Bob Metcalfe: Happy 65th Birthday Doriot Ecology

Professor of Innovation Bob Metcalfe wished venture capital a happy 65th birthday April 6 and explained why research is vital to higher education.

On Jan. 12, I arrived in Austin to start my ne­w career as professor of innovation at The University of Texas at Austin. Only two weeks later, President Obama opened his State of the Union address by proclaiming, "The first step in winning the future is encouraging American innovation."

Obama continued, "We are the nation that put cars in driveways and computers in offices, the nation of Edison and the Wright brothers, of Google and Facebook. Our free enterprise system is what drives innovation."

And then he made innovation urgent: "This is our generation's Sputnik moment. We'll invest in biomedical research, information technology and especially clean energy technology – an investment that will strengthen our security, protect our planet and create countless new jobs for our people."

So, we professors of innovation had better get rolling. But, can innovation be professed?

Yes, it can. To make a long story short, go back to Professor Peter Drucker's Innovation and Entrepreneurship (1985). There you will read how "entrepreneurs innovate" and that innovation can and should be learned and managed. For more, Google up Richard Cantillon, Adam Smith and J.B. Say, who pioneered free enterprise economics and entrepreneurship in the 17th, 18th and 19th centuries.

Innovation takes various forms, and there are many taxonomies for dividing them up. My favorite is the two-by-two matrix formed by crossing new and old knowledge with new and old ways of using it, as shown in the table.

Metcalfe's two-by-two matrix

Most people have rich and full lives in the not-innovative quadrant of this innovation matrix. But most human progress, including the new jobs our economy so badly needs, is made in the other three quadrants.

Type III Innovation is the most difficult, using new knowledge in new ways — do not try this at home. It is also especially difficult doing any of these types of innovation at large scale. But, large-scale innovation is what President Obama was calling for in his State of the Union address — technological, entrepreneurial innovation at scale. This is the kind of innovation called for in the motto of The University of Texas at Austin: What Starts Here Changes the World.

World-changing innovations often require capital, and are also therefore the focus of the National Venture Capital Association (NVCA), of which I have been a member for 10 years. NVCA is holding its annual meeting in Boston April 6 and 7, and they have asked me to keynote a startup-studded celebration being planned for MIT today, April 6: "Venture Capital in America: 65 Years of Funding Entrepreneurs and Innovation."

Another huge coincidence might be that I turn 65 on April 7. Or maybe it's that venture capital is at the core of technological, entrepreneurial innovation at scale, just what the President ordered — and my specialty. The NVCA has pinned its VC65 celebration on the 1946 founding of the first modern venture capital firm, American Research and Development Corporation (ARDC), by Harvard Business School professor General Georges Doriot.

According to NVCA, starting with ARDC, venture capital became a professional activity, an industry that has "funded innovation and enterprise development in a wide range of fields across the U.S., propelling growth in the economy, creating entirely new industries, and helping the country lead the world in economic competitiveness."

NVCA probably got the idea for our VC65 celebration from Spencer E. Ante's 2008 book, Creative Capital: Georges Doriot and The Birth of Venture Capital. In Ante's book we learn that ARDC's landmark investment was in Digital Equipment Corporation (DEC), whose founder, Ken Olsen, was in 1986 called by Fortune magazine "arguably the most successful entrepreneur in the history of American business." DEC drove technological, entrepreneurial innovation at scale, taking information technology to new paradigms, from the end of batch-processing mainframes to interactive time-sharing minicomputers to the beginning of networked personal computers.

Having been around venture capitalists since 1979 and having been one for the last 10 years, I can assure you that VCs — the good ones anyway — do not think they are the most important people in innovation. VCs give that credit to entrepreneurs. But even the list "entrepreneurs and VCs" is not complete. My experience of technological, entrepreneurial innovation at scale leads to a much more complicated model — an innovation ecology — with many more than two species.

Diagram depicting the Doriot Ecology of Innovation

Click image to enlarge.

It is hard to think of this more-complicated innovation model as a "system." Systems are intelligently designed and neat. The way we do innovation was not designed, but rather has evolved, and it is not very neat at all In honor of General Doriot, I will hereinafter call the following innovation model the Doriot Ecology (DE).

And so it is now to a study of the DE model of innovation that I would like us to turn, both here and in the years to follow. In this, our Sputnik moment, we need to be asking if our innovation ecology is healthy and how we might farm it better to achieve what President Obama has asked us to do. The Doriot Ecology celebrated by NVCA is akin to a natural resource that can be sustainably managed and harvested to produce economic growth, freedom and prosperity.

Here are some of the fiercely competing species that inhabit the Doriot Ecology, achieving technological, entrepreneurial innovation at scale:

» Research professors are the DE species who should be entrusted with the bulk of our nation's research dollars. This is a hypothesis we've been testing for a long time now. My favorite evidence indicates that we should invest in research professors more than researchers in corporate labs, because among corporations only monopolies can afford research, and we cannot afford monopolies. Further, since much of innovation is a battle with the status quo, even when monopoly research labs produce important new knowledge, they are the least motivated to change the world with it.

Of course the biggest monopolies are governments, and some of them have research labs. Alas, thanks to politics, government research labs are often nothing more than geographically earmarked jobs programs. They produce little new knowledge per dollar invested and even less new knowledge escapes their bureaucracies.

America has perhaps 100 good research universities, and it is my hypothesis that they are where President Obama should be directing all the research dollars our nation can afford. Do I propose this because research universities are well managed? No. But keeping universities competing with one another for research dollars is the best remedy for that. The real reason for doing our nation's research at research universities is that they graduate students, who are the best vehicles for carrying new knowledge out into world markets where it can do some good.

