Thursday, June 27, 2013

Strangling Innovation: Tesla versus “Rent Seekers”, by Steve Blank

A guest post by Steve Blank

The greatest number of jobs is created when startups create a new market – one where the product or service never existed before or is radically more convenient. Yet this is where startups will run into anti-innovation opponents they may not expect. These opponents have their own name –  “rent seekers” – the landlords of the status-quo.
Smart startups prepare to face off against rent seekers and map out creative strategies for doing so…. First, however, they need to understand what a rent seeker is and how they operate…
Recently, the New York and North Carolina legislatures considered a new law written by Auto Dealer lobbyists that would make it illegal for Tesla to sell cars directly to consumers. This got me thinking about the legal obstacles that face innovators with new business models.
Examples of startups challenging the status quo include: Lyft, SquareUber, Airbnb, SpaceX, Zillow, BitcoinLegalZoom, food trucks, charter schools, and massively open online courses. Past examples of startups that succeeded in redefining current industries include Craigslist, Netflix, Amazon, Ebay and Paypal.
While Tesla, Lyft, Uber, Airbnb, et al are in very different industries, they have two things in common: 1) they’re disruptive business models creating new markets and upsetting the status quo and 2) the legal obstacles confronting them weren’t from direct competitors, but from groups commonly referred to as “rent seekers.”
Rent Seekers
Rent seekers are individuals or organizations that have succeeded with existing business models and look to the government and regulators as their first line of defense against innovative competition. They use government regulation and lawsuits to keep out new entrants with more innovative business models. They use every argument from public safety to lack of quality or loss of jobs to lobby against the new entrants. Rent seekers spend money to increase their share of an existing market instead of creating new products or markets. The key idea is that rent seeking behavior creates nothing of value.
These barriers to new innovative entrants are called economic rent. Examples of economic rent include state automobile franchise laws, taxi medallion laws, limits on charter schools, auto, steel or sugar tariffs, patent trolls, bribery of government officials, corruption and regulatory capture. They’re all part of the same pattern – they add no value to the economy and prevent innovation from reaching the consumer.
No regulation?
Not all government regulation is rent or rent seeking. Not all economic rents are bad. Patents for example, provide protection for a limited time only, to allow businesses to recoup R&D expenses as well as make a profit that would often not be possible if completely free competition were allowed immediately upon a products’ release. But patent trolls emerged as rent seekers by using patents as legalized extortion of companies.
How do Rent Seekers win?
Instead of offering better products or better service at lower prices, rent seekers hire lawyers and lobbyists to influence politicians and regulators to pass laws, write regulations and collect taxes that block competition. The process of getting the government to give out these favors is rent-seeking.
Rent seeking lobbyists go directly to legislative bodies (Congress, State Legislatures, City Councils) to persuade government officials to enact laws and regulations in exchange for campaign contributions, appeasing influential voting blocks or future jobs in the regulated industry. They also use the courts to tie up and exhaust a startups limited financial resources.
Lobbyists also work through regulatory bodies like FCC, SEC, FTC, Public Utility, Taxi, or Insurance Commissions, School Boards, etc.   Although most regulatory bodies are initially set up to protect the public’s health and safety, or to provide an equal playing field, over time the very people they’re supposed to regulate capture the regulatory agencies. Rent Seekers take advantage of regulatory capture to protect their interests against the new innovators.
PayPal – Dodging Bullets
PayPal consistently walked a fine line with regulators. Early on the company shutdown their commercial banking operation to avoid being labeled as a commercial bank and burdened by banks’ federal regulations. PayPal worried that complying with state-by-state laws for money transmission would also be too burdensome for a startup so they first tried to be classified as a chartered trust company to provide a benign regulatory cover, but failed. As the company grew larger, incumbent banks forced PayPal to register in each state. The banks lobbied regulators in Louisiana, New York, California, and Idaho and soon they were issuing injunctions forcing PayPal to delay their IPO. Ironically, once PayPal complied with state regulations by registering as a “money transmitter” on a state-by-state basis, it created a barrier to entry for future new entrants.
U.S. Auto Makers – Death by Rent Seeking
