A couple of weeks ago, cleantech VC Rob Day, Partner of Black Coral Capital, wrote a post on his blog, entitled “The Rise of Information-Based Cleantech.” (http://www.greentechmedia.com/cleantech-investing/post/the-rise-of-information-based-cleantech/)

Rob’s thesis is one I’ve heard a number of cleantech investors articulate over the past 18 months. The majority of big, capital-intensive investments - particularly in cellulosic and algal biofuels, CIGS thin-film solar, battery and EV companies have (thus far) failed to yield successful exits and returns above the cost of capital for investors. Most of these mega-rounds were done in the 2006-08 timeframe, before the economic downturn, at high valuations. Although many of these companies continue to make good progress on technology development and business models, they have suffered through successive down rounds as they burn through capital trying to achieve technology and manufacturing breakthroughs, reduce costs and scale up production.

So, what is it about information-based cleantech that makes it attractive as “the next big thing?” The same characteristics about traditional IT and software businesses - namely, disruption from:

• ever-increasing chip speeds along with the rise of virtualization that greatly reduces processing costs;
• the use of open-source software OS’s, databases, applications and development frameworks, along with the globalization and increased capacity in software development skills that vastly reduces the costs of application development;
• increased penetration of the broadband Internet as well as the rise of the cloud-based SaaS models that enables product delivery to customers at low cost

The ability of information-based cleantech applications to process huge amounts of data to determine trends, improve performance and save energy/water/waste heat/carbon/money/etc. has the potential to disrupt existing businesses that have depended largely on capital-intensive hardware improvements (such as better chillers, pumps, lighting controls, fan coil units, etc.). In other words - customers can reap the same benefits through cheap software applications, instead of expensive hardware retrofits.

VCs love software and Internet businesses. You can go from 0 to IPO for $50 million in a software business. An Internet business can go global from day one, with customers all over the world, with very low-cost distribution. A cleantech business, on the other hand, might take $200 million to $1 billion in invested capital before an exit. That is due to the difficulty of manufacturing advanced lithium batteries at scale, of competing with massive Chinese government subsidization of the entire solar and wind manufacturing value chains, of precision-engineering flow batteries, of effecting cost reduction in fuel cell hot boxes, of bringing a new electric vehicle from concept to market, and scaling up biofuels production from thousands of gallons to millions or tens of millions of gallons.

However, just as scaling enterprise software sales (as opposed to consumer Internet businesses) is difficult, laborious, time-consuming, and expensive - I believe the same dynamic exists in information-based cleantech. I believe this is due to two main reasons:

1. The customers that would buy IT-based cleantech solutions are conservative and don’t adopt new technologies easily. These include power and water utilities, building owners, manufacturing companies, transportation and logistics companies, etc. Existing incumbents have significant advantages in having global sales and distribution channels and longstanding customer relationships, that are very difficult for a newcomer overcome - even if a newcomer has demonstrably superior products and solutions.

2. There are very few areas where IT-based cleantech solutions can be sold in isolation from hardware and equipment. They exist - but in most cases, software applications still need to be bundled or integrated with hardware to achieve the intended customer benefits. This means that incumbent equipment providers still control the choke points and distribution channels to customers.

Let’s look at two IT-based cleantech segments: Home Energy Management (HEM) and wireless lighting controls.

HEM

The HEM segment saw an explosion of interest, from startups like Tendril, to large IT companies like Google and Microsoft. Google and Microsoft both recently exited the businesses, after it became apparent that they were simply unable to get anyone to pay for their products and services. This was because they were unable to convince equipment and power companies - thermostat manufacturers, appliance makers, air-conditioner makers, and local utilities to integrate their components with their HEM APIs.

Without data inputs and control over energy-consuming components, an HEM is simply a useless piece of software that can’t really tell how much energy a home is using, from what sources, and is unable to do anything to improve energy efficiency. Google and Microsoft simply lacked any leverage, and were unwilling to pay inducements to the ecosystem to achieve this integration (not because they couldn’t afford inducements, but because these payments would simply exceeded any potential revenues, thus rendering the business structurally unprofitable).

