News broke yesterday of Sequoia Capital putting US$2m of funds into a joint project with Y-Combinator. While many commentators have focused on life in venture capital, most have ignored the strategic angle to the partnership.
Y-Combinator and similar organisations (SeedCamp in Europe) take what is a ball of mud, clean and polish it and see whether there is a diamond (however rough) in the middle. They reduce the risk of very early stage ideas. The funding provides Y-Combinator with more resources to find more diamonds.
Sequoia Capital gets a better pipeline of potential deals. These companies have been polished, cleaned and have core basis for growth that is articulated. To continue the analogy Sequoia Capital can do less polishing and focus on the cutting.
Doing this very early company nurturing is not the same as traditional venture capital and Sequoia Capital (for that matter any VC fund) is not set up to do it. The cost structure of the fund doesn't lend itself to company nurturing. Y-Combinator doesn't suffer that problem and so more money ends up for nurturing companies and Sequoia Capital builds on the experience of Y-Combinator.
The partnership points to an intereting evolution of the venture funding model. I expect we will see similar future deals between VC funds and company nurturing funds as all VCs aim to improve their pipeline and manage their risk.
This financial disaster requires some extra innovations in stimulus. Stimulus is needed from the governments simply because the massive reduction in demand brought about by job loss, credit freeze and re-balancing of household budgets. Tax cuts versus cash handouts are a red herring. The sheer amount of demand lost cannot be replaced by increasing discretionary income. Most of the consumer demand was credit based that 140 to 160% leverage of households. Trying to replace that with tax cuts or cash handouts is like trying to refill a reservoir with a bucket after the dam as broken. It’s not going to even touch the sides.
Nor can businesses replace the demand. They are inextricably tied to the crisis as businesses have been just as profligate as consumers over leveraging and not building up capital reserves. Few companies have built up cash reserves that they can use to invest during the down turn. Government handouts or tax cuts to businesses aren't going to do much to create the necessary investment in growth. Too many companies need to repair balance sheets (just like households).
The only point is for governments to step with their own demand. The idea isn't to replace all the demand lost (that will never happen) rather to break the cycle of lost demand causing further lost demand. Government stimulus initiatives need to be more direct than perhaps they have been in previous recessions. For the demand replacement to work it can't focus on make work like ditch digging. Stimulus programs need to consist of short, medium and long term that focus on energy, transport, communications and maintenance in order to produce a trajectory that gets us out of the spiral.
Short term initiatives are programmes that can be started in a very short space in time. Short term projects that would work are:
Insulation or wheatherisation of homes (in particular low income households),
Rebates, low interest loans or direct funding for households to install renewable energy systems and general energy efficiency for both households, schools, hospitals and government buildings,
Maintenance of roads, bridges, culverts and buildings will improve infrastructure are usually ready to go and can easily verified.
Re-opening existing funding programs for example, in Australia there was a solar-rebate program that was shut due to over-subscription. Adding money into this and re-opening would be a quick win as the bureaucracy already exists and nothing new has to be done.
Medium term require more time to get off the ground. The idea is these projects take over creating demand as the demand from the short term projects peters out. Examples of projects are:
National conduit system for communications (fibre). The idea is that the conduits are all built to the same design and can be undertaken by a multitude of companies across the country at the same time.
Installing Electrical re-charge stations would overcome the chicken and egg problem of getting plugin cars main stream. They would also reduce bills spent on petrol (gas), while stimulating demand to replace existing cars with plugin’s.
Replacing old bogies and busses and expanding the fleet will generate demand for manufacturing while improving the energy consumption of the economy. As per unit energy of transport falls productivity rises and frees up resources to be spent elsewhere. London Transport could certainly do with more upgrading the overground trains and increasing the size of the fleet. To say nothing of the underground.
Long term projects are generally large scale infrastructure projects that take time to get off the ground. These take over as the demand from medium term projects peter out. The type of projects I think should be funded are:
Fund mass transit systems in cities.
Fund fast rail projects linking up major cities. In Europe this would involve funding cross boarder connections and city bypasses.
Provide loans for large scale renewable energy projects. The loans provide the initial liquidity that is lacking at the moment and address the need to create green jobs.
Fund the extension of the power grid from sources to demand. This overcomes the chicken and egg problem that make a lot of large scale renewable energy projects dicey.
Development projects are only one part of the stimulus package. Additionally, help to start new and existing businesses is needed (many of the old businesses need to die as we progress from centralised to edge economy). For small business the hardest part is getting the capital/resources together to get the business to a point of being cashflow positive. Venture funding is not the answer. Most small businesses are not venture businesses but rather businesses that will turn a tidy profit but never exit.
