Importance of Trust

(ed: This is a cross post from the PeerIndex blog)

There is extensive buzz around influence and more recently reputation (examples here and here). As Head of Products at PeerIndex, I've spent a lot of time understanding and learning about these areas in the context of wider society.

What became clear early was that the key to understanding was to understand trust and its role in society and markets. From the perspective of trust, reputation is the trust that builds from interaction within a community. Influence is an outcome of having trust of people within a community.

In this series I'll explore why trust is of fundamental importance to society and markets and the way trust is built and measured.

The first post in this series looks at why trust is so important.

Importance of Trust

As Kenneth Arrow noted "virtually all commercial transactions and social interactions embody some form of trust". How important though is that trust to the interactions and transactions? The 2008 Financial Crisis provides a timely reminder of the importance of trust. As supposedly trust worthy (according to the ratings) investments went sour, investors lost complete trust in the market and were no longer willing to supply their cash to other participants, freezing the market. As soon as participants stopped trusting each other the markets froze overnight.

Why is trust fundamental to society? Trust enables us to rely on someone else. By relying on someone else we are able to do more than we would otherwise be able to. Trust allows us to overcome physical limitations of time and resources [Beckert, 2005]. If I can't trust others, I end up having to do everything required to live myself: food, shelter, tools, clothing. Leaving no time for anything else. No trust condems you to a subsitance life. To live in more complex societies you need trust, this way members of the society can specialize and share or trade to get the things they need [Beckert, 2005].

Trust is the result of human behaviour. It takes time and resources to build trust. On the scale of a hamlet or small village, this is not unreasonable. You will see each other everyday in which you can do the grooming necessary to build trust [Dunbar, 1993]. As the size of communities scale beyond the small village, you don't have the time nor the resources necessary to build trust between all the members. The cost of building and maintaining trust exceeds the value of the connections the trust would otherwise enable.

To overcome this limitation, we've created various measures or signals of trust [Gambetta, 2001]. These measures or signals of trust become proxies to our own efforts. These measures of trust allow us to overcome the physical constraints and create new connections.

The second part of this series will go into more detail about measures of trust, the cost of building trust and the value of reducing the cost of trust.

Bibliography

• Dunbar, R.I.M. (1993) Coevolution of neocortical size, group size and language in humans, Behavioral and Brain Sciences 16 (4): 681-735.
• Bacharach, M. & Gambetta, D. (2001) “Trust in signs”. In K. Cook (ed.) Trust and Society, New York: Russell Sage Foundation, pp. 148–184
• Beckert, J. (2005) "Trust and the Performative Construction of Markets", Max Planck Institute for Study of Societies (PDF)

Renewable Energy Target A Negawatts Market

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The failure of Copenhagen along with the sheer complexity of ETS (one which is going probably do more for financial institutions than the real economy) requires stepping back to re-consider how to achieve the aims of reducing CO2 emissions. In the post "The Fallacy of the Carbon Market" I made the point that market-based reduction methods don't have to be carbon based.

Here I want to look at using a negawatt based market to reduce energy demand. Markets consist of supply and demand. The supply of negawatts is easy - it is all the effiecency changes that can be done (insulation, improved appliances etc.). The sticking point is demand. How to create demand for negawatts?

The renewable energy targets provide the mechanism for creating demand, by allowing negawatts to count towards those targets, power companies can choose to use negawatts rather than other forms of renewable energy to meet their obligations.

Negawatts would be created by doing an audit of end user (household, office, factory etc) to benchmark the energy consumption. The purchaser then pays for improvements (adding insulation, triple glazing the windows, more efficient HVAC etc). The difference in energy consumption after the improvements are installed is benchmarked. The amount of negawatts is the difference between the before and after benchmarks. These negawatts would count to the power companies renewable energy target for 1 to 5 years.

The advantages of this approach are:

• Much simpler measurment, audit and verficiation
• Doesn't impose large scale price increases on end-users
  
• Increases productivity of the economy generally
• Frees up end-user cash for other users

Negawatts address the simple physics problem that we can't build enough renewable energy sources in the time required in order to effectively replace enough carbon based energy production. A sustainable negawatt market will drive the development of new efficiency measures and devices leading to situation that energy demand falls as our ability to generate substantial energy from renewable sources increases. We are addressing the problem from both a supply and demand side, achieving a better overall solution.