Despite the efforts by two dominant giants of the IT sector, neither could overcome the structural challenges posed by the hardware side of the business.

Wireless Lighting Controls

The wireless lighting controls business is populated by numerous IT startups from the wireless computing space. However, the lighting business is highly fragmented - and the choke points are controlled by the large players that own the customer channels.

This is due to how most lighting systems are sold. Customers - namely building owners and construction firms - don’t generally go down to Home Depot and buy light bulbs, light fixtures, and the like and integrate and install them. Lighting is generally sold through new construction projects, where a lighting design is specified by an architect, approved by the building owner, and given to the general contractor (GC) to implement. The GC sub-contracts the lighting system to an MEP (Mechanical, Electrical, Plumbing) sub-contractor that looks for the cheapest way to fulfill the design spec.

The simplest way for the MEP sub-contractor to do this is to simply buy a full lighting solution from a full-service lighting solution provider (such as market leaders like Philips, OSRAM, GE, or a whole tier of regional lighting solution providers) that can provide all the components in the solution - the electronic ballasts, fixtures, bulbs, wall switches, occupancy sensors and controls - as well as a warranty and O&M.

A small wireless lighting control company may have the best wireless lighting solution in the world - one that provides a fantastic ROI and benefits to a facilities manager as well as building occupants. However, there is virtually no chance this company can easily scale sales given how lighting is currently installed or sold. The most likely exit for an innovative lighting company would be to hope for an acquisition by a larger lighting solution provider. (While this may constitute a successful exit, an M&A valuation is generally less lucrative than an IPO to an investor.)

In summary - I agree that information-based cleantech businesses can be quite attractive  - and less capital-intensive than most other cleantech businesses. However, just because the products they develop are information- or software-based does not mean that scaling sales and customers is by any means easy, cheap, or quick.

Here are some questions I’ve been asking myself in the past few weeks. I don’t have the answers to these, and a fair amount of analysis (and guesswork) will have to go into formulating answers.

• What happens if utility-scale energy storage declines from $thousands/kW (I’ve read of anything from $900-3000/kW from various battery manufacturers, all-in, including power electronics, installation costs, etc.) to $hundreds/kW? Could wind or solar PV actually become baseload power, competitive with coal or natural gas plants that run at 70-95%+ capacity utilization?

• What happens if the world could actually save 5% of power demand through energy efficiency? 10%? 20%? What impacts would that have on the generation side in terms of actual need for new power plants, i.e. how many fewer plants would we have to install?

• Is smart grid really worth it? Or is it just a fancy way of saying ‘grid improvements’ that enables utilities to pass on capex charges to ratepayers? What if all HVAC, lighting and appliances became 10% more efficient (new build + retrofits)? Would that obviate the need for trillion-dollar grid capex and the utopian vision of a two-way digital grid? In other words - if all my major sources of demand in buildings becomes efficient because equipment suppliers are all going there already - do we need to spend all this money doing slow, expensive grid improvements?

• There are around 1 billion cars in the world today, and virtually all of them run on liquid fuels. How many years would it take to transition all light vehicles over to EV/PHEV/hybrid, given aggressive government incentives/rebates/mileage standards? What’s the aggressive case (20 years? 30 years?), and how much would this translate to in actual savings in oil consumption?

• What would it take for lighting to be sold as a service, instead of as equipment? I.e. if the major lighting equipment suppliers sold lighting subscriptions instead of capital-intensive equipment? What about heating as a service, or cooling as a service? Let the equipment suppliers finance the installation capex (they generally have pretty big balance sheets and can get low cost of capital) instead of landlords.

• Is Jevons Paradox real? (see here for a description: https://secure.wikimedia.org/wikipedia/en/wiki/Jevons_paradox ). If my air conditioner, lights and refrigerator get more efficient, will I be tempted to leave my lights on all the time and turn my thermostat down? Isn’t there some point where efficiency outstrips human laziness or greed?

OK, when I start talking about “Jevons Paradox” I know it’s time to stop asking questions…

If anyone has seen good, rigorous analysis on any of the above, I’d appreciate you pointing me to the relevant studies or reports.

Thanks!