Can Corporate VCs Compete?

Techcrunch just reported that Google will be investing $10 million in 'green' startups. This set me on a whole train of thought about corporate VC and under what conditions it can compete with standalone VCs. I was once a corporate VC, so this was a subject dear to my heart.

The best research I could find on this subject was done by Harvard professor Josh Lerner. My take away was corporate VCs can only compete when they invest in companies that are complementary to their existing lines of business. Oddly enough, almost no corporate venture capitalists follow this strategy. The reason: existing business units kick and scream when the company invests in start-ups that either take dollars away from their development programs or might one day grow up to be competitors. Corporate politics trumps common sense in most cases.

But, after that rumination and before I could take Google to task for making a rookie mistake (common as it may be), I read the press release. It's not Google spending the money, it's Google.org, their philanthropic entity.

Never mind!

Some Data to Chew On

Why am I asking you to do my dirty work? Here's some data on the US new car market: cars sold and dealer advertising dollars. Why cars? I wanted an industry subject to cyclical downturns resulting from exogenous effects, like the current mortgage downturn. Also, I wanted an industry where I already had a whole bunch of data on my hard drive.


The correlation coefficient is -0.8. Although this data set is way too small to be very significant, it's pretty darn suggestive. Data is all from the NADA.

I Can't Argue with That

A few weeks ago the Silicon Alley Insider predicted that the implosion in the subprime market would drastically cut online ad spending by mortgage purveyors, thus hurting the earnings of the online media folk. I don't agree.

Now it seems that, on the one hand, they think I might be right, but, on the other hand, they think I might be wrong. Personally, I'd like to see some actual analysis here: is there a correlation between an industry's product becoming less attractive and the ad spending by that industry? Well, obviously. The real question: is that correlation positive or negative?

I'm guessing negative. When it's harder to attract customers to a profitable product, you spend more on marketing, not less. There has to be some data on this. Anyone, anyone...?

Just Don't Increase my Property Taxes, OK?

Free Exchange, the Economist's blog, pointed me to this paper by Alan Krueger. The paper talks about one of my favorite subjects to while away my idle brain cycles with: is economic inequality in itself a bad thing? The negative answer ("why are you looking in my pocket?" as an old boss used to put it) is fairly simple to understand analytically. The positive answer less so, except from a values point of view.

Krueger argues that one of the primary drivers behind the US' recent increase in income inequality is inequality in education. This doesn't say that income inequality is bad in itself, but that income inequality is concomitant with a lack of skilled workers in an age where higher education is needed to be skilled. So, even if you think income inequality isn't an issue, you probably agree that the dearth of skilled workers is. Solve one, solve the other. Increased educational spending kills two birds with one stone feeds two birds with one piece of cake (as a sunny friend of mine says.)

An interesting point Krueger makes is that disadvantaged families have a higher implied discount rate when evaluating the decision on how much to spend for schooling. I wonder if this is a rational constraint or an evolutionary one. It would seem the latter, given Krueger's calculations on the actual returns to the educational investment. An evolutionary 'swing for the fences' strategy manifesting itself as a discount rate--a measure of the expectation of variability, not downside--would be an interesting hypothesis.

Intellectual Property is Not Property

I was reading an article in the Sunday New York Times about the fashion industry trying to get Congress to pass laws outlawing knock-offs and it started me thinking. And don't worry, once I get this off my chest I'll start thinking about lead gen again, I promise.

I should note, first-off, that I think the worries of the fashion industry are ridiculous. Perhaps this is a guy's point of view, but I get annoyed when the buttons fall off my Paul Stuart suits soon after I buy them. I expect the defining aspect of higher-priced goods to be quality, and I'm pretty sure that quality costs money to produce, justifying a higher price tag. But, that aside, the really interesting question raised by the article is about getting compensated for ideas.

Early on in my investing career I told an entrepreneur--re an argument about a NDA--"ideas aren't worth anything, execution is the only thing that matters." I was wrong, certainly. Ideas are worth something. But I was right about this: an idea does not make a business. Coming from consulting and advertising and venture capital and entrepreneurism, all businesses that rely on the constant production of ideas, I have come to the conclusion that you can make a living on producing ideas and you can make a living on taking an idea and executing it really well, but you can't make a living on owning an idea.

Unless you're a patent troll.

Which brings me back to what I was thinking when I read the article: is intellectual property worth protecting? I'm not going to go into the justice of it--except to say that ideas are not property in any sense that Locke would have recognized--I'm more interested in what is best for society.

The argument for intellectual property protection has historically been an economic one--"to promote the progress of science and useful arts"--not an ethical one. Do IP laws do this, promote the progress? Are consulting firms, advertising agencies, tech entrepreneurs, fashion designers and artists of all stripes at a disadvantage because they usually don't have protection for their ideas? (not the expressions of their ideas, these often are protected, but the ideas themselves.)

