Bet the Jockey

Local Power

2007-07-30T13:25:00.000-04:00

"…..all experience hath shewn that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed." The Declaration of Independence

What motivates people to change their habits? It is easy to forget that people don't adopt new technologies because they should. Change is painful. Even when you know it is good for you. Nobody experienced the pain of change more than our founding fathers who personally risked "our Lives, our Fortunes and our sacred Honor" for the Big Idea. The fear of change and the danger of inertia were so central to their experience that the idea made it into the Declaration of Independence.

I am on a quest for Acorn's next big idea. My search has been helped by two great books: Nassim Taleb's The Black Swan, The Impact of the Highly Improbable and Pip Coburn’s The Change Function: Why Some Technologies Take Off and Others Crash and Burn. The thesis of the Black Swan is that venture investors should be looking for opportunities with three characteristics: (1) totally unexpected (2) massive impact and (3) understandable in retrospect. Google was a Black Swan because nobody thought a search engine was a good business until its founders, Sergei Brin and Larry Page, linked searchers to advertising. Coburn's book helps shed light on why often just having the better technology doesn't matter. These two books offer good insights to how we at Acorn are going to "see around the corner" to the next Big Idea.

I think the next Big Idea might be linking electricity market deregulation to renewable energy and climate change to massively deploy energy efficiency and renewable energy systems under a system called Community Choice Aggregation.

Wall Street loves following the cow path. Lately, it has been rewarding developers of new energy technologies. If one solar energy cell company is well received by investors then Wall Street brings twenty five more. Coburn argues that investors are forgetting that technology, no matter how great and obvious, only gets adopted when the pain of a crisis exceeds the pain of adopting the technology. The Comverge load switch has been around for twenty five years. The recent breakthrough was the Virtual Peaking Capacity (VPC) contract that made it easy and compelling for the utilities to buy capacity not capital equipment from Comverge. Every commodity is a service waiting to happen. I think the really compelling "what's next" for energy is the implementers, more than the developers of new technology.

Really big crises like global warming, energy and water shortages can only be solved when public policy and consumer choice align to create a demand for technology. Wall Street is right that we need to reward the developers of great new technologies, but for the technologies to be deployed on a large enough scale to make an impact, the right public policy needs to be in place. I believe we have discovered a Black Swan at Acorn in our most recent investment, Local Power a pioneer in the deregulation of the $325 Billion US electricity market.

There is no more poignant example of necessary technologies needing support from public policy than the relatively recent adoption of the toilet and municipal sewer system. It is almost unthinkable to us today that until the 1850's it was common practice in cities like New York to dump bed pans off the balcony onto the street below. Finally the city fathers had to take action when persistent cholera epidemics were linked directly to the rise in population density and level of human waste in the streets. Toilets and indoor plumbing had been around since the time of King Minos of Crete but had not been adopted outside the palaces. Only a cholera epidemic in New York City forced the city council to mandate the installation of toilets and create the model for the modern sewer system which has been adopted around the world. It is important to note that this change came at the local, rather than the federal level. Cities lead and the Feds follow. The German city of Aachen pioneered the customer payback system that turned Germany into a solar powerhouse. The German federal government copied and helped spread Aachen’s success to other German cities.

Mankind is facing a perfect storm of unprecedented size. Global warming, massive underinvestment in our energy and water infrastructure, coupled with rapidly rising standards of living around the world are on a collision course. Just as a small group of influencers created the American Revolution, and mandated the first sewer system, we can expect a small group of visionaries will lay the foundation for the coming Global Energy Revolution. Whatever you think of his politics, Al Gore and a small group of savvy filmmakers deserve recognition for arousing the American conscience to the climate portion of the storm with their An Inconvenient Truth.

Another less well known but no less important revolutionary is Paul Fenn, the creator of Community Choice Aggregation (CCA) and founder of Local Power. There is a terrific video on CCA on Google made by an independent environmental action group, EON. CCA is a law that has been adopted by five US states and over one million industrial, commercial and residential consumers. CCA is a new model for energy markets that puts cities in charge of their energy future. San Francisco adopted CCA on June 29th in their bid to build the largest renewable portfolio of any city in the world. San Francisco's adoption of CCA is no empty unfunded mandate. As part of adopting CCA, they have authorized a $1.2 Billion H Bond authority to fund a public private partnership to support the achievement of a 51% Renewable Portfolio Standard (RPS) by 2017 that was authored by Local Power.

Community Choice is spreading to other cities across California like Fresno. A public private partnership between Cleantech Inc. and the city of Fresno have agreed to build a solar farm seven times the size of the world's biggest plant and double the largest planned farm. In a interview with CNN, Bill Barnes, CEO of Cleantech, said the scale of the Kings River Conservation District Community Choice Solar Farm will change renewable energy and make California the global leader for huge solar projects and replace Germany as the solar energy hub of the world. "We're pretty confident that solar farms on this scale are going to have an industry-changing impact," Barnes said. "We think it's the wave of the future. This scale of project, I think, creates a tipping point for renewable energy. We think the impact for it will be similar to the impact of the computer chip," which gained computing power once made on a large scale, Barnes said. "So too will economies of scale like the Community Choice farm drive down the cost of solar," Barnes said.

The single most important problem we face is the lack of institutions and incentives to change. We have the technologies today to improve the efficiency of our energy and water systems and to reduce our environmental footprint. Wall Street continues to pay huge multiples for better alternative energy technologies but they are failing to ask what is going to cause their adoption on a massive scale. Solar technology represents much less than 1% of total US electricity supply and relies on federal subsidies that have only been legislated for the next two years. Technologies like solar, biofuels and smartgrid solutions are disruptive and we know that entrenched monopolies never adopt disruptive technologies. The incentive for utilities has been to sell more electricity. To date they have no motivation to push technologies that make their networks smarter or help consumers consume less electricity. They don’t want to adopt renewable technologies because they don’t have any experience with these new assets. The regulators believe their job is to keep a lid on electricity prices, therefore they fight utilities putting in more capacity that will swell the rate base. The unintended consequence is that the average age of the equipment of our electric grid is over 40 years. We need to add new, competitive institutions and incentives like CCA to avert the worst effects of the inevitable perfect storm.

