A recent panel discussion with John Doerr (KPCB), Vinod Khosla (Khosla Ventures) and John Holland (Foundation Capital) in the WSJ caught my attention. The lesser known of the three panelists, John Holland, had a quote I felt trumped his two better known colleagues when asked what is “hot” in the CleanTech sector.
Mr. Holland: “We’ve focused our efforts around the demand side, around energy efficiency, smart grid, smart materials and so forth. I’m disappointed in, but I’m not surprised by, some of the things that we’ve seen—you know, technology’s trying to drive to sort of a lower cost per watt. That’s just a very, very difficult place to play. You’re making a bet that your set of scientists is going to beat the other 500 sets of scientists that are working on that one particular piece. And then how long is that competitive advantage going to last?”
This quote I believes sums up a remarkable albeit less discussed facet of the CleanTech sector which is that a efficiency company can trump an energy supply side company anyday, anywhere. Here is why:
Supply side technologies face replacement risk. E.g. a competing solar or wind technology may out engineer or innovate your firm’s basis for existence whereas a consumer will always have a need for a device or system that reduces the need to spend money on electricity so long as the economics are favorable. For example, I can and would purchase multiple technologies such as a smart grid technology, more efficient lighting, windows, and insulation for one place even though some of these products offer better economics than the others. If a newer and more efficient version of these demand reduction products arrives, my existing products are still viable and offer cost savings to me, the consumer. Contrast this to selling solar panels, where a competitor’s improvement notches you further back on the supply curve if you have higher capital costs or a less productive panel. A consumer has no incentive to buy a less efficient producer of electricity, all else equal, whereas the same is not true for products that reduce consumption/save money.
Consumers seek efficiency even if it is not a market leader, perhaps seeking it at a lower price but still desire the cost savings offered whereas an outdated energy producer might be used until it no longer functions and then scrapped. From the investor’s perspective, you want your investment’s product to be as relevant and attractive as long as possible despite competitive entrants to the market.
The Asymmetry Principle: Reducing consumption of one watt of energy, saves the production of 50 watts of energy. Accounting for the inefficiencies of electricity production, transmission and conversion to light, in this example, it takes 50 watts to receive one watt of work (light.) Thus, reducing the consumption of watts is a much more efficient product than attempting to marginally improve production of watts. For a lightbulb this ratio is 50:1 as noted, for a car it is 6:1 and for many common household products this ratio is somewhere between these two examples. The Asymmetry Principle heavily weighs the odds in favor of efficiency over production in both cost savings and efficient use of resources. (Credit to Peter Tertzakian, The End of Energy Obesity.)
An advantage in efficiency is why it is inevitable that one day electric cars will replace the internal combustion engine as we note here. An improvement in efficiency for existing technologies is easily the most cost “efficient” way to lessen electricity demand and consequently lower emissions as we note here.
With this in mind, no improvements in efficiency will ever wipe out all demand, only lessen it of course. There is and always will clearly be an enormous market for innovation in the power markets (“supply side.”) John Holland’s quote merely helps point out that when comparing the two, one side of the fence is safer, more economic, readily distributed and likely a safer, long term investment.