When it comes to patents, supporters like to argue that the pharmaceutical industry would not create new life-saving drugs if they did not have patent protection. Is this true? It seems so intuitively correct: no effort would be made without a reward, it's like a defining axiom of economics. But the flaw in this reasoning is the same flaw people often have when thinking about economics: that it's about money.

Who has been more intellectually creative over the past century: pharmaceutical companies or physicists? I can't answer, partly because there's no metric for creativity, but also because no matter what the metric, the two groups are both pretty far off the right end of the chart. And what do physicists get for their creativity? Fame? How many physicists can most people name? (Okay, present company excluded, because you're all a bunch of geeks.)

Physicists share knowledge because it's their culture, they generate knowledge for non-monetary reasons. I believe that scientists do what they do because thinking of new things is a reward in itself. Physicists love to be creative; people love to be creative. You can't buy creativity, you can only allow it. The old cliche that the best way to ruin an artist is to have people start paying for her work is a cliche because it has a grain of truth in it. What sense does it make to have a monetary reward (because that's what a government-granted monopoly is) for an inherently non-monetary activity?

What would the pharmaceutical industry look like if there was no patent protection? I think it's a question worthy of the rejection of preconceived notions. It would certainly be vastly different. But I would venture to guess that we would have just as many drugs; that our development path for new drugs would be faster, cheaper and more open; and that, in the end, we would all be much better off. All of us except for the pharma company executives, lawyers, lobbyists and shareholders, that is.

Previous Mortgage Origination Readjustments

It's a two post day because I'm out of town tomorrow and Thursday.

I was digging through mortgage origination data and found this interesting paper co-authored by some guy named Alan Greenspan. The paper uses the available data to suss out mortgage originations.


Purchase origination volume has been pretty steady over this time period (this is annual data.) But refinance has had its ups and downs. This seems pretty intuitive: when you have to buy a house, you have to buy a house, but you refinance when the stars align (i.e. lower interest rates, better investments elsewhere.)

Note the two downturns in refinance volume shown in the chart: in 2000 and 2004. Now think back to the online mortgage lead market in those years... I know it was a long time ago... think, think... internet years are so long...

Here's a hint: in 2000 LendingTree's revenue almost quintupled. And everyone here remembers 2004 and the ginormous growth in volume.

I know this is all circumstantial and the past is no predictor of future returns and you get what you pay for, and I'm not getting any investment bank analyst job offers (that's not a solicitation, btw. Ugh. Uh, unless you're paying a LOT), etc. But I haven't found any data to contradict my point. I mean, aside from IACI going from $40 to below $30. But, hey, who knows what goes on at IAC anyway?

Whither Mortgage Lead Gen? More Thoughts.

I wrote about where mortgage lead gen was going last week and got quite a few responses from people I know in the industry. It's an interesting question, and a complicated one.

A few data points. In "Mortgage Originations in a Down Market" Booz Allen says that the average retail cost per loan (meaning, in this case, the cost to the originator) is about $3,000. From their graphic it looks like about half that is sales cost.

My friend Bill Rice over at Kaleidico (a great lead management system company), who has an interesting vantage point on the industry, pegs the close rate of a mortgage lead at 2%-3% (although he points out that companies that use his LMS have a much higher close rate.) If we assume that two-thirds of the sales cost is lead acquisition, then the effective break-even cost per lead from the originator standpoint is between $20 and $30, higher if they use a LMS (or have otherwise implemented some sort of financial accountability in their handling of leads.) Note that this is the lead-gen versus all marketing break-even: the point at which it is more effective to buy leads than to do other sorts of marketing.

Here's the dynamic as I see it:

1. People looking for a mortgage become harder to find; the cost of marketing to them increases;
2. Mortgage originators decide to lower their marketing risk by doing less marketing themselves when they can buy leads at a lower effective cost-per-close;
3. Lead generators also have a harder time finding borrowers; this leads to fewer leads and a higher cost for generating a lead;
4. Higher demand and lower supply of leads increases the purchase price of a lead;
5. Each lead sells more times, lowering average close rates for everyone;
   
6. Originators with already low close rates can't compete;
7. Originators who know what they're doing get the additional business.

Note that the increased demand for leads at a higher price and the additional difficulty in generating them means an increase in mortgage advertising spend by lead generators, my point last week. Whether this is offset by the decrease in direct mortgage advertising by originators is beyond me.

Two other things I see happening:

• Originators will scramble to implement lead management systems;
• Providers of low-quality leads (those that have the lower close rates) will be squeezed out of business quickly (as Niki Scevak pointed out last week).

I'm still pondering the impact on internet advertising as a whole, but I think the impact on quality lead generators will be positive.