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iPad - The Freedom Device

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The discussion around the iPad has missed what I see as a vital use case. One that is becoming increasingly relevant in many countries around the world. Previously, I had written about a device that could provide unblocked accessed to the internet and outside world. The iPad is that device.

Coupled with portable satellite broadband basestation and some mesh networking software, a million iPads would make for a very difficult internet access method for oppresive regimes to block.

What can be done about North Korea and the Bomb?

North Korea undertook their second nuclear explosion and is firing off missiles that is more reminisce of someone trying compensate for a small dick. The UN Security Council will probably pass a resolution that by and large will do nothing. China will keep propping up the regime for both political and strategic reasons, South Korea is limited by what it wants to do and Japan will probably make the strongest moves to "punish" North Korea by beefing up missile defences.

Peter Hatcher puts forward what he thinks will make the regime pay attention to the international community. In effect it is having China, South Korea and Japan cut off cashflow to the regime. Sensible, but I am not convinced that any of those countries will do what is necessary particular as it doesn't meet their strategic aims.

Short of military action is there anything that can be done? It is a question that I've been pondering over the last week or so. Nothing leaps out as a great solution but a remembered article from years back about how information is probably the best weapon against the regime stirs.

The idea (as I remember it) was to air drop self-contained internet access devices that would provide the populace with access to the outside world that wasn't controlled by the regime. As much as the idea seems fanciful, I think a variant on it is something to consider.

In the variant, use OLPC-like laptops with windy handles for powering the device. The devices will need to include a verbal interface so that people who are illiterate can use it. The main issue is how to provide outside access? One potential way is to include a satellite access device that also acts as a wireless access point. Bearing in mind that as OLPC laptops can create mesh networks large numbers of the hubs would not be needed. Indeed, additional access could be provided by wireless connections beamed in from South Korea and naval ships.

The aim of internet access devices is to break the strangle hold on information that the regime has. That opens the door to working around the regime to provide food, water and power. In effect the internet access devices (remembering they can be used to share information and coordinate activity within North Korea as well) allows new centres of power to form and for the people to negate the advantages the regime has.

Would it work? I don't know and I don't think anyone really does. Anthropologists and psychologists can give you an estimate of potential effects it would have but until it is tried we won't know. So should it be done? I think it should be seriously be considered. At the very least it would be another potential noose to tighten around the regime's neck.

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Making the Economy Robust To Black Swans

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In a recent twitter conversation about managing chaotic systems by pushing the system to linear instead of non-linear responses to shocks.

Which does lead to the question can you have linear response to shocks in a non-linear system? Short answer is yes. Even in non-linear system there is a portion of response that is linear, with the response becoming non-linear with further driving.

In effect you structure the system (with dampeners etc) based on the potential response of the system to the shock. This method doesn’t plan based on a probability of an event occurring rather based on what would happen to the system should the shock occur. The aim isn’t to prevent shocks rather control how the system (in this case the economy) reacts to shocks.

Economic systems respond to shocks in 2 ways by destroying demand and freezing of money (or credit). Unfortunately, the responses are coupled and one will cause the other which in turns feeds back in. The key is to keep either from precipitating the other.

The money freeze occurs as the system tries to workout where the risk is. An event has occurred (such as a failing institution) that has demonstrated that the risk in the system is not understood. Money stops flowing as everyone aims to identify where and who has the risk.

To dampen this response:

• Ensure all financial transactions are transparent. This involves using marketplaces and exchanges and avoiding all trading in financial instruments over the counter.
• Reduce the amount of risk that is in question by structuring the economy so financial institutions can never large.

The demand destruction is as it’s name suggest the removal of demand from the system. An event has occurred such as the explosion in price of a key input over a very short time (such as the oil shock of the 1970s) that creates a situation of mass layoffs reducing the demand within the economy.
To dampen this response:

• Provide a system that allows private demand to be replaced quickly by public demand (i.e. infrastructure building)
• Reduce the loss of demand by income smoothing that avoids people suddenly reducing spending drastically as they are laid off

It is reasonable to point out these dampeners are already in place. Yes to extent they are but it is ad hoc and not very effective as currently done. Take for example the demand replacement. Many countries have proposed infrastructure programs. However, these don’t get underway (the building aspect) for a period of years. The demand needs to be replaced immediately not in 2 years time when private demand will be increasing. Instead, projects that create public demand need to be maintained at a point that allows them to be instigated within 3 months.