Paul Fenn and his partner John Cutler have convinced me that the solution to the perfect storm exists locally. Local Power's goal is to establish a new institution, an Energy Service Bureau, to help cities adopt CCA and implement intelligent systems that result in the implementation of energy efficiency technologies and foster renewable resources. A lot of smart people are calling for an Apollo program for energy technology by the Federal government. This is a really bad idea because energy is a local issue. The Midwest has coal and corn therefore they want clean coal and ethanol. The west has solar and geothermal. Why should Santa Fe or Tucson subsidize a broad ranging ethanol policy they won’t benefit from? Each locality should be free to make the decisions that match its local interests and assets.

This is an exciting time. Bill Galvin, former CEO of Motorola recently said "Electricity today is where telecom was thirty years ago. This is where the Motorola’s of tomorrow will come from."

The “Magic Trenton Moment” Finding the Formula

2006-12-07T18:53:00.000-05:00

What is More Important? A Great Business Idea or a Great Jockey?

I believe investing in the right Jockey is more important than investing in the right business idea. I think there is a common misconception that entrepreneurs succeed because they have the “right vision.” Vision is essential - it gives you the energy and incentive to get started - but it is determination to succeed that creates happy endings. I believe the principle of determination is the most critical factor of success in business, sports or war.

As an investor you will improve your returns, and be a more valuable supporter of the Jockey if you view setbacks as inevitable learning experiences and invest incrementally as they find the correct formula. Consequently, I like to fund businesses with just enough cash to give the Jockey a fighting chance. I am always mentally prepared to make additional investments.

The Two Vital Qualities of the Jockey are Determination and Flexibility

When I invest in a new business I have learned to assume from the start that while I can be compelled by the entrepreneur’s vision to make an initial investment, we will probably not be successful executing on his first business plan. Most entrepreneurs are barely able to raise enough money to support their first product launch. Naturally, there is a huge amount of learning once they actually call on customers to generate revenues. There are very small differences between success and failure and that means the Jockey has to be capable of “broken field running.” This is a football term that describes a leader’s ability to improvise and act quickly in the split seconds after the snap, as they watch their game plan dissolve. It is the determined Jockey who can continue to believe in the business and muster resources after the inevitable multiple setbacks (aka learning) that ultimately rewards investors. It is the ability to attract incremental capital, combined with the determination to persist, that decides whether a business gets all the chances it needs to try and fail until ultimately, success is achieved. As Soichiro Honda, the founder of the car company so aptly said, “Success is 99% failure.”

George Washington Demonstrates the Rebels Can Win

Nobody had a bigger vision than America’s Founding Fathers. Yet General George Washington had a poor record of winning battles in the American Revolution. He does, however, rate among history’s best strategists for his dogged focus on his ultimate goal. Arguably the greatest test of his leadership was simply keeping his Continental army viable. It took charisma, cajoling and conviction to convince his hungry, cold, unpaid, dispirited troops to extend their enlistments. The crushing loss in the fall of 1776 at the Battle of Long Island left the viability of the Continental Army hanging by a thread as they retreated to the discomfort of Valley Forge. On Christmas Eve, 1776, George Washington made a decision to risk everything for a chance to turn the tide of the American Revolution in a surprise attack on the Hessian forces at Trenton. In his moment of desperation he found his formula. Instead of pitched land battles against the numerically superior and better-trained British forces, he used guerilla surprise techniques to win. As if God was throwing down the final gauntlet to test his determination, a severe winter storm came up as the troops were preparing to cross the river. General Sullivan sent word that the men's muskets will not fire due to being exposed to the storm all night. Washington sent word back to rely on the bayonet-"I am resolved to take Trenton." He knew what would happen if he failed to take Trenton. His army would dissolve and he would be captured and hung as a traitor to King George.

We all know what happened next. The battle was the first decisive American victory of the Revolution and would shortly be followed by another victory at Princeton. Washington turned the tide from desperate, waiting for the “axe to fall,” to aggressive victor, chasing the British forces from the Delaware River. It was the vital victory the colonials needed to see them through to the “day the world turned upside down” at Yorktown. (Source:http://www.doublegv.com/ggv/battles/Trenton.html)

Finding the Formula to Win

All successful entrepreneurs have their Magic Trenton Moment where everything clicks and they find their formula with which to succeed. What is not obvious to most inexperienced investors and entrepreneurs is that the Magic Trenton Moment takes longer to find than you could ever dream. Here are some interesting examples….

One of my greatest mentors, Gerry Rimer, the founding partner of Index Ventures www.indexventures.com, always told me “The secret to financial success is to find a profitable operation and repeat it as many times as possible.” I have learned that finding the formula of the profitable operation is as vital as it is elusive. Even Gerry found it elusive as he struggled (between golf games) for over a decade to find the formula for turning his marginal bond trading business into the number one performing venture fund in Europe, managing over $1 Billion. His formula was to partner with his sons to leverage his financial contacts with their vision of the potential of the Internet economy and their knowledge of California style venture capital to fill a need for providing capital to European entrepreneurs like the founders of Skype.