The U.S. auto industry is a textbook case of rent seeking behavior. In 1981 unable to compete with the quality and price of Japanese cars, the domestic car companies convinced the U.S. government to restrict the import of  “foreign” cars. The result? Americans paid an extra $5 billion for cars. Japan overcame these barriers by using their import quotas to ship high-end, high-margin luxury cars, establishing manufacturing plants in the U.S. for high-volume lower cost cars and by continuing to innovate. In contrast, U.S. car manufacturers raised prices, pocketed the profits, bought off the unions with unsustainable contracts, ran inefficient factories and stopped innovating. The bill came due two decades later as the American auto industry spiraled into bankruptcy and its market share plummeted from 75% in 1981 to 45% in 2012.
Innovation in the Auto Industry
According to the Gallup Poll American consumers view car salesman as dead last in honesty and ethics. Yet when Tesla provided consumers with a direct sales alternative, the rent seekers – the National Auto Dealers Association turned its lobbyists loose on State Legislatures robbing consumers in North Carolina, New York and Texas of choice in the marketplace.
In these states it appears innovation be damned if it gets in the way of a rent seeker with a good lobbyist.
Much like Paypal, it’s likely that after forcing Tesla to win these state-by-state battles, the auto dealers will have found that they dealt themselves the losing hand.
Rent seeking is bad for the economy
Rent seeking strangles innovation in its crib. When companies are protected from competition, they have little incentive to cut costs or to pay attention to changing customer needs. The resources invested in rent seeking are a form of economic waste and reduce the wealth of the overall economy.
Schumpeter’s theory of creative destruction - that entry by entrepreneurs was the disruptive force that sustained economic growth even as it destroyed the value of established companies – didn’t take into account that countries with lots of rent-seeking activity (pick your favorite nation where bribes and corruption are the cost of doing business) or dominated by organized interest groups tend to be the economic losers. As rent-seeking becomes more attractive than innovation, the economy falls into decline.
Startups, investors and the public have done a poor job of calling out the politicians and regulators who use the words “innovation means jobs” while supporting rent seekers.
What does this mean for startups?
In an existing market it’s clear who your competitors are. You compete for customers on performance, ease of use, or price. However, for startups creating a new market – one where either the product or service never existed before or the new option is radically more convenient for customers -  the idea that rent seekers even exist may come as a shock. “Why would anyone not want a better x, y or z?” The answer is that if your startup threatens their jobs or profits, it doesn’t matter how much better life will be for consumers, students, etc. Well organized incumbents will fight if they perceive a threat to the status quo.
As a result disrupting the status quo in regulated market can be costly. On the other hand, being a private and small startup means you have less to lose when you challenge the incumbents.
If you’re a startup with a disruptive business model here’s what you need to do:
Map the order of battle
  • Laughing at the dinosaurs and saying, “They don’t get it” may put you out of business. Expect that existing organizations will defend their turf ferociously i.e. movie studios, telecom providers, teachers unions, etc.
  • Understand who has political and regulator influence and where they operate
  • Figure out an “under the radar” strategy which doesn’t attract incumbents lawsuits, regulations or laws when you have limited resources to fight back
Pick early markets where the rent seekers are weakest and scale
  • For example, pick target markets with no national or state lobbying influence. i.e. Craigslist versus newspapers, Netflix versus video rental chains, Amazon versus bookstores, etc.
  • Go after rapid scale of passionate consumers who value the disruption i.e. Uber and Airbnb, Tesla
  • Ally with some larger partners who see you as a way to break the incumbents lock on the market. i.e. Palantir and the intelligence agencies versus the Army and IBM’s i2, / Textron Systems Overwatch
AirBnb – Damn the torpedoes full speed ahead
For example, Airbnb, thrives even though almost all of its “hosts” are not paying local motel/hotel taxes nor paying tax on their income, and many hosts are violating local zoning laws. Some investors and competitors may be concerned about regulatory risk and liability.  AirBNB’s attitude seems to be “build the business until someone stops me, and change or comply with regulations later.”  This is the same approach that allowed Amazon to ignore local sales taxes for the last two decades.
When you get customer scale and raise a large financing round, take the battle to the incumbents. Strategies at this stage include:
  • Hire your own lobbyists
    • Begin to build your own influence and political action groups
    • Publicly shame the incumbents as rent seekers
    • Use competition among governments to your advantage, eg, if  New York or North Carolina doesn’t want Tesla, put the store in New Jersey, across the river from Manhattan, increasing New Jersey’s tax revenue
    • Cut deals with the rent seekers. i.e. revenue/profit sharing, two-tier hiring, etc.
    • Buy them out i.e. guaranteed lifetime employment
Lessons Learned
  • Rent seekers are organizations that have lost the ability to innovate
  • They look to the government to provide their defense against innovation
  • Map the order of battle
  • Pick early markets and scale
  • With cash, take the battle to the incumbent