While unemployment benefits go towards smoothing income, it still results in a massive reduction in demand as unemployment benefits a pegged at subsistence level. To smooth income properly, a program of income-contingent loans for redundancies and training are needed that avoid the drastic reduction in for a period of 6 to 18 months.

Focusing on system response to shocks instead of trying to model the probability of shocks moves us away from the realm of make-believe that is probability forecasting to focusing on making the economy more robust and able to handle Nassim Taleb's Black Swan events.

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The Web & Sainsburys

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This post is part of a series on how web technologies and concepts can benefit various organisations, the particular focus being APIs and open data. In this post I will look at supermarkets via Sainsburys.

Sainsburys is the UK’s second largest supermarket chain. Sainsburys wasn’t chosen for any particular reason merely it is representative of supermarkets in general. Before proceeding it is worthwhile considering what a supermarket really is. A supermarket is an organisation that aggregates shoppers by providing the convenience of purchasing a majority of consumables from one place. Larger supermarket companies can also be considered a logistics company specialising in moving groceries from producers to shoppers.
Sainsburys provides a fairly stock standard website and online shopping portal. It is rather difficult to use in my opinion and one of the key reasons that I haven’t bothered to try and shop for groceries online.

The game changes by providing APIs.

The APIs would provide access to data such as purchasing habits, aggregated demand data (e.g. 2000 tomatoes where purchased today), current stock, current prices, how much carbon/energy used in getting an item to the store. But the APIs shouldn’t merely provide data but also provide access to functionality such as making a payment, placing an order, ordering stock and communicating with the consumer.

The APIs would form the basis of Sainsburys online offerings allowing them to be easily updated and changed to allow new services and applications to arise and fall. The APIs also provide a means by which internal teams can create internal applications without the need to extensive resources. The APIs become a means to allow innovation at the edge of the organisation.

The real power of the APIs comes from allowing 3rd parties to use the APIs. Suddenly startups and entrepreneurs can create new applications that mash Sainsbury data and functionality with other data and functionality creating new value. Sainsburys creates an ecosystem of functionality based around it. The APIs allow Sainsburys to move from being simply a supermarket chain to a shopping platform that blends bricks and mortar with the web.

Many will say that the information is valuable or would provide Sainsburys competitors with an edge. They would be wrong. Information is only valuable when it is useful. Lots of the information contained in Sainsbury only becomes useful when it is unlocked. Take for example my weekly grocery list, while that is locked in Sainsburys it isn’t useful. It has no value, but provide that information to me along with items I can substitute to reduce my grocery bill then there is value, which leads to the second requirement to be useful, which is context. Information is only useful in context with other information.

The competitive edge one is very traditional thinking and it ignores the reality that the competitive advantage accrues to the company that is more open rather than less. The ecosystem allows new resources to be devoted to creating new applications, far more than Sainsburys could muster on their own. The ecosystem creates a positive feedback loop that is hard to disrupt creating advantage. Rather than Sainsburys having to devote resources to picking winners for new applications, the ecosystem does that for them. Those that create value for the ecosystem survives while those that don’t wither away.

Here is a short list of potential applications that become possible with the APIs and open data:

• Review my shopping list
• Subscribe to regular grocery delivery
• Import my shopping list & prices into another app
• Local supplier Dashboard
• Tracking energy and carbon of purchases
• Mobile application for navigating stores
• Mobile application for store management

Let’s consider a few of these in more detail.

Review My Shopping List
The user gets access to all their purchases and the prices they paid. This is then reviewed looking at what could be substituted to bring the price of the weekly shop down. This could be something done by Sainsburys or could be done by 3rd parties. Probably both.

The review My Shopping would more than likely be part of a broader finance and shopping management application, but even on its own would be valuable to many people. Extensions of this basic application is to allow users to see suggested recipes based on what they purchase, start with a set of recipes and build a grocery list and set a budget and build a grocery list based on the budget and standard needs.

