/she developed a vision for how to fix the problem/fill the need
4. He/she became so convinced in its widespread appeal, they were compelled to start a company

Founding myths are incredibly powerful. They are critical recruiting tools for start ups, who in absence of more tangible factors like rapidly accelerating revenue, use them to sell the promise of the company to prospective employees. Internally, they provide a common vision that everyone can hold on to - especially important as companies are finding their way in the market. Founding myths actually grow more powerful over time. Companies use them as a lens that sees every success as a reinforcement of the myth's validity and setbacks as caused by other factors.

However, founding myths also have a downside. If (actually when) the founding myth collides with market reality, it takes a very long time for a company to adapt. The myth is so interwoven with the fabric of organization that it takes a major negative event before companies are willing to let go.

Documentum, where I worked in the mid 1990s, is a company whose founding myth cut both ways. Documentum was founded to be the Oracle of Content. Buried into this myth was the vision that like Oracle, Documentum would have one repository into which all types of content would be stored. Initially, the myth led to the creation of the most scalable, feature rich, and flexible content management system on the market (it had to store everything). This enabled Documentum to easily tailor its solution to meet the needs of its customers. However, the myth ran aground when the Internet and HTML came along. Unwilling to part with the idea of a single repository, the company tried to force fit HTML into a system that was never designed to support it. As a result, the company opened the door to Vignette, Interwoven, and other web content management companies. Only much later did the company abandon the one-repository vision.

While failing to challenge the founding myth ended up costing Documentum a major opportunity, it can be fatal for companies whose founding myth runs into market reality earlier in their lives. Therefore, we recommend that challenging the founding myth be an integral part of all strategy development work. Start by listing the core beliefs about the company (one repository for all content, we are Open Source, etc.) and consider the following three questions:

1. Where did this core belief come from?
2. What facts do you have to support or refute its validity?
3. What would happen if you tossed it out?

If you are short on supporting facts and you can come up with a few good things that would happen if you tossed it out, it may be time to let go.

Consumer Investing Continues to Roll

Tomorrow, we will be releasing our Q3 Follow the Money report. Follow the Money is Topline Strategy’s quarterly analysis of venture capital investment in information technology. As opposed to the traditional venture trend analysis that categorizes companies based on technology (software, computers, etc.), our analysis is organized around the customers companies are looking to serve (businesses, consumers, OEMs, carriers), business models (Open Source, SaaS, advertising, transactions) and go to market strategies. By understanding investments on these new dimensions, we are able to quantify collective decisions, identify investment patterns, and discover insights in ways never before possible.

The major finding of this quarter’s report is the continued growth in the funding of consumer-oriented businesses and the strong leading indicators that point to the segment continuing to gather steam in the coming quarters – the surge in first round investments, the durability of the market even as investment in social networking cools, and the continued growth in Internet advertising.

The strength of the consumer segment comes as the signs point to a softening in the investment climate for business technology products, the largest segment of IT investing.

You can download the entire report at http://followthemoney.toplinestrategy.com.

A Call for a Solar Salesforce.com

If there are any entrepreneurs or investors out there looking for an idea, you might think about starting or investing in the Salesforce.com of solar power. Solar power is unique among electricity generation technologies. Where economies of scale mean that gas and coal fired plants, wind turbines, and nuclear power will all be owned and operated by utilities (I don't think anyone has plans to install a 400' high wind turbine capable of powering a few thousand plasma TVs on their roof), solar power costs about the same per kilowatt if you install 10 kilowatts - the average usage of an American homeowner - or 10,000 kilowatts - the size of a commercial power plant.

The table below shows a comparison of the price of solar energy and traditional electricity for utilities and residential and commercial customers in $/kilowatt-hour. 

	Price of Conventional Electricity	Price of Solar Electricity*
Residential/Commercial	$.137	$.131
Utility	<$.03	$.131

*California prices. Solar Electricity costs are calculated post subsidies and rebates.

As you can see from the numbers, While it never makes sense for a utility to install a large solar farm (it would cost them over $.13 per kilowatt-hour vs under $.03 to buy electricity on the wholesale market), it is theoretically possible for solar power to be cost effective for a homeowner or small business operator to install. I use the term theoretical since if you have ever tried to buy solar electricity equipment, it becomes evident that the pain of acquiring it well exceeds the modest financial benefits of doing so.

That is why we are calling for entrepreneurs and investors to start and invest in a solar Salesforce.com. Just as Salesforce.com made CRM accessible to the mainstream market by making it simple to acquire, configure and use, someone needs to do the same for solar power. Since I am planning on installing solar electricity at our house in the spring, I'd appreciate if someone could get this started before then.

Download our paper - What the Solar Power Industry can Learn from Google and Salesforce.com to learn more. Or: Read the Red Herring article.

Adoption: When is it Too Much of a Good Thing?

The primary challenge for all start up technology companies is adoption. How do you get people to buy something new from a company they have never heard of? To be sure adoption is a good thing. However, it does not necessarily follow that maximizing adoption is always best. Remember, the ultimate goal for companies is to maximize revenue and there are many cases where the two are not necessarily linked.

In the past, when the predominant business model was selling high ticket item solutions to enterprise IT, adoption directly drove revenue. However, today, where many business models are predicated on providing low cost or even no cost entry level versions, the relationship between adoption and revenue is no longer a sure thing.

At Topline Strategy, we break markets into three categories – high, medium, and low – based on the correlation between adoption and revenue and recommend companies set their strategy accordingly.

