Disruptive Technologies

I have been wanting to write a blog post about this topic for some time. I think it is one of the greatest concepts in technology marketing strategy, and yet I think it is one of the most misunderstood. When I use the term Disruptive Technology, I am referring to the phemonenon discussed by Professor Clay Christensen in his book, The Innovator's Dilemma. I highly recommend this book, and it's follow-up, The Innovator's Solution, for anyone devising a marketing strategy for a technology company. These books show how certain types of technologies, as they mature, can displant Sustaining Technologies, even though they originally may be inferior to these technologies.

Let me begin by describing what does not constitute a disruptive technology. Many people assume that a disruptive technology is one that is "really different"; specifically something that is technologically impressive, the "next generation", and generally a lot better than what it is replacing. As I will discuss, this is generally an incorrect way to look at these technologies. For example, some people mistakenly say that the CD was a disruptive technology over the audiotape, because, CDs are "really different" from audiotapes. By the same logic, it is argued that the Internet itself is a disruptive technology (in this case, it isn't even mentioned what technology the Internet "disrupts"), solely because, well, the Internet is really different, isn't it? I mean, it's a pretty big thing, so it's got to be disruptive, right? The same argument is used for iPods, GPS navigation, and DVRs. In some cases these are disruptive technologies, in most cases they are not.

A marketing manager at one of the companies I worked with in the past used to say to me, "Selling disruptive technologies into conservative markets is really hard." This company made a lot of extremely cool technological products, however, few of them could be argued to be disruptive technologies, and there were many other reasons that it was difficult for the firm to sell its products. The key thing to understand is that a disruptive technology will almost certainly be hard to sell into a conservative market - that's why you shouldn't try. The beauty of a disruptive technology is that it should be sold into the market that values the product. Most disruptive technologies, when tried to be sold head-to-head against traditional sustaining technologies will often lose.

The reason that the definition above is often incorrect is that a disruptive technology is often one which is inferior to a current technology on the metrics valued by the incumbant organization and market. However, the technology addresses market needs by a different market - often one without competition, and (here's the best part) often unattractive to the incumbant firm. This allows the startup to grow its product without competition.

The reason that the incumbant firm cannot compete effectively against the startup in these situations, is that the incumbant firm either cannot recognize the value of the inferior product, or it is making good margins selling a premium product, and the sales the incumbant loses to the startup (if any) are the low-margin unattractive customers. When this happens, the incumbant sees its gross margins increase - it actually feels good to lose its business to the startup, and thus it does not recognize the threat.

Because of this, the CD is not a disruptive technology to the audio tape. The metrics that the incumbant manufacturers and the market value about traditional audio tapes - recording quality, recording time, compactness - are the same metrics which are improved by the CD. It was very easy for cassette tape manufacturers to realize that the CD was a potential threat. Likewise, the iPod was a sustaining technology to the Walkman, GPS navigation was a sustaining technology to the map, and the DVR was a sustaining technology to the VCR.

No, a true disruptive technology might be something closer to a comparison between Virgin Blue and Qantas. Virgin Blue (like Southwest Airlines, Easyjet, and others) is a discount airline. These types of airlines are great for value concious consumers. Qantas (and BA, United, and others) offer services for Business Class travel and enjoy fantastic margins on their premium business. Now, from this point of view, Qantas might say they have nothing to fear from Virgin Blue - all the low price rabble that fly on Virgin Blue lower Qantas' margins anyway. They may convince themselves that they are a premium product who cater to a more valuable customer. However, as has been shown many times already, as the discount airlines begin to succeed and offer better service, more frequent service, and become the airlines of choice for millions, it becomes harder and harder for the full service airlines to compete. In fact, faced with declining revenues, a full service airline will likely move upmarket in an effort to extract even more money from their premium customers. Virgin Blue is able to grow their market, with little competition from Qantas - not because Virgin Blue is better, but because Qantas has a harder time competing with Virgin Blue when Qantas' most valuable customers, the ones that Qantas will work the hardest to keep happy, are not demanding the discounts that Virgin Blue can apply. The metrics valued by the Qantas business class traveller are not the same as those valued by the Virgin Blue traveller.