Local Supplier Dashboard
The dashboard would in effect allow local suppliers to provide Sainsbury with produce to particular stores using a JIT framework. The dashboard would allow the supplier to enter what they have in stock and then they can bid on meeting the stores needs for the next day.

Suppliers would also get access to information on patterns in demand allowing them to change their own production to match demand better.

Mobile Application for Navigating Stores
Each store is different and their stock availability, to say nothing of location changes all the time. The application would use the APIs to provide accurate and up-to-date location and availability for items within a store and provide directions to the location.

The application can also serve to provide a feedback loop for the store, as it would allow the user to enter information about the quality and similar information for the items.

In The End
The APIs open up a lot of opportunities and create an ecosystem based around Sainsburys. This ecosystem becomes an advantage that is very hard to disrupt. By creating value for their customers and suppliers Sainsburys will be creating value for themselves. Value that is sustainable.

Let a 1000 flowers boom - Using Income-Contigent Loans with Startups

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TechCrunch UK posted an open letter by Robin Klein of The Accelerator Group to the Chancellor of the Exchequer Alistair Darling and Lord Dryson Minster for Science and Innovation about what to do with purported stimulus funds. BVCA wants the money to go to large VC funds whereas Robin Klein wants to see the money channelled to supporting very early stage companies (amounts less than £100k).
Robin’s logic and reasoning is sound and I agree with them. But it is not a good use of the money for two reasons.

Tech (web) Focused
The idea is far too technology (read web) focused. There are lots of opportunities throughout theUK for entrepreneurs to create businesses; many, indeed most, outside the world of the web. Why shouldn’t someone starting a lawn-mowing business have access to early stage funding as a technology developer? Both create value. We in the technology sector tend to be myopic about start-ups, small businesses and entrepreneurs. Richard Branson can hardly be accused of creating a technology business and yet he is by most measures the UK’s most successful entrepreneur.

Yes, technology creates long term value and wealth, but the vast majority of wealth is created by companies outside of the technology sector using technology and not developing it. It is created by a lawn-moving business using twitter to alert their customers that their lawn is done and having a website where clients can go and book a visit using something like BookingBug to provide the functionality. The lawn-mowing business is creating value through better customer service and consequently generates wealth. Would a business angle or early seed stage fund invest in such a company? What about if it is located in the hinterlands of Wales?

Relying on Judgement
The mechanism for distributing funding relies on someone making a judgement call as to what is potentially a good opportunity. The act of making a judgement takes time and as many commentators pointed out in response to the open letter, time is very precious at the early stages of a business. Waiting more than a month for a response is a massive drag on very early stage businesses. They need responses fast.

More problematic is that a person can only make the judgement based on their experience and expertise. Many great opportunities will be bypassed as the judges’ focus on what they know. Now however is a time to fund companies that are moving into new areas and new ways. It is a time to let 1000 flowers bloom. In the end the only real judgement that matters is that of the market. It would be better to create a situation where those companies can be judged by the market rather than a limited individual. The market is crowd-sourced investment decisions.

Proposal
In place of co-investing or creating lots of seed funds, I propose that the UK government create a scheme of income-contingent loans. Under the scheme an entrepreneur can take out a loan that covers his previous salary up to a maximum of £50k to £60k. The loan is paid monthly like salary and is re-paid by the individual (not the company) through the tax system (similar to student loans). Other characteristics of the scheme are:

• The scheme would provide loans for up to 3 people per business in the first year, followed by another 2 new employees in the second year
• The loans are tied to the individual and are re-paid by the individual based on the individuals income
• An individual can only take out a loan under this scheme once every 5 years

An income-contingent loan scheme provides funding irrespective of industry or goods and services. It addresses the funding gap that is a barrier to entry for all entrepreneurs and has a lower administrative burden. The loan scheme can be administrated through the existing Government banks and through an online loan application system which are widely geographically diverse, scalable and most importantly can return a fast decision.

One big objection is the potential for fraud. Nothing involving money is without the potential for fraud and venture funding is not immune (witness Tiger Telematics). By putting the liability to re-pay the loan onto the individual reduces the avenues for fraud using this scheme. The other limitations are also designed to reduce the attractiveness of fraudulent behaviour.