High: These markets are ones governed by the network effect. Under the network effect, the intrinsic value of a product or service increases exponentially as the number of users increases. Therefore, more adoption drives more value which in turn drives more adoption, etc. For these companies, the strategy is simple – acquire users. YouTube, where more users means more videos, and eBay, where more users mean more products up for auctions and more buyers, are both examples of network effect businesses.

Medium: These are businesses, like technology platforms such as databases or application servers, where the value of the company’s products is enhanced by a community of companies offering value added products and services. While adoption is important for generating a community, it is not necessarily true that the company that has the most adoption wins the market. Instead, it is the company that generates the most robust community. These companies strategies need to focus on community development.

Low: These are markets where the fact that one user has adopted a new technology has little bearing on the value that the next user receives. Application software companies, online content providers, and search engines are all examples of businesses where the intrinsic value of adoption is low. For these companies, the strategy needs to focus on acquiring profitable users, not just any user. The most common mistake companies make in this segment is to under price their offering based on the assumption that all adoption is good adoption.

One example where this dynamic has played out is the Vulnerability Management (VM) market. VM solutions are corporate security solutions that scan devices attached to corporate networks to identify vulnerabilities to hacker attacks. Two of the main competitors in this market are the SaaS company Qualys and the Open Source company Tenable. Since Tenable gives away the base version of its solution, it has a total user base that is over thirty times larger than Qualys. However, Tenable has been able to convert only 250 of its 75,000 free users into paying customers. In contrast, Qualys has over 2,000 paying customers, nearly ten times as many as Tenable. Ultimately, Qualys gained adoption where it mattered most, among paying customers. It didn’t matter that Tenable had the most total adoption.

Social Networking Meets Economics 101

My recent post on VentureBeat addressed analyzing venture investing trends from a suppy (of companies) and demand (of customers) point of view.

Under normal conditions, the supply of venture-backed companies is not a problem. There are only a handful of companies chasing any given market. Yet occasionally, there are categories where a slew of companies jump into a market all at once. This happens when a category with low barriers to entry takes off quickly. Seeing a market with explosive demand and little competition, entrepreneurs rush in to fill the void. Ultimately, demand is spread across so many companies no one wins.

That may be the case today with Social Networking as companies have rushed into the market behind MySpace, Facebook, and YouTube. Our Follow the Money report for Q2 showed that 25 Social Networking companies received $500K or more during the period.

The economics of Social Networking favor first movers and established players. Social Networking, like auctions and marketplaces, is governed by the network effect. The more people using a site, the more valuable it becomes, which in turn drives even more usage. This opens up a gulf between the leaders and everyone else, and once that occurs, it becomes next to impossible for anyone to succeed. Only established players who can bring their existing user base to the table to provide critical mass have a chance.

So where are the opportunities in social networking if starting MySpace or YouTube for <fill in the blank with your favorite demographic or interest niche> is untenable?

• Creating the truly differentiated offering. Where MySpace and YouTube will make their money by giving away their service to tens of millions of consumers and charging advertisers, the next round will need to be able to drive revenue from much smaller user bases. Think 250,000 users paying $20 per month each. To charge a consumer $20 per month, there needs to be a compelling and difficult to reproduce competitive advantage.
• Serving the established players. Given the consumer interest in social networking, established players will need to add these features to their site. It's unlikely that Kayak, the leading metasearch site for travel will sit back and allow the two new metasearch+social networking start ups to go unchallenged. Same goes for Match.com and other leading dating sites who are facing new competition from dating+social networking start ups. Soon, everyone will be a <category>+social networking site.  There is money to be made in serving those companies.

SugarCRM vs. Salesforce.com

I'll say one thing for SugarCRM, they certainly have generated a lot of buzz. I don't know anyone actually using their system, but there are a lot of people talking about them. Now the question is whether they can turn buzz into commercial success.

One thing the company has going for it is its choice of markets. Since Low Price x Low Quantity is not a recipe for success, the key for Sugar, and all Open Source companies, is volume, volume, volume. Like Open Source success stories RedHat and JBoss, Sugar is playing in a market with enormous opportunity. At an average of $350 per user per year and 20 users per customer (Salesforce.com's average), the company will reach the IPO escape velocity as it closes in on 10,000 customers. Since the number of potential businesses that can use CRM is measured in the millions, that certainly seems possible.

However, one key difference for Sugar vs. other Open Source successes is its competition. From our interviews with Open Source users, the vast majority are attracted to Open Source because of price. Linux/RedHat was able to offer Unix functionality at lower than Microsoft prices - something Sun, IBM, and HP couldn't match. JBoss could comfortably undercut BEA and IBM without fear that those companies would respond with price cuts of their own. Their cost structures couldn't support it.

To be sure, Sugar is underpricing Salesforce.com - $40 per year list price for an OnDemand user vs. $65 for Salesforce.com. However, even if that relatively small price differential is enough to sway people to choose a company other than the market leader, it isn't clear that it is sustainable. A quick look at Salesforce.com's income statement shows a company with 10% net profits. For Sugar to be break even at a price 39% lower than Salesforce.com's, the company would need to have much lower cost structure. Given that Salesforce.com is already lean and mean, I'm not sure how that is possible.

That leaves Sugar with precious little to differentiate their business.

• Alternative Delivery Methods: Sugar offers an installed version and an appliance. The success of Salesforce.com has already shown that the market has voted against installed. As for appliance, if it really takes off, expect Salesforce.com to follow suit.
• Code Customization: This is a relatively small segment of the market. Few Open Source users ever touch the code.

Ultimately, the biggest argument for their success is that they can be the AMD to Salesforce.com's Intel, the Sybase to their Oracle - a distant number two who does reasonably well simply because the market is so big. In the meantime, don't sell your Salesforce.com stock.