It is urgent that we ask how we might improve our research universities for the important innovation challenges ahead. Are university management practices working well? Should research be driven by professorial curiosity and not focused on solving problems? Should research be managed by peer review? Should faculty tenure contracts so strongly thwart performance management?

A good question being pursued in Texas at this time is whether mixing research and teaching is a good idea in universities. I think we will reconfirm that the answer is a resounding "yes," because:

» Graduating students are the species of innovators who should be counted on to carry the discoveries of their professors' research groups out into the world. This role is so apt that many students don't wait to graduate before starting their own companies — undergraduate drop-outs like Steve Jobs, Bill Gates, Michael Dell and Mark Zuckerberg come to mind. There are many effective variations on the startup process, but it's my hypothesis that students make the best founders, especially when their professors are on the teams that back them.

Should students be encouraged to stay in school rather than leaving to start companies? I think so, but the famous counterexamples make the case hard to argue.

» Scaling entrepreneurs are the species of innovators who should be recruited to join with professors and graduating students in building their startups. The processes of heat-seeking market opportunities, team building, product engineering, efficient manufacturing, marketing, sales and administration are every bit as complicated as the new knowledge upon which innovating startups are based. The nerds and the suits, as they too often call one another, must team up.

We often hear that vision and passion are requirements for startup founders, but they don't get very far without the marketing and management that scaling entrepreneurs provide. Among VCs it's called "adult supervision."

» Venture capitalists are the species of innovators who can help build and finance innovation startups through early developments and market validation. Some of the best startups manage not to need venture capital, getting their early funding from customers. Customer funding is validating and often non-diluting of ownership, and thus is a very good way to go. But often venture capitalists are needed for their capital and expertise. Thank you, General Doriot, for the mutation that created modern venture capitalism.

So-called angel investors are these days ascendant. Definitions vary, but the best angels are usually successful entrepreneurs investing their own money in startups in markets in which they have expertise. Angels often invite venture capitalists into later rounds of startup finance, offering lower risk but requiring more capital.

Many angels say that startups now need much less money than in days gone by, so venture capitalists are less relevant. They say that venture capitalists can only invest large amounts of money — more than is needed — and that VCs are risk-averse: "VCs put the NO in innovation." VCs counter that angels say startups should raise less money only because angels have less money. These accusations ring true especially in the current wave of social networking startups, but maybe the Social Networking Bubble will burst. Perhaps then angels will welcome venture capitalists back.

In any case, speaking ecologically, there was a VC bloom around 2000. The ensuing VC die-off was probably started by poor VC returns after the bursting of the Internet Bubble. The data on the extent of the die-off is obscured by the fact that it typically takes VC partnerships 10 years to die. In the remote future, paleontologists will find a thick stratum of sedimentary rock rich in the bleached skeletons of VCs, Starbucks cups and Blackberries.

As innovation ecologists, we should be concerned about the VC extinction and to what extent upcoming innovations will starve despite the best efforts of angels. Did we have too many VCs during the Internet Bubble, do we have insufficient early-stage investment capital now, or both? Maybe the only startups we'll get for a while will be those coding up Facebook applications, financeable by new species of angels with prehensile tails. Such startups can be launched and file to go public during a bus trip from San Francisco to Austin. Or maybe we'll need other kinds of startups, say ones that break the laws of thermodynamics, which will take much more time and money to develop.

» Strategic partners are the species of innovators who can help startups find large market opportunities. These strategic partners are industry incumbents who know many customers; have brand and distribution; have development and manufacturing people, processes and scale; and have funds to bring innovations to market. Sometimes they license the products of the startups; sometimes they buy the startups.

President Obama has made energy innovation a new national priority, and it's not going well yet, at least among VCs. One diagnosis of the problem is that energy is very large-scale and a commodity, so energy innovations take too much time and money for Doriot-style venture capitalists.

Another diagnosis is that incumbent companies in the energy space have not yet learned to leverage venture-backed startups the way pharmaceutical incumbents have. Perhaps Doriot VCs shouldn't change for energy, but energy incumbents should adapt to VCs. There are hopeful signs that strategic partnerships are on the rise among energy-innovating startups.

» Early adopters are the species of innovators who begin the process of bringing innovations into the hands of customers. Because early adopters have competitors, they are motivated to go out on the bleeding edges of new technologies. They sometimes buy expensive and untried new products in hopes that early engagements will put their companies in a stronger position longer term to better serve customers. I recall failing to sell my early Ethernets in Germany, where I was not Siemens, and in Japan, where I was not Nippon Electric. We do not hear enough about the teeming early adopter species in American innovation.

Early adopters are motivated by their own competitive markets. But they can be deterred by government regulations. These regulations are often put in place by defenders of the status quo, who are experts at lobbying and litigation. The worst case of this I know of is in nuclear energy, where the Nuclear Regulatory Commission (NRC) has been blocking innovations in nuclear energy for 30 years. Now, with Obama pushing for nuclear energy, the NRC is blocking innovative small modular reactor designs under pressure from the incumbents, who are still planning to sell their behemoths.

So, that's our Doriot Ecology, and it's been working pretty well for most of the last 65 years. But it's time to see how we can better encourage our research professors, graduating students, scaling entrepreneurs, venture capitalists, strategic partners and early adopters in their Doriot Ecology. For starters, let's today wish venture capital Happy Birthday.

Metcalfe's article originally appeared April 4 on the Texas Enterprise Web site.

Bob Metcalfe

Bob Metcalfe, professor of innovation in the Cockrell School of Engineering, delivered a keynote speech at the National Venture Capital Association annual meeting in Boston April 6-7. His talk was titled "Venture Capital in America: 65 Years of Funding Entrepreneurs and Innovation."