Safeguard Scientific invested $50 million trying to make Novell a viable portable computer company to help migrate its successful “One Write” manual accounting system to computers. They failed miserably. In a last ditch effort to save the company, Safeguard’s Board allowed the engineers several months of operating capital to market NetWare, their pioneering computer networking solution. At the “final” Comdex trade show in 1982, a retired computer industry executive, Ray Noorda, saw the importance of the development and convinced Safeguard’s Board to allow him to take over as CEO and invest $300,000 [of his own money] for a 30% stake in the Company. Within two months of Noorda’s taking the helm, the business was profitable and Safeguard ultimately realized a return of over $1 billion from their “failed investment.”
Source: http://www.whiteworld.com/novstory/surf00.htm

Steve Jobs bought Pixar from George Lucas in 1985 for $10 million. Over the course of a decade he sunk tens of millions of dollars into the company only to fail repeatedly. At first, he tried to make it a success as an animation hardware company, then a software business and failed. Jobs was desperate from personally being bled by losses at Pixar and Next. He was down to his last few million. He was determined to show the world his success at founding Apple was not a fluke. Finally, the brinksmanship paid off with an unexpected deal with Disney to produce “Toy Story,” the first full-length computer animated picture. Producing full-length animated pictures was not in any of Pixar’s business plans for the first ten years - it was the result of the desperate need to find a winning formula. In the process Pixar invented computer animation as an industry, eventually holding their partner Disney hostage, forcing the resignation of Michael Eisner, Disney’s CEO, and ultimately the acquisition of Pixar for $7.4 Billion by Disney in May 2006.
Source: iCon: Steve Jobs, The Greatest Second Act of the History of Business by Jeff S. Young and William L. Simon

I don’t want to underestimate the value of vision - it is crucial to getting started, staying motivated and capturing people’s imagination. However I am convinced that most investors and entrepreneurs would benefit from understanding these lessons from history demonstrating how long and how much it takes to actually achieve the “Magic Trenton Moment”.

I invite you to post any other great stories of determination snatching victory from the jaws of defeat.

Why Take Risks?

2006-10-16T09:45:00.000-04:00

Neil Armstrong spoke at the Union League Club in New York on September 26, 2006 where he was honored with the Theodore Roosevelt American Experience Award. In his acceptance speech he asked, “Why are we, the American people, driven to take national and individual risk?”

The concept of risk is so inherent to the American Experience that it is barely visible. The willingness of our citizens to take risk is at the heart of what makes America great. There is something unspoken in the phrase, “America is the Land of Opportunity.” Opportunity, but for what? The unspoken words are “to take action and risk” and sometimes to fail and try again. The nature of the threats and opportunities that we face today, as a nation and as business people, are different than they have ever been before and that requires us to change the way we think about risk.

Armstrong chronologically compared the risks and effort that Theodore Roosevelt took in building the Panama Canal with the risks taken by the Wright Brothers in pioneering manned flight. He went into detail about the setbacks, the effort and the ingenuity that was required for success. Today, we take both of these amazing accomplishments for granted but they have unquestionably added hugely to the development of our nation. His talk explored what drove TR and the Wright Brothers.

The common denominator between the Wright Brothers and Teddy Roosevelt was that they had the magical ingredient in the American Land of Opportunity: the bias for action and the determination to do whatever it took to succeed. Neil Armstrong talked about the two methods of learning to ride a horse. The first method is to jump on the horse’s back, get thrown off and get back up again until mastery is achieved. The second method is to sit on the fence, watch and observe and retreat to your quarters to reflect on how you would react to each movement by the horse. Armstrong stated that the first method produces a lot more trained horsemen. Similarly, TR and the Wright Brothers had to take action and overcome enormous obstacles in order to achieve their goals.

John F. Kennedy spoke before Congress on May 25, 1961 in one of the most poignant addresses ever made by an American President. He announced his intention to place a man on the moon by the end of the decade. The context of his speech was the shock, America had experienced one month earlier when Russia cosmonaut Yuri Gagarin became the first human launched into space. The Soviet Union was overtaking the USA. Our entire way of life seemed at risk.

“First, I believe that this nation should commit itself to achieving the goal, before this decade is out, of landing a man on the moon and returning him safely to the earth. No single space project in this period will be more impressive to mankind, or more important for the long-range exploration of space; and none will be so difficult or expensive to accomplish. We propose to accelerate the development of the appropriate lunar spacecraft. We propose to develop alternate liquid and solid fuel boosters, much larger than any now being developed, until certain, which is superior. We propose additional funds for other engine development and for unmanned explorations—explorations which are particularly important for one purpose which this nation will never overlook: the survival of the man who first makes this daring flight. But in a very real sense, it will not be one man going to the moon—if we make this judgment affirmatively, it will be an entire nation. For all of us must work to put him there.”

Leaders Need Vision and Determination

Aside from pushing the nation to take risks, what JFK did that is truly entrepreneurial is being truly VISIONARY. He says that the US will put a man on the moon in 10 years. He doesn't have any idea how it will be done or what it will ultimately cost. There are huge unknowns and challenges but he sees the moon from where he stands and he is convinced that it will happen. He died two years later, so we don't know how he would've defended his vision through the 10 years...but you can bet that no matter what setback he encountered he would always dispel the nay sayers and tell them why NASA was going to prevail. Taking risks is important but having a vision—and even more—having a charismatic leader who can infuse the people around him with that vision is ABSOLUTELY KEY. America is a perfect place for that because it allows people to dream and not get bogged down by the details. Someone has to work out the details but the guy that goes after the “blue oceans” must focus on success at all times and keep his eye on the prize.

On July 29, 1969 Neil Armstrong walked on the moon almost two years ahead of JFK&lrsquo;s vision.

The Two Different Types of Risk are Synergistic

TR and JFK mobilized our country to take monolithic national risks. Neil Armstrong told the audience that we as Americans take risk because if we don’t, “Other, bolder peoples will overtake us.” Risk is at the core of the American Experience. We believe the risk we take today will impact our children and the world in which they will grow up. The success of the Panama Canal and putting a man on the moon inspired the American people to believe they could do anything. This is in sharp contrast to the communist and European socialist view of, “Don’t break a sweat because the State will take care of me.”