So, if you can set up your business strategy to allow you to compete in a market niche along a different set of value metrics to an incumbant, you will likely not face immediate competitive threat. In fact, if you can position your business to attract a market untapped by the existing incumbants, that also is unattractive to the existing incumbants because of their current commitments to their current best customers, then you will be well positioned to grow your company, improve your product, and prepare to compete before your competitors even see you coming. It is that type of disruption which earns the title Disruptive Technology.

Business Plan Tips Part 1

Part of the purpose of this blog is to help describe what issues are necessary when trying to succeed as a venture capital backed startup, with a focus on Australia and clean technologies.

So, I've started to start a series of postings called Business Plan Tips. These tips will help your business plan be more readable by, and therefore more interesting to, investors.

Today's tip is something that, when I first saw it, I dismissed it as an anomaly. However, I have since seen it four other times, and so I decided it was worth discussing, so here it is. Please do not include a "Total" column in your Income Statement.

I'll explain. If you look to the figure at the left, you see a three year Income Statement for that hot new startup, Fantastic Co. You can see modest growth in revenue and EBITDA, until glancing at the last line you see $9m in sales, with almost $5m in EBITDA. But, wait! Looking up you will see something odd. The company doesn't have $9m in sales in year four. Instead, the company has had $9m in sales across the previous three years. What does this mean?

In short, it means almost nothing. Nobody cares what the cumulative sales/EBITDA/COGS or anything else performance is over some arbitrary period of time. Putting in a Total column is just misleading, because most investors will look to the last line to see how the company is performing in the final year. Companies are valued as multiples of EBITDA, or multiples or revenue, but no company is valued as some total of previous years. I suppose the only purpose of this column would be if the company were to be liquidated at the end, but even then, the Retained Earnings figure on the Balance Sheet would be more appropriate.

So, please don't put a Total column. It's misleading. It's pointless. It frustrates the reader (and worse, once they realize their mistake, the next emotion is disappointment, because the actual final year figure is much less - even if the final year figures are reasonable, why would you ever want your reader to feel the emotion of disappointment when reading your business plan?) The goal of your business plan should be to quickly and clearly communicate your good-news story of why your company will be a success. A Total column just gets in the way.

Adventures in Domain Hosting

As I work towards improving this blog I registered the name www.aaronfyke.com (however, if you click on it, you come back here). However, doing so has been a bit of an adventure for me. First off, I'm not entirely certain that I've set it up correctly. I have it set up so that if anyone visits aaronfyke.com (or www.aaronfyke.com), they are sent here - which is actually my old aaronfyke.blogspot.com address.

The thing is, that's not how Blogger suggested setting it up. Instead, they suggested using DNS management and setting up a CNAME alias. So, I'm wondering if this will make it so that aaronfyke.com never gets picked up by a search engine? I'll have to wait a few days and see.

Bizarre Formatting!

This is one of the most bizarre Firefox/IE compatibility errors I have come across. For some reason the posting below looks very different in Firefox vs IE. I always use Firefox, but I looked at my blog using IE and I see that one of the lines is Greek! I've repeated it here rather than changing the previous post so you can see too. Have a look at the blog using Firefox and IE, and you'll see what I mean.

what are the most likely sources of renewable energy for regional Australia?

Renewable Energy Conference

There is an interesting conference happening in September in Bendigo, Victoria, regarding renewable energy. I'm going to be speaking at the conference, giving an overview on how venture capital investing works, and some of things that VCs are looking for in new investments. If you think this might be interesting, I recommend that you look into it.

A national conference on ideas, examples and action being presented in Bendigo, Victoria on 16th, 17th and 18th September 2007.

Regional Australia is particularly vulnerable to the vagaries of alternative energy supplies. Energy for transport as well as industrial, mining and agricultural development is essential if regional Australia is to develop and continue to play its role in the long term success of the Australian nation.

The conference presentations will address questions such as:

· what are the most likely sources of renewable energy for regional Australia?