Conclusion
Granted, the loan scheme is unlikely to produce the next Google but I would rather see the loan scheme generate 100,000 businesses all employing an average of 10 people. That would be far more valuable to the UK economy as a whole than 1 Google.

Ideally, you would run both an income-contingent loan scheme and co-invest in early stage investments. However, given the realities the loan scheme is more valuable. The co-investment scheme should follow. By the time the co-investment scheme is up and running many of the first lot of companies that have benefitted from the loan scheme will be ready for their first round of funding.

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Open Access Will Make the NBN Work, not Price

Ok this is getting ridiculous. There is lots of commentary going on in the Australian press and from the politicians about the NBN. Most of it inane and demonstrating the commenter's complete lack of understanding about the technology and the issue.

The NBN will provide economic, social and environmental benefits. This fascination and indeed obsession with cost of access is self-defeating. Here is a quick overview of the benefits

• Economic: NBN improves access to SaaS solutions and increases effective collaboration both improving producing and reducing costs. NBN opens up new possibilities for new companies and industries that hadn't existing before. Could anyone have predicted YouTube or Twitter when we were using 56k modems? NBN brings very high speed access to businesses of all sizes rather than just the largest.
  
• Social: NBN, as others pointed out, provides the ability to role out education and health applications right to where people are. Some are already talking about providing free basic access to the poor.
• Environmental: NBN will create a boom in video calling and telepresence cutting down on travel and reducing pollution. The NBN goes a long way to reducing energy intensity of the economy.
  

The NBN is the convergence of communication and data. It will be used for applications ranging from video calling to web access to television and radio to smart metering to health monitoring. To see it only in the light of access misses the larger value of the NBN. Nor is the speed a big issue either. Speed through the fibre is determined by the equipment at either end and not by the cable itself. Should users and the access providers decide they can put in the equipment that supports 1Gbps without much problem. Far more than copper, fibre is future proof.

Have a look at these videos that Microsoft produced as a look into the future of computers. The NBN is the key to enabling this world.







The key to the NBN living up to its promise is how the Government structures it and it is quite possible they will get it wrong. That shouldn't stop us from trying though. Life is a risk and we cannot be afraid of making a mistake.

For the NBN to fulfil its promise the following items have to be done:

• The conduit/real estate and fibre should be help in separate companies
• The company sold at the end of the 5 years should only be the fibre layer and assets. The conduit/real estate company needs to remain majority Government owned.
• The legislation has to guarantee Open Access to both the conduits (so other companies can label cabling) and the fibre.
• Fibre should be laid direct to the house. The NBN shouldn't use shared access.
• Access must be symmetric the same upload speed as download speed.

By embedding Open Access to the conduits and the fibre you create an environment where organisations can compete on the fibre but also at the physical layer. The largest barrier to entry remains digging up the ground and laying conduit followed by the fibre.

The Opposition needs to hold the Government to implementing the about principals. They have to work with the Government to split the construction of the NBN into two parts:

• Building the Conduits. This is the stimulus part of the NBN and can begin quickly and should start in the large regional towns before moving to the city
• Laying the fibre and installing the Equipment. This is the key planning stage and in order to avoid prolong delays, can be done will the conduits are being built.

The conduit building can be done by any construction company that can dig a trench, lay piping and install access points. The contracts should be standard and let out to as many of the construction companies as possible. There is no need at all for one company or small group of companies to win the contract to build all the conduits. In terms of speed by letting out contracts to various companies around Australia the construction can go on in parallel in many different locations.

The core issue here is not the price of access. It is Open Access. The Opposition must be holding the Government to providing Open Access not only to the fibre but also to the conduits. Open Access is the key to the NBN working.

Busting Recessions - Income Contingency Loans for Redundancy & Training

I’ve touched on income-contingency loans in previous posts, time to explore them in more detail.