Individual and national risks are in many ways similar. Todd Sullivan, the CEO and founder of Spirit Shop says, “I think of taking risk as answering a calling. For me, the rewards for taking risk are usually greater for my spirit regardless of the outcome. I feel like I cannot fail taking risks in business because I always learn something.”

Immigrants continue to come to America in record numbers. Ask a new arrival to this country why they took the risk to come here. Almost all will say that they answered a calling. They say they feel electrified by a sense that they can do anything here if they work for it. They are free to succeed or fail and try again without stigma. A bigger threat to our society than Islamic fundamentalists are the forces inside our country that try to “protect” us from risks, like Sarbanes Oxley (SOX). These protections actually have huge unintended consequences of adding friction to the forces of progress. SOX makes it more difficult for businesses to succeed by adding enormous compliance costs and distraction of management’s time and resources without making anybody more honest. These resources would otherwise go to the two highest value functions of business; innovation and marketing.

The Risks and Opportunities America Faces Today Are Distributed

Today, America faces new national challenges ranging in scope from strategic nuclear threats to guerilla warfare and terrorism. Our military is being reshaped to fight multiple small insurgent groups all over the world. The challenge for American politicians is that it was easier to capture voter’s imagination in the fight against the monolithic forces of communist Russia than against the far subtler, distributed enemies like terrorists. There are huge stakes riding on proposed changes in American force structures: disassemble our military that was designed for fighting pitched land battles in Europe and reassemble it to protect us against distributed threats. Today and tomorrow we need to protect the global supply and demand chain, the home front and multiple small fronts around the globe. In the future it will be a contest between our silicon versus their sons. The stakes are immense.

Losers and Winners in the Future

Likewise, business leaders today face splintering markets where the old rules of market share and economies of scale are out the window. How to inspire potential investors and partners? Entrepreneurs must launch differentiated products into market voids where no focus groups or competitive intelligence can help predict success. The losers of tomorrow are the MBA’s at big companies who are sharpening their pencils to figure out how to steal market share from entrenched competitors and achieve economies of scale for their factories. The winners of tomorrow are discovering “blue oceans” by harnessing economies of connections and removing friction from commerce and improving choice and speed to market. They take multiple small and medium risks. They are willing and able to fail, but with success allow customer demand to take the business where no one has gone or would have planned before.

Power to the People!

Winners of the future are entrepreneurs and investors who invest in businesses that push power from monolithic, slow moving big companies to the blindingly fast and amazingly diverse masses. Three critical dynamics of “power to the people” are mass customization, democratization of commerce and outsourcing. Mass customization is about business platforms like Dell or Spirit Shop where customers are free to design the specific product they want. Build the platform; give customers the tools to design just what they need to take out inefficiency and excessive inventory. Spirit Shop’s CEO Todd Sullivan says, “For me, economies of connection is really about connecting with your customers on an emotional level through their peers. It is empowering your customer to be a company advocate, an enthusiastic marketer and your greatest salesperson to his or her community.” eBay is democratizing commerce by giving anyone with access to a computer the ability to create a market niche. eBay is one of the world’s fastest growing companies. Outsourcing is about enabling a company to focus entirely on the highest value tasks they perform so they can get to market faster. Winners in outsourcing are innovators like Apple Computers and their suppliers like Flextronics as well as Janeeva, a leading provider of software solutions for outsourcing. Apple doesn’t do any manufacturing. It can focus its resources on what it does best: innovation, design and marketing.

At Acorn Factor, we are seeking to back determined entrepreneurs with business models that benefit from economies of connection. Ideally, they should have demonstrated proof of concept, near breakeven, where small investments of capital can dramatically accelerate growth.

Something From Nothing or Nothing from Something?

2006-08-10T17:30:00.000-04:00

What do you believe is more powerful long term; man’s ability to create or his ability to destroy? I believe newfound freedom around the globe is poised to launch us on the greatest economic expansion mankind has ever experienced.

Thomas Friedman in his great book “The World is Flat” discusses the growing power of small groups of individuals to impact the world for good or evil. He discusses the world of 9/11 and 11/9. The impact on the world by a small group of thugs on 9/11 is understood by all.

Few people remember why the date 11/9 matters because its impact has been so profound and so benign. The ripples of 11/9 continue to impact us all.

photo credit: Frederik Ramm

On November 9^th, 1989 the Berlin Wall fell. It was an amazing symbol. A wall created not to protect people but to keep them in. Berlin was a symbol to the world. It was a capitalist island in the Soviet sea of East Germany. In 1948, the communists tried to starve it out of existence, starting a blockade of supplies into the city. The western allies began the famous airlift, flying in 8,000 tons of food and other necessities of life to the 2.5 million residents of West Berlin. The airlift works and in May 1949 the blockade is lifted.

The Berlin Wall forced thousands to risk their lives to escape. Over the 28 year history of the Wall, 5000 brave souls managed to escape but 246 failed and were killed by East German border guards. The Wall also prompted some of the most memorable statements by American Presidents like “Ich bin ein Berliner!” by John F. Kennedy and “Mr. Gorbachev, Tear down this wall!” by Ronald Reagan.

Then it happened. A unexpected rambling speech by a senior East German official says people can now cross into West Berlin. No one knows what it means. No orders have been given to the border guards. Complete confusion reigns. That night and for days later people take hammers and sledge hammers and tear down the Wall.

The impact of the Wall coming down released a flood of immigration, capital and reunited families. It unleashed Eastern Europe from communism. The impact on the world’s human capital was immense. It allowed millions of individuals to seek their own destiny instead of one dictated by the state. It is easy to lose perspective on how the world has been impacted by 11/9. I believe we have not yet seen the full positive impact from the fall of the Berlin Wall.

A hundred brushstrokes and a palette of paint. Van Gogh’s Sunflowers. An MP3 player and a music download website. Apple’s iPod. Something from nothing.