· what is the state of development of these different sources?

· how accessible are these energy sources to people in regional Australia?

· what needs to happen to make them readily available? and

· what can regional communities do to assure their access to renewable energy?

Keynote presentations from government, business, academic and community leaders will be complemented by a focus on practical renewable energy initiatives.

For more information or to download a registration brochure: www.renewableenergyconference.com.au

Business Strategy

One of the first things I look at when evaluating a deal is the business strategy that is being proposed. If I understand the strategy, I have a pretty good idea of whether the business will make money, and how likely it may be to succeed. Most of the business plans that I've decided to pass on have been because of a bad strategy, or having no strategy at all (or at least one that wasn't made clear).

So, I thought that a good thing to write about, at least over a few posts, would be to talk about some of the best things I've learned about strategy - marketing strategy, technology strategy, etc.

One of the simplest places to start is by examining the supply curve. The profit of a venture is shown in the green area. Q is the quantity of a good sold, P is the price of the good being sold, and C is the cost of delivering the good.

So, when starting any business, ask yourself, what can you do to make the green rectangle bigger? You can either increase the price by offering a premium product, decrease the cost, by being more efficient, or shift the supply curve to increase the quantity sold.

Once you have thought about how you are making money, the next question is - how is this sustainable? What can be done to ensure that these profits can be made over time.

The next model helps examine how easy it will be to protect profits over time. This is the famous five forces analysis (Porter). The five forces analysis helps determine where the value is likely to end up in the value chain. A mantra of management consultants is the notion of creating value and capturing value. Most inventors only think about creating value. One of the most important parts in determining the success of a business is its ability to capture value. This can be determined through the five forces analysis. These forces are:

Supplier power - The strength of a company's suppliers in negotiation.
Buyer power - The strength of a company's customers in negotiation.
Threat of new entrants - The ease by which competitors can enter the marketplace to compete with the company.
Threat of substitution - The threat that other, different, products can compete with the company's products.
Threat of competition - The strength of the company's competitors.

The higher each of these forces are, the less attractive the industry is for that company. When devising a strategy, it is important to work to weaken these forces. Reduce supplier power by purchasing commodities from multiple suppliers. Reduce buyer power by selling to several customers. Erect barriers to entry through IP protection, exclusive agreements, and switching costs to prevent other competitors from entering the market. Reduce substitution threat by developing unique products. Reduce the threat of competition through entering untapped markets.

All of this sounds easy to say, but understanding these frameworks can help entrepreneurs frame business strategy which is profitable and sustainable over time. And it is these business plans which are most attractive.

Stay tuned for further posts including a discussion of some of my favourite technology strategy books - Crossing the Chasm, the Innovator's Dilemma, and the Innovator's Solution. Lot's more to discuss!

Farmer's Viewpoint

Interesting. Last night ABC (the Australian public broadcasting network) ran a movie called The Great Global Warming Swindle. It was a pretty shonky piece of non-science, and it was quite fun to try to unravel the various half-truths that were said in the piece. The ABC took too much of an "anti-skeptic" stance, in my opinion. It would have been better to show the fallicies and let the data speak for itself. But no matter. I am worried at the number of people who would be mislead by this film.

Nevertheless, I was reading some of the online comments and there were a few from the Australian farming community. I thought of my posting a while back, and thought I'd share one of them with you.



Author Backblock
Date/Time 12 Jul 2007 4:39:22pm
Subject A farmers viewpoint

As a farmer, climate change is not just an academic question. It affects my life, and the life of my associates. The question of whether global warming is real or imagined could mean the difference in whether our farm is viable or not.

For years we have watched on as academics fought it out over whether man-made global warming is real or not. We placed some hope in the possibility that climate change sceptics were right, but kept an open-mind to other climate experts.

As many people know, the current drought has had many of us worried because if it keeps going many farmers will go broke. While some areas are looking better with recent rains, our local district still has lower than average soil moisture levels and our dams are empty. But many of us have hung on with the hope that climate change has been exaggerated. Australia's climate can be highly variable naturally.