Redundancy

The point of redundancy is to allow businesses to shed staff as necessary without throwing the people onto the garbage heap. The flexibility provided to hire and fire staff is important in keeping an economy resilient and flexible. Society also benefits from redundancy payments as it reduces the fear of not being able to pay bills. As most redundancies occur during recessions it helps to cushion the demand destruction of job losses.
There are two problems with redundancy systems as they currently stand:

1. From the point of view of a person, redundancy payments are not enough to survive on, and
   
2. From the point of view of the company, redundancy payments are a big hit to cashflow.

The Nordic countries use generous welfare system to reconcile the two competing interests but have high taxation as a result.

The same reconciliation of the competing interests can be achieved by using income-contingent loans. When making someone redundant the company takes out a loan from the Government to pay for the redundancy of the person. The loan is then paid back through the taxation system from the profits/income of the business taking out the loan.

Redundancy payments can then become 75-90% of final salary for a period that can last 6 to 1 year without driving businesses into the ground.

Using income contingent loans allows:

• Businesses to lessen the impact on cashflow from redundancy payments
• Individuals get larger payments that reflect their final salary for longer periods
• Redundancy can be provided to all employees instead of just those that have been at the business for a long time
• Bills, rent and mortgage continue to be paid reducing negative flow on effects from redundancy to the wider economy
• Redundancy is guaranteed even if the company eventually goes bust
  

Training & Education

One of the aspects of recession is that there are too many people chasing too few jobs. Income-contingent redundancy helps lengthen the time an individual has to find another job but it isn’t the only way of smoothing things out.
The second method is to provide income-contingent loans to businesses for training employees. The business would take out an income-contingent loan that would pay for the salary and training. A modification is that the loan is jointly held by the individual and the business.

These loans would achieve:

• Improved cashflow for the business as the employee is effectively removed from the payroll
• The person is improving the skills and training so that they are more effective when business picks up
• The business can hold onto good employees that would otherwise have to be made redundant
• Less people are chasing the limited number of jobs
• Bills, rent and mortgage continue to be paid reducing negative flow on effects of redundancy/job losses to the wider economy
• Society benefits from better trained and skilled workforce

Income contingent loans better address the needs of business and employees without trying to jam them all into the same one-size-fits-all. They recognise the benefits of redundancy payments and training doesn’t accrue just to the business or individual or society but to all three in varying amounts.

On the face of it the training loans are better overall but training will not be suitable for all situations or occurrences. Both systems should be implemented to allow flexibility and support the uniqueness of each redundancy situation.

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Aussie Gov re-entering the telco game

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The Rudd Labour Government has announced that rather than tendering building fibre optic broadband network to a private consortium or telco, they are going to do it themselves. At a cost of AU$43bn over 8 years.

The logic sounds nice nice on-going stimulus during a time of economic crisis that is productivity enhancing. Broadly I agree with the sentiment. Broadband is a viable stimulus that will have positive benefits in productivity. The larger the pipe the greater the economic opportunity and productivity.

I have two problems with the announcement though.

1. It does seem like an idealogical policy to get the government back into the telco game - not something that is warranted or needed
2. More importantly the value of the Government involvement is limited

Where the Government should be involved is creating a national conduit system which is open and easy for any company or organisation to run their cables. The largest cost in building a broadband network is digging up the ground and putting in the conduits to carry the cables. By doing this the single biggest barrier to entry into the provision of broadband is removed which will do more to increase competition and improve services than all the regulation and legal proceedings.

Laying their own cable is an unnecessary expense, but given that this is likely to happen then I hope the Government learns the lesson of KPN in The Netherlands that open access to the network benefits not only the consumer, but the owner of the network. Open Access has to be a requirement for the Government network and must be a requirement if the network is ever sold to the private sector.

Saul Griffith, Energy Intensity and Trading Negawatts

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Saul Griffith of Squid Labs fame recently gave a presentation at Green:Net looking at the engineering challenge that is climate change/energy renewal. It is an informative presentation and one that builds on previous work he has done to quantify the problem. However, since seeing the math on a BBC documentary and then again in this presentation something has been bugging me and I couldn’t put my finger on it.

Saul certainly produced a fine statement of the engineering problem. Saul isn’t the first to layout the problem in that way David McKay of Cambridge University is doing a more comprehensive expose of it. Either way it is a sobering presentation.

Considered in the context of the system, though, I think some to the base assumptions may be wrong. I expect that the carbon reduction is not a linear progression but will grow slowly until a tipping point is reached at which point the carbon in the economy will drop seemingly overnight.