For many (if not most) small businesses labour is the largest cost in the early years. To help new businesses start, governments need to provide income-contingent loans that pay salaries for up to 5 employees for the first year with an option to extend for a 2nd year. The income-contingent loans would be on the employee and not the business (reduces gaming of the system and also means the employees are invested in getting the business to succeed). Large numbers of new small business will go a long way to address demand destruction. The government also needs to reduce the costs they impose on business through the amount they charge for services and cost of complying with regulation and legislation. This will free resources leading to increased investment and lower prices which benefit the economy overall.
Why energy, communications, transport and maintenance? Energy has two effects it addresses the simmering problem of peak oil and energy security (that hasn't gone away only been pushed to the background and will come roaring back soon). Additionally, by increasing energy efficiency cash is freed up (households, business and government) that can be used elsewhere whether repairing balance sheets faster or for consumption. Communications and transport projects also go to increasing energy security but primary reason is that improved communications and transport increase the productivity of the economy. Maintenance improves the performance of assets while also extending their life.
Moral hazard will be raised along with the supposed unfairness to people who where sensible. This is a concern but one that shouldn't, mustn't, hold up initiatives to break the spiral. The market can only work if there is a market and we are all part of a system. Just like destruction of one part of an ecosystem flows on to destroy other parts, so too will the spiral flow on to effect even the sensible. Within the three pronged approach you can put in place methods to address moral hazard and poor behaviour. For example, with the mortgage principal reduction the government can take a majority of any future realised capital gains. People who have the mortgage reset can also face additional credit restrictions in the future.
All of this is further complicated by the need for Western countries (particular the Anglo-Celtic countries) to coordinate the implementation of such a sweeping initiative. If the countries go it alone they will only make the whole job harder.
These are unusual times and call for unusual measures. The aim here is to reduce the crushing debt and cushion the economy from the plunge in demand by making it easier for new businesses to start and creating demand to replace some of what was lost. Make no mistake; the world will not return to levels of demand seen previously and the point of stimulus packages is to make the shift in the economy orderly rather than chaotic. Now is not the time for ideological battles or programs. The world needs pragmatism and the leadership to break the spiral and begin the path to recovery.
Many have talked about how to solve the current crisis. I have my own view. I’ve written this as two comments so far; on Tom Evslin’s blog and Fred Wilson’s blog. At Fred’s suggestion and prompted by Neil Ferguson’s recent article in the Australian about similar proposal I’m turning this into a blog post.
The continual drip feed of rescues and bailouts is like keeping someone who has been bitten by a snake on life-support without removing the poison from the body and wondering why you have to keep treating heart attacks and seizures. Until the poison is removed from the body nothing is going to change. The economy is poisoned and the rescues and bailouts are doing nothing to remove the poison.
The poison is fear. Fear of investors who don’t know where the risk is and how risk exists. Fear of households who don’t know whether they will be able to keep food on the table or a roof over their heads. Fear breads fear. It feeds off it and becomes self perpetuating. To begin recovery, initiatives need to short circuit the fear.
The poison entered the system via inflated asset prices and loans. The principal on loans is simply too large. Now the loans are sucking up increasing amounts of income to pay off reducing consumption and increasing default rates, both feeding into the broader economy to reduce demand and in an on-going spiral leading to a recession, job losses and further defaults. As job losses mount consumers reduce their expenditure as they fear losing their own jobs and not being able to put food onto the table and a roof over their heads.
Investors injected fear as they suddenly found themselves in the unknown. Their safe investment s weren’t and now they had no idea where the risk is or how much, leaving them to stop investing and lending causing liquidity to dry up. The liquidity loss caused further increase in risk and default feeding further problems. It is all a spiral and until the spiral is broken it keeps going.
So far initiatives have halted the convulsions and resuscitated from heart attacks, but it is now time to draw the poison from the system.
Drawing the poison starts with loans. Until loans reflect the actual value of the assets, foreclosure rate will be high, subsidised payments and modifications notwithstanding. It simply doesn't make sense to continue to pay a mortgage, even at subsidised rates, when the value of the underlying asset is 20% or more less than the mortgage. In the end the mortgage principal needs to be reset to be within shouting distance of the underlying value of the asset.
Governments need to look at wholesale reduction in principal, something along the lines of financial institutions writing down the principal by 15 to 30%, the government purchasing 30% of the principal from the institutions. Depending on the location the Government can either write-off their purchase principal, suspend interest on their part of the principal or do nothing. The mortgage principal in effect is reduced by between 30 to 60%. The price of housing gets a massive reset to something resembling reason and underlying value. The principal reset has the effect of creating massive re-balancing of household balancesheets and freeing up income for discretionary spending.
Where it that simple of course. Unfortunately, underwater equity is only a small (although extremely toxic) part of the problem. The abject fear of not being able to keep food on the table and roof over their head is causing consumers to save. That fear undermines all stimulator policies. While new jobs may be created they are not going to be created fast enough to replace the jobs lost. Job loss happens far faster than job creation. The fear is creating a spiral to disaster that needs to be short-circuited. A short circuit would be to guarantee 75% to 90% of previous salary for a period of 12 to 24 months (the time length depends on time lag between job loss and job creation). This would remove the fear of not being able to buy food or keep a roof over their heads.
