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Tuesday, January 31, 2006

Disrupting VC, pt 2: The Opportunity Cost of Experience

Let me add some more thoughts to the disrupting VC discussion.

Part of the problem with VC is that it's an inverted pyramid. The vast majority of VCs are guys with lots of experience.

This was fine when VC was about execution. And unfortunately, most VCs still think execution is worth more than ideas.

I think that's about to change.

Today, execution is easy. Access to global supply chains is ubiquitous and cheap. Lightweight standards and open source software are everywhere. Capital intensity just dropped by an order of magnitude. Even relationships are discontinuously cheaper to obtain and maintain.

All this means execution is going to continue to be commoditized. In a flat, Friedmanesque world, ideas count more.

I know most of my VC readers will either spill their coffee, or chalk this up to youthful excess.

But consider a case study: delicious vs delirious. Same execution - delirious was, in fact, a near-perfect clone of delicious. What made the difference? Josh had a great idea first. This unlocked powerful dynamics (FMA, blah, blah). And he continued to sustain this innovation, adding cool new features.

OTOH, if execution was what counted, we would see delirious and it's numerous competitors also realizing minimal exits. But we don't.

All of which brings us back to the inverted pyramid. This is a toxic structure for an industry where ideas count. Why? Because revolutionary ideas need fresh blood, fresh perspectives, and fresh thinking. Experience, often, abhors innovation.

But there's very little room for fresh thinking in today's VC industry. What do young people do? There's no place for them, except really as spreadsheet jockeys. A very few will ultimately get funded.

But this means all the ideas that were barely just not good enough are a deadweight loss. This is efficient when execution counts; but it's deeply, deeply maladaptive when ideas count. And that's why we see funny things like funds going backward, and combing the archives for old, good ideas.

This tells us that VC, is, ultimately, becoming a creative industry. In a sense, it's always been one. But structurally, it needs to adapt. Every other creative industry has built very powerful mechanisms to grow and nurture fresh thinking.

Consider the record industry. The ecosystem of clubs, bands/DJs, concerts, A&R reps, etc - as evil as it is - is still orders of magnitude more efficient than VC, where, most often, you can't even get face time unless you're referred by CEO xyz.

The same equation holds across creative industries. Except VC. This is why the inverted pyramid is, I think, maladaptive - and I think the real disruption for VC will be building newer, more efficient structures.

-- umair // 6:15 AM //



A very interesting post. While I don't agree with your statement that "execution is easy" and that ideas are scarce, I do believe that the real opportunity to disrupt the VC industry "is to build newer, more efficient structures".

If ideas are common, but execution and development of the ideas is scarce, the VC still needs to build newer and more efficient support structures.

In my post yesterday, on Innovative VCs, I touched on the two start-up stages where a VC can add creativity and support.

This structure would not only stimulate and nurture creative ideas, it would help turn the idea into a business.
// Anonymous Fraser Kelton // 3:52 PM


I think what you (and numerous other commentators) are missing is that while buidling a "built to flip" company may be easier than it ever was -- building a profitable business on the internet -- is actually just as hard as it ever was.

My two cents...

Fred Krueger
CEO of (not yet profitable) TagWorld.com
// Anonymous fred krueger // 3:59 PM

Yo Umair,

nice post. Yeah, VCs are living in Neverland. They go for the big deals and ignore the small-to-midsized opportunities. This is where Paul Graham's Y-Combinator is right-on, investing small amounts of money into small, high-risk startups.

Cheers, Chris
// Anonymous Chris // 7:50 AM


Thanks for the comments.

Fraser, I liked your post.

Fred, I take your point - but I'm not implying that profitability is easy; in fact, I'm implying that it's harder...so...good luck with TagWorld!!

Chris, I don't think VCs are living in neverland - I just think there is a lot of inertia in the industry at the mo. That said, there are quite a few focusing more than ever on small/mid-size opps... :)
// Blogger umair // 8:13 AM

Can I also say that being named after the schlockiest horror movie villain in history is awesome :)
// Blogger umair // 8:33 AM

Per the last comment -- I think we should add to the list of VC lies "We are only interested in Billion Dollar businesses".

That's just not true anymore. VC's may say that, but the actions speak otherwise. Seems a lot of people are putting microsopic amounts of capital to work on ideas that will certainly fail if not gobbled up in short order...
// Anonymous fred krueger // 4:40 PM

Hi Umair - nice to see so much good dialogue on your blog. I only now read your innovation vs execution note, and I would contest two points you make here:

First, I think there are plenty of innovative ideas coming out of Europe. Certainly there are not more me-too ideas springing up here than all across the US. But me-too ideas are sometimes more defensible here because in some cases there are at least some barriers to entry associated with geography.

Second, I don't agree that in the Web 2.0 world execution is easy. It's much harder because everyone has access to the same easy "get-started kit". So while the first 90 days of a new venture may be easier, successful execution over the medium- to long-term is a lot lot harder. And in most cases first-mover is not much of an advantage.

From our vantage-point--that is of a later-stage investor--we track the survival and sustainability of ventures built on good ideas AND good execution. An we definitely see more good ideas badly executed than the other way around!
// Anonymous Max Bleyleben // 3:16 PM
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