Steve Blank is best known as the progenitor of the lean startup movement, although this is only one of a lifelong  list of  his substantial  achievements.   Reprinted by permission from the Steve Blank Blog.  

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Monday, June 24, 2013

North American Angel Capital Association Expands Board, Adds Four Directors

The Angel Capital Association (ACA), the North American trade association of angel groups and private investors investing in high growth early-stage ventures, has elected to its board  Matt Dunbar of Upstate Carolina Angel Network (Greenville, SC), Curtis Gunn of Desert Angels (Tucson, AZ), Parker MacDonell, Executive Committee member of Ohio TechAngels (Columbus, OH), and Theresa Sedlack of Innovation Notre Dame (South Bend, IN).

The ACA Board of Directors is comprised of representatives of leading angel groups.  “In our role of advocating on behalf of accredited angel investing and nurturing investing best practices across North America, ACA is pleased to bring new talent to our board to continue to best serve the needs of our constituents”, said David Verrill, ACA Chairman.

The new Directors (bios below) will be added to the current board increasing membership to eighteen.
  • Chair: David Verrill, Hub Angel Investment Group (Cambridge, MA)
  • Vice Chair: Jamie Rhodes, Central Texas Angel Network (Austin, TX)
  • Vice Chair: Mike Eckert, Atlanta Technology Angels (Atlanta, GA)
  • Secretary / Treasurer: Ralph Mayer, Tech Coast Angels (San Diego, CA)
  • Michael Cain, Wilmington Investor Network (Wilmington, NC)
  • Jim Connor, Sand Hill Angels (Palo Alto, CA)
  • Ross Finlay, First Angel Network Association (Halifax, NS) - NACO Liaison
  • Allan May, Life Science Angels (Sunnyvale, CA)
  • Christopher Mirabile, Launchpad Venture Group (Boston)
  • Catherine V. Mott, BlueTree Allied Angels (Pittsburgh, PA)
  • Katherine O'Neill, Jumpstart New Jersey Angel Network (Mt. Laurel, NJ)
  • Jean Peters, Golden Seeds (Richmond, VA)
  • Dick Reeves, Huntsville Angel Network (Huntsville, AL)
  • Dan Rosen, Alliance of Angels (Seattle, WA)

Added to those above are the following.

Matt Dunbar, Managing Director of Upstate Carolina Angel Network, is responsible for the strategy and operations of the Greenville-based group of investors that has invested $7 million in 26 companies since its founding in 2008.  Dunbar began his career as a chemical engineer with Eastman Chemical Company and later worked with several Fortune 500 clients as a management consultant with the Boston Consulting Group after completing his MBA at Stanford.

Active in his community, Dunbar also has a passion for education and serves as a Visiting Lecturer in Venture Finance in the Clemson University MBA program and with the Property and Environment Research Center in Bozeman, Montana.  He is a volunteer Board Member of Junior Achievement of Upstate South Carolina, which teaches young people finance and business and empowers them to own their economic success.  He also serves as Director on multiple portfolio company boards, providing guidance and education to the entrepreneurial ecosystem.

Curtis Gunn is Chairman of the Desert Angels, an angel investment group of over 95 accredited investors in Tucson, AZ that review presentations from early stage startup companies looking for potential funding. Prior to this role, Curtis traveled the world competing as a professional cyclist riding for both US and Australian-based professional cycling teams. Previous to his life as a professional athlete, he was an entrepreneur founding and operating companies based in retail, Internet, healthcare and real estate. As an angel investor, Curtis has invested in over 30 different companies across a broad base of industries, technologies, and geographies.

Parker MacDonell is a seasoned financial services and business executive whose personal mission includes helping others succeed in business. Though his advisory firm Invergarry Partners, he assists business owners with capital formation, succession planning, goal-setting and value creation. His goal is to help business owners through the next step in the growth of their enterprise and to remove obstacles that may stem from access to capital and funding.

MacDonell’s financial services career has combined commercial banking, angel investing and startup business ventures. At Bank One, he led teams of retail, commercial and community bankers to serve their clients. At CFBank, he successfully launched the entry of the company into the Columbus market and built a base of satisfied clients. As a member of the Executive Committee of, and an investor in, all four of the Ohio TechAngel Funds, Parker assists entrepreneurs with the growth of their emerging businesses.  He has invested in 18 businesses and served on the boards of five startups.

Theresa Sedlack brings more than 10 years of experience working with entrepreneurs, market experts, and investors throughout the Notre Dame family and currently serves as Private Sector Engagement Director of Innovation Park at Notre Dame. Prior to joining Innovation Park, Theresa served as venturing programs manager for Notre Dame's Gigot Center for Entrepreneurial Studies Her professional background includes eight years working at Procter and Gamble. She teaches the M.B.A. venture capital class in the Mendoza College of Business. Sedlack has strong ties to the university ecosystem and actively works to develop mentorship programs for entrepreneurs who are seeking early stage funding.  Currently, she teaches the M.B.A. venture capital class in the Mendoza College of Business.

The  ACA provides professional development for angel groups, family offices and individual accredited investors and delivers services and benefits to support the success of the portfolio companies of ACA members.  ACA also serves as the advocacy voice and the trusted authority on accredited angel investing. 

“We look forward to working with these new board members,” said ACA Executive Director Marianne Hudson.  “Each brings new talents and perspectives to help us continue to develop new programming that furthers the personal success of our members and strengthens our innovation economy.”

About Angel Capital Association (ACA)
The Angel Capital Association is the leading professional and trade association supporting the success of angel investors in high-growth, early-stage ventures.  ACA provides professional development, industry voice, public policy advocacy and an array of benefits and resources to its membership of 200 angel groups and more than 8,500 individual accredited investors.; Twitter: @ACAAngelCapital.

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