How is something made from nothing? The magic of incentives, risk, imagination and hard work is called human capital. The individual is smarter than the State. The swarm is smarter than the Queen bee.

Are you amazed by the success of the Apple iPod? There had been the Sony Walkman. There were MP3 players aplenty before the iPod. You could illegally download thousands of free songs before you had to pay for them at the iTunes store. The genius of the iPod was the imagination and ingenuity to create the system, infuse it with coolness through great design and build an easy to use website and sell music cheap enough so people would buy instead of steal.

You can be distraught by war in the Middle East and Islamic terrorists. It is more fun to realize that never in the history of the world have so many people been free from Europe to India and China to express their creativity and prosper than ever before. If you want to fight terrorism help spread global prosperity by starting or funding a business, develop new products that make life better and fund micro-finance projects in third world countries that promote peace.

I believe the future belongs to those who create something from nothing. We are out of control. The border guards have no orders. Fasten your seat belt and grab a sledgehammer.

The Most Powerful Economic Force of the 21st Century - Collaborative Networks

2006-04-27T14:45:00.000-04:00

What makes one business “better” than another? Ebay is the world’s fastest growing business and promises to continue as such for many years. Instinctively we understand that they have a better business model and a brighter future than, for example, China Textile Factory # 5 the world’s fastest growing apparel supplier to the world. But why?

The best explanation I have ever heard was put forth by Kevin Kelly, the founder of Wired magazine in his book “New Rules for the New Economy”. It is out of print but you can read it for free online at www.kk.org/newrules/newrules-1.html. He makes a very compelling argument that there are important differences between the economics of industrial businesses like China Textile Factory #5 (hereafter fondly referred to as #5) and network based businesses like Ebay.

#5 and other industrial economy investments benefit from economies of scale, which benefit investors through arithmetic increases in value, during the good times, where success is self limiting and obeys the law of diminishing returns. Typical examples are businesses like maritime shippers or chemical producers who because of long lead times associated with adding new capacity are always out of sync with demand resulting in exaggerated boom and bust cycles. It is emotionally difficult to build new capacity at the bottom of the cycle or to sell when business is good but it has been the best strategy for investors in these sectors.

Ebay and other network economy companies’ benefit from economies of connection that result in exponential increases in value as you add members to the network. The network economy benefits from the law of increasing returns. Metcalf’s Law says that the sum value of the network increases by the square of the number of members. In other words, as the number of members of a network increase arithmetically, the value of the network increases exponentially.

Understanding Kelly’s “New Rules for the New Economy” is as important for investors as understanding the miracle of compound interest. Investors can give themselves a huge advantage by investing in network businesses that have proven their significance “cheaply” before the compounding effects take the company to the point of runaway growth or “tipping point.”

My favorite example of this is Microsoft which became the standard for the PC network. It took Microsoft 10 years (1975-1985) to grow to $100 million where we all had a chance to buy in on the IPO. I remember where I was and what I thought of the Microsoft IPO, “It's great but probably too expensive”. The next ten years saw sales grow from $100 million to $5 billion and the value of a $10,000 investment turn into $6 million. I (sob!) had $10,000 in 1985 but instead was investing in financially troubled manufacturing companies.

The best investments of the past 20 years have been companies that understood and harnessed the power of the network economy like Google, FEDEX, UPS, Ebay, Yahoo Amazon and Cisco.

Future Opportunities
Each successful network business creates new opportunities as part of its ecosystem (see below). If you are like me and missed out on the IPO of Ebay and are looking for the next ground floor opportunity, your best bet is to figure out who is facilitating Ebays growth and provide the early stage capital for them. The rise of Ebay was aided by facilitators like Paypal, the online payment system (acquired by Ebay for $1.5 Billion in 2002) and Skype, the voice over internet protocol provider (acquired in September 2005 for $3.6 Billion with only $7 million in sales). Investors made exponential returns. Clearly there is a huge economic opportunity to figure out the third wave facilitator that will be acquired by Ebay. My big bet on the Ebay ecosystem is a dropshop chain, Paketeria which are adding dramatically to the growth of Ebay.

Each new network creates a space from which several more networks can be created. And from each of those new innovations comes yet more spaces of opportunity.

My next post will explore the dropshop phenomena.

Paketeria - My Latest Investment Adventure

2006-03-06T19:32:00.000-05:00

It all started because of a trip he didn’t really want to take and could barely afford. In 1991 Andy Roesch received a call from one of his business advisors sheepishly asking him to meet me in the Frankfurt airport. His partner had heard that I was considering offering one of Andy’s competitors the German representation for our line of medical instruments. “Take on the representation and just sit on it,” his advisor said. That just wasn’t in Andy’s DNA. He had just started his business. A trip with such a lukewarm recommendation didn’t sound worthwhile. Luckily he listened to his instincts and met me. During our two-hour meeting and he agreed to take on the representation of our line of medical instruments. The next year he was responsible for 80% of our Company’s overall sales. We bought his Company, Roesch AG for $700,000 and some stock. When he took the Company public in 2001 he returned $100 million in cash to us. He was named “One of Germany’s Top Five Entrepreneurs of 2001”.

In 2006, I find myself taking trips to visit Andy in Berlin. I have just made my second investment in his biggest idea yet. Paketeria is a novel franchised supermarket services concept he is launching in Germany. Paketeria offers five services; E-Bay service (Germany is the second largest market for E-Bay), photo shop, package service and printer cartridge refilling (in cartridge refilling Germany has only 10% of cartridges refilled versus 50% for the USA). Besides the obvious “Bet the Jockey” strategy, I find Paketeria compelling for the following reasons:

1. He is building a network of entrepreneurs to beat an entrenched monopoly.

Deutsche Post is a hugely profitable newly privatized giant that is shutting down many small post offices throughout Germany and investing capital in helping their DHL subsidiary compete against FEDEX and UPS overseas. They are taking their home market for granted and are counting that their customers will have no other option but to accept reduced service. One of the most proven business models is to attack a complacent monopoly.