More importantly, the focus on carbon is leading the world astray. The primary problem isn’t carbon per se rather the energy intensity of the global economy is growing. While global energy intensity per unit GDP grows the sources of energy is relatively academic. The core problem remains the growing energy intensity per unit GDP. This is what has been bugging me about Saul's presentation - it was from the context of carbon and not about energy intensity.

To demonstrate what I mean consider Peak Oil. The Peak Oil problem is only a problem above a certain energy intensity of GDP. Below that level two effects are seen, 1) the life of oil reserves increases and (more importantly) 2) substitution for other energy sources becomes easier. By reducing the amount of oil used by reducing energy consumption less carbon is produced. The advantage is that reducing is far easier than substitution.

The answer to climate change is to set in place incentives and processes that reduce the energy intensity faster than the economy grows. Energy consumption can only be reduced when saving energy is worth more per kW than consuming energy. Some ways of doing this are:

• Net Present Value in Energy for energy generation schemes: Like Net Present Value for evaluating monetary investment this looks at how much energy is needed over the life of the generator. All generators use energy in order to produce energy. Using NPVE will allow the comparison to see how different generation schemes reduce overall energy intensity.
• Energy Audits: The audits would show businesses and consumers where the energy is going and suggest real changes that would make material differences to the energy they use and consume.
• Stamp Duties/Sales blocks for low efficiency housing: Energy efficiency is in for homes with steadily rising standards but new homes only make up a small percentage of the housing stock. The biggest impact in home energy consumption will be made in improving existing housing stock. The only way to incentivise owners to improve energy consumption across the board is to either not allow the sale/rental of homes that don’t meet a certain energy standard or add an energy duty onto of the stamp duty that is determined by the energy consumption of the house.
• Life-cycle energy labels: Transparency works wonders and the more relevant information consumers have about the products and services they consume the better purchasing decisions they can make. Providing a single number that shows how much energy is tied up in a good or service will help consumers pick products and services that consume less energy over their life and so reduce energy intensity of the economy.

In the final analysis reducing energy consumption will only be self-sustaining when the negawatt is tradable. Ultimately, personnel energy budgets or some sort of cap and trade system will work best. Trading negawatts is far more tangible than trading carbon. Carbon is intangible and there is no daily interaction with it. People understand energy; they use it every day and can see its effect. That single fact will see the far more rapid adoption of energy/negawatt trading than carbon trading.

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Developing the Venture Capital Model

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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.

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Breaking the Financial Spiral - Part 2

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(for part 1 see here)

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.

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Breaking the Financial Spiral

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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.

Part 2: Stimulus and more

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Digital Engagement - Making it Work

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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Turning Book Publishing Inside Out

Image via WikipediaContinuing the series of collaboration and coordination platforms (C&C platforms) I wanted to look at a more concrete example of how cc platforms can change an industry and how they work to turn existing businesses inside out. My example will look at book publishing.

Book publishing has a range of steps to produce an end result (a book in the shops that is purchased by a consumer). Let’s look at the steps:

1. Author a book
2. Find a publisher willing to publish your book
3. Edit the book
4. Make changes to your book
5. Create Cover art
6. Print and bind book
7. Market Book
8. Ship book to stores
9. Distribute revenue

Now I realise it isn’t necessarily as smooth as the list makes out and some of the items happen in parallel, but for purposes of the example it works. Steps 3 to 9 are currently the realm of the publisher. That arose as a publisher was the only one who could organise the resources needed to complete steps 3 to 9 at reasonable cost.

But with Collaboration and Coordination platforms this is no longer true. C&C platforms reduce the costs of coordinating the various activities that you don’t need a vertically integrated publisher to achieve a sold book.

For an author to publish their book, the C&C platform would provide them with access to a market of editors, designers to create cover art, print-on-demand services, book marketing services and payment features. The C&C platform doesn’t provide all the services rather it organises them and reduces the transaction costs of using services from multiple providers.