Existing unemployment benefits don't work in this situation as people can't downsize their life nor do you want people to down size their life quickly as that only exacerbates the asset and consumption problem. Broadly, the economy needs a short circuit and breathing room to allow stimulus and automatic re-adjustment to gain traction. The current disaster spiral overwhelms normal automatic adjustment in the economy.
Reducing principal and supporting salaries will draw the poison for the system and provide breathing space to begin recovery. But just like a patient, the economy needs physical therapy to return to full health. This is where the stimulus comes in.
Digital Engagement, Gov 2.0 whatever moniker you want to use is on the up and up now. President Obama’s successful use of social networking and other social media tools during the campaign followed by the change.gov and new recovery.gov sites has brought the issue front and centre for many governments. In Australia both the PM and the Opposition Leader are on twitter and the Opposition Leader recently launched a blog for conversing with Australians. The UK government is hiring a Director of Digital Engagement and has a various initiatives like the Number 10 e-petition system.
For all the enthusiasm, Andy Oram wrote a very good post yesterday about the questions about government participation. For Governments and citizens looking at digital engagement, these questions have to be answered. Without answering these questions, initiatives will fail.
Is digital engagement worth it? It is as implemented well it has the following benefits:
Reduction in cost of compliance for business which leads to lower prices reducing cost of living,
Supports the flourishing of new businesses,
Lower cost to running the government, and
Improve perception of the value of government services.
While these benefits may not seem like much they produce a positive feedback loop that increases the overall value to society.
So the question isn’t so much whether we should do it but rather how do we do use digital engagement tools effectively?
Just get out of my Way
Digital Engagement isn’t simply about holding a conversation. The context matters. For example, if I am looking for the address of a service centre I don’t want to enter into a conversation. However, if there is a new bill on the table in parliament then I will want to join the conversation.
The minute digital engagement gets in the users way or adds no value to what they are doing at the time is when you get push back.
The context is king for digital engagement.
Policy and bills before parliament are a perfect example of where digital engagement can work extremely well. In this case the bills would be available online. It is to borrow a phrase, a social object. To bring engagement to policy and bills would be in the form of comment system like Disqus or Intense Debate. In essence each policy or bill becomes its own blog post.
Build a little, test a little
Rome wasn’t built in a day, but often initiatives such as digital engagement try to build Rome in a day. Instead, digital engagement should use Werner Von Braun’s engineering approach: build a little, test a little. The idea here is to build prototypes that are quickly deployed, which are then iterated based on user feedback. Trying to build an all encompassing solution simply chews up time especially when the users will start using the system in ways no designer could have foreseen. The evolution of Twitter is a great case study for how users take a system and begin using it in ways the designers and builders never expected.
Winning the Sceptics
Winning over the sceptics is likely to be the hardest part of any digital engagement initiative. Sceptics will question the value of digital engagement. They will also worry about how it changes their workload and job. Even for some whether it will mean losing their job. Others will ask whether the government will keep the conversation two-way. Addressing these real and legitimate concerns has to be the primary responsibility for those in charge of any digital engagement initiative.
The build a little, test a little approach neatly provides a way of demonstrating the value of digital engagement without extensive investment in time and money. Perhaps more importantly, it provides those involved with concrete and tangible feel for how their work will change.
The on-going involvement from both sides of the conversation will be the hardest to tackle. The key here is to be realistic. Fred Wilson continually points out how the community around his blog is built from his active involvement. For digital engagement to work, the public service and Government will have to participate in providing answers to comments and questions. Will Ministers and senior public servants want to do this? Some will and some won’t. The answer is to have “Untouchables”, “Community Managers” or “Community Advocates” who can effectively engage in the conversation.
Work/Life Balance
Drawing a line between work conversation and personal conversation is fraught but important for any digital engagement to succeed. Some organisations take the ridiculous view of everything being professional. It doesn’t work that way and is an imposition on people because organisations don’t want to address the issue at stake but instead repress it.
Mistakes will be made, gaffes will happen and the “wrong” thing said. Creating a policy that doesn’t address that is madness and will drive people (particularly Government and public servents) away from participation. Instead the policy needs to recognise when someone is a representative of the public service and government and when they are private citizens.
Showcasing Engagement
Without showcasing the prototypes across the Government and Public service web presence, all of the above will be wasted. Case in point, the OPSI “Unlock Service (beta)” is buried in the jungle of government portal pages. I only found it by accident. Given the importance of open government and digital engagement, this service needs to be showcased on the Direct.gov portal at the very least. Without making the prototypes, tools and developments that come out from a digital engagement initiative its very likely they will fail. In this President Obama’s Change.gov, Whitehouse.gov and recovery.gov are good examples of surfacing the tools.
Digital Engagement initiatives will change Government. How much change and how effectively they realise the benefits of Digital Engagement, depends on execution.
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