2. Paketeria is designed with first-time entrepreneurs in mind

Many of the target franchisees will be from the ranks of Germany’s six million unemployed so capital will be tight for most of them. Paketeria’s fee is only 15,000 Euros and the investment in inventory, the bane of most retail businesses, is tiny. The five interrelated services increases store traffic and spend per customer visit.

3. Paketeria is more inviting than a traditional post office

Germany’s post offices are dark, cavernous spaces where customers wait in long lines to be served by slow and surly union employees. During my past summer vacation I waited 45 minutes to buy stamps in a Deutsche Post office. Paketeria stores provide a stark contrast. The stores are bright with cheerful colors and staffed by entrepreneur owners who are happy to see you. Believe it or not friendly service is a unique concept in Germany.

4. Paketeria is a collaborative network supported by a proven team.

Andy is truly a great entrepreneur but the power of him working with a network of smart franchisees will certainly magnify his success. It is also no surprise that Andy’s team is largely composed of people, like me, that participated in his past success.

Paketeria and Spirit Shop are two of my first investments in the field of “collaborative networks”. In my next entry I want to explore why investors have made such huge fortunes in collaborative networks like Ebay, Google and Amazon.com.

The Adventurous Stationmaster and the Watches

2006-02-24T20:02:00.000-05:00

The Stationmaster of Redwood Falls had a problem. The shipment of watches that showed up at his small train station was refused by the local jeweler. The stationmaster, Richard Sears, decided to buy the watches himself. He started a side mail-order business. Later looking to expand his thriving jewelry catalog he advertised for a watchmaker and made Alva Roebuck his partner. Sears Roebuck and Co. was born. Like the jeweler from Redwood Falls, Roebuck had little need for adventure and left the company after just a few years.

Is life an adventure or do you have a plan? Most people believe that having and sticking to a plan is best. Both the jeweler of Redwood Falls and Roebuck the watchmaker had a plan. The jeweler didn’t order any watches. Roebuck was a watchmaker and he wanted to fix watches not run a mail order business. Richard Sears was a lowly stationmaster who had no plan for watches, no plan for a direct mail company. His only plan was to look for opportunities where others saw only problems.

My wife and I once organized for a Smithsonian exhibit on African American Inventors to be displayed in the basement of a boys’ prison. We invited an African American scientist who worked for DuPont to speak to the boys to help bring the story alive. The speaker faced a hostile audience but he won them over by comparing the styles of the different inventors to that of basketball stars they all knew. He spoke about the value of people and the importance of forming partnerships especially with women. He spoke about Madame CJ Walker, the first African American self-made woman millionaire. He asked, “How many guys rolled over this woman without understanding the power of being her partner?”

I believe we are all stationmasters. Our friends and our relationships are our network and our understanding of the intrinsic value in the people in our life and our willingness to feed our network and support our friends is what determines our prosperity. It is the small things we do every day which helps support our network.

Partnering with the best people and helping them on their journey is the best plan of all.

Dangerous Ideas — Maybe Everybody is Wrong

2006-01-12T04:51:00.000-05:00

In my constant search for the really "big idea," I invest in four of the most dynamic sectors of the world economy: biotech, energy, consumer products and information technology. These are four fast-moving industries with many very smart people. I love learning from the different entrepreneurs I meet. Three of the qualities I prize in a CEO are curiosity, humility and a creative dissatisfaction with the status quo. Lateral thinking can transform industries. Often the lessons from one business can translate into "insanely great" ideas for a totally unrelated business.

Henry Ford made himself one of the richest men in the world by seeing a connection between meat packing and car production. He did not invent the automobile. For over thirty years hundreds of automobile manufacturers hand-assembled cars one at a time in garages. One day, Ford took a tour of a meat packing plant. He learned that the meat industry had learned to improve productivity by dividing complex and tedious tasks into a series of specialized tasks each performed by a seperate butcher. Ford had the humility to look outside his industry for a revolutionary idea. He had the audacity to believe that maybe he and the most successful men in his industry were wrong. He also took massive action to exploit his learnings.

First Comes the Breakthrough and the Opposition from the Establishment....
What is so exciting to me is that what we "know" is constantly being challenged. The best ideas are often considered dangerous by the establishment. The 2005 Nobel prize in Medicine was won by Dr. Barry Marshall for proving that stomach ulcers were not caused by stress but by bacterial infections. What made the story of his Nobel so interesting was the opposition he faced because his idea was so controversial. He was prevented by his University's Institutional Review Board from recruiting patients for his study, so he swallowed a large dose of the ulcer-causing bacteria to prove his belief.

Next Comes the Business Opportunity
It is now believed that stroke and heart disease as well as many other common diseases may be related to bacterial infections. This should be a major opportunity for the antibiotic drug companies. Unfortunately there is a road block. Only 2% of all strains of bacteria can be cultivated in the lab. Now how can you make money off that? I recently ran into a really cool company — www.athenabio.com — that believes it has figured out how to produce many of these hard to cultivate strains.

How can lateral thinking transform your business?
Are you a good listener? Are you a thoughtful observer? Do you have the humility to accept that you may be wrong? It is an audacious humility that says perhaps we have been wrong all along. Are you willing to consider "dangerous ideas? My friend and mentor Bob LeBeau brought to my attention www.edge.org, which publishes the answers to a provocative question given by a large group of the world's leading scientists and thinkers. Here's the link to this year's question, "What is your most Dangerous Idea?"

Hope, Renewal and Risk

2005-12-29T15:35:00.000-05:00

My Christmas card to my friends this year included Jean Giono's The Man Who Planted Trees. The writer is French and the story parallels the American story of Johnny Appleseed. The narrator is a young man who observes the main character, Elzeard Bouffier, singlehandedly reforestate a region of France that has been stripped bare by charcoal burners. As a result of the reforestation the destitute inhabitants are transformed as life and hope returns to the land. A nice story. A fun story. Kind of simplistic and very romantic.