However, I noticed that the issue of increased solar activity has been recently ruled out by academics, and it seems that there is no other viable explanation for global warming other than greenhouse gases like carbon dioxide.

I now feel that the people who are saying man-made global warming is not real have hoodwinked many in the farming community. You sceptics seem more interested in saving face rather than finding out the truth. You gave farmers false hope, and have influenced many of us to keep going when this may be ill advised. One good year in 10 is not enough to maintain a viable farm in our area.

What you sceptics need to remember is that climate change also affects people’s lives. It’s not just an argument to win at all costs. And if everybody else thinks this will not affect them, think again. The current increase in vegetable prices is largely a result of an increasingly unstable climate.

In the end you sceptics will have to face your conscience and God.

More fun with numbers!

The analysis I did in my last post was quite enlightening. To grapple with the sheer scale of the issue of CO2 reduction, it was helpful to determine what year would have the equivalent emissions as a 40% reduction in 1990 levels (1959), and what year would have equivalent per capita emissions as a 40% reduction in 1990 levels in 2050 (1900ish).

Another analysis would be to take the per capita emission levels we are taking about and compare it to equivalent countries today. The point of this analysis shouldn't be misinterpreted. I am not suggesting that people's standard of living will become equivalent to the countries mentioned. However, I think this shows how substantial the changes need to be in order to meet the cuts required.

I determined that in 2050, in order to have emissions equivalent to 40% of 1990s levels, the world would need to average only 0.25 tons per person. The current average per capita emission rate now is approx 1.23 (2004 data). Looking at the list of countries we see that the country closest to this today is either Morocco (1.2 tons/person) or Colombia (1.3 tons/person). Now, if we need to reduce the emissions to 0.25tons/person, that would be equivalent to dropping the average world's emissions to the levels of Bangladesh (0.25).

I should note that I was confused when one of the sources I quoted mentioned tons of CO2 and the other mentioned tons of CARBON. I am going to assume that by "Carbon" it is meant CO2, otherwise this comparison isn't fair.

So, if the world's average country will have to go from Colombia to Bangladesh, I'm not sure if that tells us a lot. Mostly because I only have a really vague idea of what the CO2 emissions and standard of living is like in both Colombia and Bangladesh. So, the next useful thing is to try to equate US/Canada/Australia emissions. Let's assume that if the mean per capita emissions has to drop by a factor of five that we can safely scale *all* countries by a factor of five. This might be unrealistic, but maybe not. The countries with near zero per capita emissions would not change much and the ones with the most per capita emissions would change the most - maybe that's fair. So, if we take current U.S. per capita emissions, they are 19.8 tons. Reducing this by a factor of five becomes only 4 tons per person. Today, ironically, Mexico has 4 tons per person.

So, let's review. If the U.S. were going to match South Australia's requirement of a reduction in CO2 emissions to 40% of 1990s levels in 2050, this would result in a drop in emissions per person from what the U.S. has today to what Mexico has today. Or, put another way, if the U.S. does not want a massive drop in standard of living, there is a MASSIVE amount of clean energy that needs to be implemented to accomplish this.

Actually, there is a bit of a flaw - I'm assuming that the US will see a population growth rate equal to the growth rate of the rest of the world. However, this isn't likely to be the case as most developed countries are seeing a drop in population growth rates, but still, the irony of comparing the U.S. and Mexico was too good to not persue.

South Australia emission targets become law

I got this from Responsible Investment News. It will be interesting to see how this plays out - less than 40% of 1990 levels by 2050 is a lot, but it's also a long way off. More interesting is the 20% renewable energy target by 2014, which is only seven years away.

---
South Australia has become the first state in Australia to legislate targets to reduce greenhouse emissions with the Climate Change and Greenhouse Emissions Reduction Act 2007 becoming law on 3 July 2007.

