If you drive down Evelyn Avenue in the heart of Silicon Valley at night, you will often be able to see through the office windows where I'm sitting with my CEO, Ashok, as we discuss my concerns, frustrations and disappointments with the entire process of starting a company. One such evening he said something that I recall vividly as I looked out onto the street and absorbed his thoughts. He said, "What you did wasn’t rational so you're making yourself crazy trying to rationalize it."
That’s when I realized what was really required to actually do this: irrational people. In fact, you really have to be almost crazy to start something like this and those around you need to be irrational and crazy to invest in it. California has that in spades. Michigan has nearly none of that type of thinking.
Being a scientist and engineer, I understand what is irrational very well. In science, it is called a stochastic process – a collection of randomness, often as a function of time. In practice, it is noise. In reality, it can all be modeled and understood, just as in science. I often hear people discussing the "idiot" venture capitalists (VCs) in California or the "West Coast mentality" and I have come to realize that those in Michigan who say such things have no idea what they are talking about because they don't understand the model. In fact, the California VCs have developed a very successful "stochastic" model for all of the irrational processes that go into starting a high-tech company.
First they recognize that this process is irrational. They are not looking for guarantees or sure things. Rather, they are looking for well-differentiated technologies, which lead to products with a clear value proposition and that play in huge markets – that is, billion dollar markets.
Further, it is better to be intersecting with emerging markets than existing markets. Large existing markets are commoditized, just like oil and sugar, so the average selling price and gross margin are low. These are indicators that innovation has saturated. Ultimately, that means that net income and return on investment are low as well.
So why is this the model? Inevitably your business plan and your product are going to change. That's the noise in it all. The world is always changing and if a company actually executed exactly to plan, then that plan would be executed by one of the Big Three and not some small start-up.
However, if you possess a well-differentiated technology in a big market, then there is a good chance that you will find your way no matter what the market conditions because you have so many customers and applications to serve. Additionally, if you intersect that technology with a large and high-growth emerging market, you have a good shot at defining some of the products of the future based on your technology. If that can be achieved, the success will be unparalleled. Believe it or not, nearly every success in the Valley has gone down this zigzag trajectory while remaining contained within this model.
That model is further refined in the due diligence process – that is, the process of vetting investment in a new start-up. I often hear entrepreneurs complain that VCs speak out of both sides of their mouths or that they want results that seem diametrically opposed. That is incorrect thinking. The California VC is going through a process of filtering. There is risk in purely emerging markets. What if the market doesn't arrive? (By the way, that happens all of the time.) And there is distaste for commoditized markets because these markets are not where returns are realized; yet the risk is reduced because such markets can be "served" now.
Ultimately an investor seeks both. That is the filter. It seems like double-speak, but clearly the best start-ups fit down the middle and not outside the filter. Then the capital is injected and this "irrational" plan is executed – often to success.
Beyond all of this, there are some unfortunate outcomes to this model. Sometimes, very low-value businesses realize huge returns on pure hype and without a single product. This is often the case in emerging markets and that was clearly the case in the late 1990's. These economic "bubbles" can be very frustrating, as they have nothing to do with building great businesses. My only advice is to not let that bother you and to ignore advice from those who exited in bubbles as they don't know what it takes to build a great business, particularly in an economic climate like today. Learn for yourself how to build a great business and success will come under nearly any economic condition.
So where does that leave Michigan?
Michigan doesn't have a model.
What I'm really saying is that Michigan has most of the ingredients and yet they have not been synthesized into an executable model. First, Michigan has well-differentiated technology. My work, among that of many other world-class researchers, at the University of Michigan and all of the Michigan institutions is proof positive that we do.
Second, Michigan has the passion. Of all of the places I have lived, nowhere in my life have I known people more passionate than those in Metro Detroit.
Third, Michigan has the capital, but it is not making its way into the irrational investments. Put simply, there is a terrible lack of risk capital. From Q1/02 to Q4/07, all of which is post-bubble, California invested $49.5B in companies while Michigan invested a measly $363M. In less time, Mobius has raised over $20M as a single company.
This is where it gets complicated.
There is also a lack of deal-flow. Related to my previous blog entry, there is a lack of "doers" in Michigan. Yet, it is not that simple. There is also a lack of experienced management. Start-ups are a cottage industry in the Valley where thousands of executives have had experience in one. They are an anomaly in the industrial Midwest so it is terribly difficult to build an experienced management team worthy of investment.
Further, our leadership in Michigan focuses on maintaining the status quo and has failed to diversify the economy with a focus on emerging business. Thus, there is little justification for the capital; yet, when someone like me shows up, I'm demanding capital and forced to relocate to California without it. Meanwhile, Michigan is sixth in the nation for new patents issued; yet most of those revolutionary innovations sit in laboratories, never to see the light of day.
So where do we go from here? Michigan is stuck between the chicken and the egg in developing its model.
In my next entry, I will share my passion to hand Michigan both a chicken and an egg.