There were three really important messages I got out of this short book that have parallels with investing in emerging companies. The man who planted trees knew: 1) that what he was doing was vital but he did it with utter humility, 2) his math told him that one or two seeds out of twenty would mature, and 3) that his perspective was long and therefore he was extremely patient.

I sent The Man Who Planted Trees to my friends because we all have a passion for supporting entrepreneurs to create really important new businesses. The things I have learned over the past year are:

1) What we do is really important, but to the extent we let others take credit we can be more successful. People create wealth and talented people, people with vision and determination,will create extraordinary wealth that ripples through the economy, which will affect thousands and sometime millions of people...

2) Failure must be part of your investing strategy therefore diversification is essential.

3) Truth in investing is time related. The same investment can seem wrong over 12 months but brilliant in 36 months.

Over the last three years I have been exposed to the biotech institutional investment community. They are very smart people, often very self impressed and also incredibly jaded. I think institutional venture investing is in crisis. The world has changed. In the early eighties biotech VCs were able to invest $10 million to take a drug into phase I trials and then take the Company public at a $100 million valuation before they knew whether the drug was effective. Investors were really buying into the idea of the biotech revolution more than the specific products or risks of a clinical trial. Today public investors are only willing to invest if the drug is in late stage or approved. This means that VCs now must invest $200 million and if they are successful they can take the Company public for a $150 million. Not a very attractive business model. The VCs have reacted by funding fewer companies but investing more money. Intuitively this seems like a mistake as I find most businesses prevail for often impossible-to-predict reasons. They remind me a lot of the big US studios in the 1970's that brought us big-budget disaster films like The Poseidon Adventure, Towering Inferno and Earthquake. Then unpredictably, a director named George Lucas brought us a small film with an $8.5 million budget called Star Wars that brought audiences a story of hope, good triumphing over evil and renewal, and the US film industry was transformed.

I would like to think that one or two of the companies Edson Moore is funding, all of which couldn't get the attention of the big VCs, have a chance to be the Star Wars companies whose success will bring on a new era where funding small companies with big dreams is easier and more rewarding.

The Power of Partnership

2005-11-20T17:33:00.000-05:00

Inside Guy has started a business and is considering bringing in a partner, Outside Guy, to help him take it to the next level. Before entering the partnership they decide to go on a bear hunting trip in the mountains to see how they get along. On the trip up to the cabin Outside Guy tells Inside Guy, “When I go hunting I kill 10-20 bears. I’ve never seen a bear big enough or mean enough to scare me.” The Inside Guy simply says “We’ll see.”

When they arrive at the cabin Inside Guy arranges all their gear in the cabin and the Outside Guy takes their canteens to the stream to fill them. As he is filling one of the canteens he looks up and sees, charging at him, one of the biggest, meanest bears he has ever seen. He drops the canteen and starts running toward the cabin. The bear is nipping at his heels and right in front of the cabin door he drops to the ground. The bear has too much momentum and barrels into the cabin. Outside Guy stands up and yells to Inside Guy, “You skin this one, I’ll go get another!”

The ability to form effective partnerships in life and in business can take you to heights you have never imagined. The creative tension between an inside and outside perspective of the business is the critical magic. Every successful investment I have made was the result of a partnership. Longstanding partnerships are rare. Mutual respect is the essential glue that keeps partnerships together. “Bear killer” inside guys are rare and should be treasured but so are the “Bear deliverer” outside guys.

I look for businesses where Inside Guy has created something really special but needs the help of Outside Guy to turn it into a business. The Biotech industry is a target rich/hunter poor environment for inside guys with huge ideas looking for capital. Biotech inside guys are almost always academic inventors. The Inside Guy’s biggest liability is his lack of appreciation of the value of branding, marketing, business development and capital formation. They consider these “soft issues” that are trivial and it dooms many to failure because they believe their technology will stand on its own. They think, “My problem is money. Just give me some money and I will make millions for everyone lucky enough to invest.” The problem is almost never money as much as it is lack of an effective partnership.

Value Investing

2005-10-06T09:57:00.000-04:00

The Smartest Discipline for Investors—Value Investing
Value investors are contrarians and free thinkers. The practice of value investing keeps evolving from the original work in 1934 by Graham & Dodds Security Analysis. The original premise of value investing was that the investment in any financially solid company could be profitable if it was bought cheaply enough relative to its historical price to earnings and price to cash flow. Normally a value investor looks for asset rich sleeping giants for $.50 on the dollar because they have suffered a business misfortune but where the perceived misfortune is overblown or the underlying asset misunderstood. They count on making outsized returns by waiting for the market sentiment to change and pay full price again.

Value Investors Look for Value Not Reflected on the Balance Sheet
There have been several evolutions of the strategies behind value investing with huge success for the innovators. The earliest value investors like Max Heine bought defaulted bonds in bankrupt railroads. They made fortunes because they recognized the railroads like Penn Central had huge real estate holdings that were undervalued on their balance sheets. Warren Buffet is a value investor. He recognized that the brands of Coca Cola, Gillette and Washington Post were not properly accounted for on their balance sheets and had huge marketing leverage. David Dreman recognized companies with low expectations outperform companies with high expectations. Most recently Bill Miller of Legg Mason has outperformed the S&P 500 Index for an incredible 15 straight years by expanding the definition of value investing to include internet retailers like Amazon and EBay because he felt they were beneficiaries of secular trends and the shares were available at prices below their intrinsic business value. I have been a student of value investing for the past twenty years so I felt it natural to see if some of the tenets that I had learned could apply to emerging growth companies where there is no price to cash flow, dividend yield or price to earnings ratios on which to evaluate a stock.