The legislation sets out three targets:

- to reduce by 31 December 2050 greenhouse gas emissions within the State by at least 60% to an amount that is equal to or less than 40% of 1990 levels as part of a national and international response to climate change;

- to increase the proportion of renewable electricity generated so it comprises at least 20 per cent of electricity generated in the State by 31 December 2014; and

- to increase the proportion of renewable electricity consumed so that it comprises at least 20 per cent of electricity consumed in the State by 31 December 2014.

For more information go to: http://www.climatechange.sa.gov.au/news/news_4.htm

---

For interest, I decided to see at what year the world was emitting 40% of 1990 levels. I grabbed some data here. It looks like 1990 levels were 6.2 billion metric tons of carbon (note, that this says carbon, not carbon dioxide. Since the molecules have different weights, I wonder if the difference is intentional? At any rate, it should still answer our question. So, 40% of 6.2GTons is 2.48GTons which is the rate of emission in...1959! Hmm...

An even more interesting analysis is to determine what that works out to be in CO2 emissions per capita. In 2050 the population of the world is expected to be about 10 billion. I know the link shows a graph of around 9.5 billion, but another pop clock put the population at 10 billion by 2037, so I took a round number in the middle (besides, it makes the math easier). So, 2.48GTons/10Gigapeople = .248 Tons/person. So, to achieve, for the whole world, what South Australia is proposing requires cutting our carbon emissions to a quarter of a ton/person. Seeing as our current output is 1.23 tons/person, the last time emissions were down to about .25 Tons/person was between 1897 and 1907 (depending on population data, which I didn't have handy). To support the number of people on this planet in 2050, and to achieve, globally, the South Australia targets, we need to turn the CO2 production clock back to the turn of the century - the previous century. Clearly there is a huge need for low-carbon solutions to maintain our standard of living!

Rural folk

I have noticed something with the upcoming Cleantech revolution, and that is a growing power placed with one of this nation's earlier entrepreneurs (as well as the entrepreneurs of my previous nation - the US - and my previous nation before that - Canada). I'm talking about farmers and ranchers. These people don't get much thought these days (at least by city-dwelling folk like me), and in many ways I think that they've been sold short. I've noticed in all three countries that I've lived that there is a divide between rural and urban dwellers. That being said I must say that the divide in Australia is the narrowest, and in the US it is the widest (so much so, that the political spectrum is almost neatly divided between urban "blue states" - Democrat supporters, and rural "red states" - Republican supporters). As an aside, I've noticed that the split is nearly reversed in Canada - the rural people are left wing, and the urban people are right wing (sort of), but I digress.

Where am I going with all of this? Well, with much of the "new economy" hoopla over the past ten years many people in the media have given the impression that entrepreneurs are all engineering students between the ages of 20 and 30 starting up web-based businesses. Everyone else was dismissed as "old economy". Agriculture wasn't even hip enough to be classed as "old economy", it was simply dismissed entirely. Growing up in Saskatchewan (a very farming oriented, rural province of Canada) I saw a lot of this. However, farmers are some of the most entrepreneurial people I know. The original pioneers who populated the West of Canada and the US (and rural Australia) endured risks far more than any dot.com entrepreneur, and the farmers of today know what it takes to run a business, and are very innovative.

What I think we'll see happen, and in many cases I have begun to see it already, is the entrepreneurial spirit of farming will resurge and play a major role in Cleantech. At least three huge sectors of Cleantech are a good fit for rural life - wind farms, solar farms, and biofuels production. Farmers are used to using their land as a business to make money, and I've seen many cases where farmers were eager to set up a wind farm or grow biofuel suitable plants. There is a lot of push in the rural community to make big on the opportunities presented by Cleantech, and given the entrepreneurial history required of rural life, I think it is somewhat exciting that this group, often overlooked by traditional urban, tech-oriented folk, could have a resurgance and play a major role in this new wave of tech adoption.

Introduction

It seems that most venture capitalists these days have a blog and I decided it was time for me to share. I'm an Australian VC investing in Cleantech, which is a big deal here in Australia. This blog will discuss the Australian private equity industry, the Cleantech industry (renewable energy, water efficiency and pollution abatement), as well as my general musings from moving down-under.

G'Day!