Say I am an author of a book. I upload my manuscript to the C&C platform. I then begin the workflow of publishing the book with the system creating an alert to editors that a new manuscript is ready for editing. The editor that I select then makes the edits and uploads the changes to the manuscript; I review and accept or push-back on until we arrive at something both are happy with. I then need to create the cover art and the system again creates an alert for designers. I select a designer and they get access to the manuscript so they can create relevant cover art. Once the cover art is agreed, the art is uploaded to the system and I progress to the next stage.

I now have a book ready to go, so I need to pass the manuscript and cover art along to a POD provider. This I do with a simple click on a button loading the book into the system of the POD provider I have selected. This also puts advertising and listing of the book into key retailers and I can begin the marketing of the book. It may be that I need support for the marketing which I can source through the platform as well.

The C&C platform guides the user through the steps necessary to complete a task (publishing a book), handles the necessary communications, makes sure everyone is paid and manages the media. It coordinates the various markets for each service so that together they can achieve a task. C&C platforms reduce the transaction costs to the point that a Firm in the Coaseian sense is not the most effective manner in achieving a task.

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Answering API requests or not (QOOP)

Image via WikipediaOk in this day and age, it shouldn't, nay, mustn't take 2 business days (and counting) to respond to a request for an API key. Unfortunately, that is what QOOP is doing.

I fail to understand why they do not have an automated system for generating API keys so developers can get started integrating QOOP into their sites. Even if the key is restricted in usage, the verfication of commercial intent can happend later. But it is vital that any company offering an API make it dead simple to get started. Doing otherwise is simply the creation of a needless barrier to entry and will drive potential partners to competitors that don't have that barrier.

Honestly, this is simple stuff. You can't rely on human vetting in an environment like the internet. People do not scale, automation does.

Technorati Tag: QOOP

Reinventing the Wheel of Finance

Image via WikipediaOne of the ideas batted around every so often during the financial crisis is whether it would simply be easier and cheaper to create new banks and leave the old ones to die. On and off I’ve been thinking what this would mean. Which lead to the question of “are the current financial institutions the best way to manage capital?”

Banks have three primary roles: 1) store money 2) transfer money and 3) lending dormant money. Storing money is to the consumer the main view of banks. They store your money for you until you need it to pay bills and purchase stuff. Transfer money is what allows you to get your money from storage to where you needed it e.g. an ATM or to pay a bill online. Banks aggregate deposits and then lend this out of businesses and individuals to buy assets. It is this process that keeps money circulating and supports wealth creation.

There is no reason why these various roles need to be contained in one institution. We could in the future have one type of institution that stores money, another focused on transferring money and another on lending. What would happen if we separated these roles? For a majority of day-to-day banking tasks not much would outwardly change. The institution that stores your money would outwardly look like an existing bank with branches, debit cards and bank accounts. The transfer role is already there to an extent through various interbank agreements. Broadly, you won’t notice much.

Separate roles with be very noticeable in lending. Banks aggregate deposits and lend this out to individuals and businesses to buy assets (property, machinery etc.) Banks keep a percentage of deposits for people to use to pay bills and buy stuff. This works with the assumption that all the depositors are not going to need their money all at the same time. This process gives banks access to very cheap money which they can then lend out.

By separating the roles banks wouldn’t do the aggregation and lending. Instead those that lend would need to develop various ways to aggregate deposits from companies that store money in order to fund lending.
It is fair to ask whether this system would be more effective for society. I don’t know but it is worth exploring the idea. The advantages that I can see are:

• Reduce conflict of interest between storing money and lending
• Competition among deposit aggregators will produce a sustained increase the interest paid to depositors
• It opens up the financial utility system for horizontal innovation and competition leading to better delivery of financial services

The existing banks and financial institutions will cry bloody murder as it attacks the status quo and potentially their profitability. However, they really haven’t demonstrated keen management of one of society’s key utilities. A potential more important issue is that individuals will be personally confronted with the idea that not all of their money is in their account. The existing illusion of your bank account actually having all your money ready to go will be stripped away as individuals have to decide how much of their account to lend to the aggregators. The removal of the illusion is very likely to create problems as people adjust to reality.

Separating the roles isn’t something that needs to be forced on existing players. Instead the various regulatory bodies should reform regulations to allow companies to step up and fulfil each role. Unleashing innovation in the delivery of financial utility (rather than in financial instruments) to society will do much to resolve the financial crisis.

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