Great Management and Strategy is the Hidden Value in Emerging Growth Value
Peter Lynch of Magellan Fund fame is often quoted that he liked to invest in businesses where “any idiot could run this joint because sooner or later any idiot probably is going to be running it.” In biotech, for example, it couldn’t be any different. The barriers against success are so huge and there are so many ways to fail in biotech that management and strategy are the key value drivers. In biotech it can cost $900 million to get a drug approved by the FDA and many great products fail in clinical trials for a whole host of reasons mostly scientific and financial. Returns in biotech are hypersensitive to management and strategy to circumvent these barriers while maximizing the shareholders’ return. Great management and go-to-market strategy combined with mediocre products like a cancer product that will extend a patient’s life by as little as three months can result in billions of dollars of value for investors. Conversely, great products that save peoples lives, when combined with mediocre management, are zeroes. Believe it or not, the science bias in most biotech companies means that mediocre management is the rule rather than the exception. My heroes in biotech are guys like John Jackson and Sol Barer at Celgene, who took thalidomide and got it approved off a four-patient clinical trial in Leprosy and today the product is a leading cancer drug.

I want to use this blog to discuss my strategy generating outsized investment returns by leveraging value investing disciplines in emerging growth opportunities in biotech, alternative energy and consumer products and services.

The Ten Lessons of Value Investing in Emerging Growth Companies

Invest in companies that because of macro trends are in the right place at the right time
Start with a great idea that is defendable
Bet the Jockey.The right Jockey will find a way to succeed.
Invest at a deep discount to intrinsic value
Find a cash flywheel that can fund incremental growth
A great team with the right organization can do anything
Be contrarian and change the rules of the game
Branding and positioning are the keys to making a big dream come true
Invest in companies that leverage your equity with non-dilutive financing
Add to your winners and sell your losers.

Steve Jobs On Life and Work

2005-09-29T16:44:00.000-04:00

If you haven't read it, do:

Steve Jobs' commencement address to Stanford's Class of 2005

To the partners and friends of John A. Moore

2005-09-29T12:14:00.000-04:00

Dear Friend:

All of us are so busy chasing the urgent tasks in our lives we have no time for the important. It is not just you and me and it's not just our industry, it's all of the world. The entire world seems to be plunging headlong into the future without so much as a road map sketched on the back of an envelope.

While I know we need to study the future, I believe the best rules for success come from history. My ongoing study of business has led me to believe that while technology is changing exponentially, the hearts of people aren't changing at all. We are still the same predictable creatures we've always been.

People and business seem subject to certain laws of the universe that are impervious to change. I believe the knowledge of these laws is the key to placing yourself in the right place, at the right time, doing the right thing in the right way.

Let's you and I make a deal. If you will agree to pause for just six minutes a week to think about your business and your future, I'll write a blog post here at www.betthejockey.com about the timeless truths on which I and the most successful people I know have come to depend. At the end of the year, you will have spent more than three hours viewing the blurry, unknowable future through the sharp, bright lens of the past. That's exactly three hours more than any of your competitors are likely to invest in thinking, learning and planning. Like you and me, your competitors are simply too busy to plan.

Do we have a deal?

John A. Moore

My learnings from age 18 to 40:

2005-09-01T09:32:00.000-04:00

1984: I start my career on Wall Street as a cold caller at Lehman Brothers. That year I acquire defaulted debt for $70 per $1,000 bond in a small public company, CGS Scientific, a thermocouple manufacturer. It’s my first Board seat and after converting the debt into equity, I get the company listed on the Philadelphia Stock Exchange. I sell my stock three years later for a 50x return on my money. This was important for me because it proved “big baggers” existed and I was sure there were more where this one came from. I was hooked on value investing in small companies.

1986: I graduate from college and become Assistant to the President of D.H. Blair. I work here for one year and learn a lot about financing small companies. During this time, Blair owner Morty Davis is reputed to be the highest paid person on Wall Street; I am certainly the lowest paid.

1988: I acquire control of Lindly & Company, a publicly traded textile machinery manufacturer. I manage to triple the sales and quadruple the costs of the firm. Something has to change as the company flirts with insolvency. I announce the firm is being liquidated and sell enough spare parts to pay our debts and recapture shareholders' investment.

1991: Acquired a large stake in American Electromedics and October Films and distributed the shares to the Lindly shareholders. My partner and I turned AECO from losing $1,000,000 per year to making $1,000,000 per year. The big success came for this business when a German subsidiary we acquired for $500,000 went public at a $200 million valuation.

Also in 1991, my company backs Andy Rosch in a new venture. Eight years later, Rosch will return $100 million to us and will be named Germany's Entrepreneur of the Year. In 2005, Rosch will start a new venture, Paketeria, and I'll havethe privilege to back him again.

1994: Start Optimer as a textile fiber development company with my brother and father. Eventually my sister joins us and in 2004 Readers Digest calls our product, Dri-release^®, “One of America’s 100 Most Important New Discoveries.”

1996: Initial investor in Bluegill Technologies at an initial valuation of $3,000,000. In 1999 Bluegill is acquired by Checkfree for $250 million. Far more than the money I made from this transaction, I valued my friend Hal Davis completely transforming my understanding of how to build a valuable company.

2002: Acquire a $150 million portfolio of 16 joint venture securities from Elan Pharmaceuticals through Shelly Bay Holdings and later Edson Moore Healthcare Ventures. We eventually exit seven of these investments at two- to twenty-fold returns. Two were zeroes.

2003: Joined the Board of Elite Pharmaceuticals and eventually fire the founder and become Chairman and hire an industry veteran, Buddy Berk, to be CEO. We launch the Company’s first product within the first year. I resign as Chairman, Buddy raises $6.6 million, and Edson Moore exits at a 5x return.

2004: Become Chairman of ImaRx Therapeutics, another Edson Moore company, and in 1½ years raise $17 million from high-net-worth individuals at pre-money valuations of $20, $40 and $68 million.