The Cleantech Market and Predictable Irrationality

Ahead of the NextWave Greentech Investing conference (early bird registration rate ends Wednesday, btw), I'm taking a look at some of the shifts in thinking and strategy that are underlying this next wave of investors.

One of the more important shifts, I believe, is the abandonment of the quaint idea that buyers of clean technology are inherently rational decisionmakers.

I mean "rational" in the economics sense, of course, I'm not intending to be disparaging of anyone. But during the past decade there was too often a sense that it all came down to unit economics for customers. That a compelling economic value proposition (a production cost for biofuels well below the market price of oil, or a two year payback period for an energy savings solution, etc.) was sufficient to have the world beat a path to your door. Unfortunately, that didn't happen often.

I've been a big fan for a while of the writings of professor Dan Ariely, on the subject of irrational decision-making. His behavioral economics based approach to thinking about why people predictably make "mistakes" (from a simple economics calculation perspective, at least) in situations like purchases and investments can offer a lot of useful lessons for cleantech entrepreneurs, I believe. I highly recommend his books for anyone trying to figure out how to start turning clever cleantech ideals into actual successful revenue growth stories... Mandatory reading for cleantech entrepreneurs.

So I was very glad to get a chance recently to pick Dan's brain a bit on cleantech-specific topics. I asked him a wide variety of questions -- and I thought folks would enjoy hearing what he had to say:

First, I asked him for his thoughts on why so often we see customers take a long time to adopt "no-brainer" economic value propositions in the cleantech sector. I mentioned a recent episode where a cleantech startup I knew offered a customers a 6 month payback period, and it took the customer 9 months to say yes. And I asked Dan if he had any thoughts on why this long sales cycle problem is such a pervasive problem that so many cleantech entrepreneurs deal with -- one that often leads to slower than anticipated growth for cleantech startups.

"Of course," Dan said, "it's very tough to move people to do LOTS of things, people don't like to change. And a big part of the problem is regret. If you keep on doing what everyone else is doing, there's no way to regret it. But if you switch, all of a sudden you have made a particular decision. It could of course turn out badly, and you can regret later making that decision.

"Imagine if you bought a stock today. If the stock goes down, you can really regret it, but if you don't buy it there's nothing you can regret about it, particularly today. Of course, the stock market can go up and you can miss out on gains, but you're not going to have a specific action, a particular day you can regret, if you don't buy the stock.

"On top of that, we should think about the no-brainer as not just about the new versus the status quo. There's a question of whether or not something better will come along in the future. So the moment you have an environment that keeps on changing, people need to have confidence that this is not only better than the alternative, it's also better than what will come in the near future."

So what this means for cleantech entrepreneurs is that they have to stop trying to sell solely on the basis of the benefits of the solution they're offering -- they need to do a lot more to signal to prospective customers that they won't regret making the decision. That probably doesn't mean citing statistics about reliability, etc., as much as it means having "champion customers" give testimonials about how happy they are, to talk about how it'll make the buyer's life easier, and so forth. Not performance stats, but happiness anecdotes.

It also means figuring out how to "future-proof" customers against further advancements or other new tech. I think in many ways, in fact, cleantech entrepreneurs have been a victim of their own success over the past decade. The rapid proliferation of compelling new solutions not only makes for a more complex purchasing decision, it also raises the specter of yet more compelling new solutions soon to come -- so why buy now? Future-proofing is as important, I believe, as solving the infamous capex-opex dilemma so many are focused on right now.

Next, I asked Dan about the importance of having good channel partners in light of the above Regret dynamic.

"Channel partners basically help reduce the perception of risk. They make it seem like somebody's there to take care of you, someone that you know, that you're familiar with. Somebody whose business is more involved in this particular area than yours is, and therefore that through them you're more connected than you would be."

The problem in so many cleantech sectors, of course, is that the channel partners are as unfamiliar as the customers are about these new solutions, or even that they may be downright averse to them because of structural constraints and mis-incentives. This is one reason why I believe channel disruption is such a key investment opportunity in cleantech right now -- but Dan's comment also points out that new channel partners must work hard to establish customer trust as a first priority.

And on the general topic of trust, I also asked Dan about the recent results which suggest that clustering within neighborhoods has been an effective sales accelerator for residential rooftop solar. 

"We can think about a rational and a non-rational reason why it works. The rational reason is that clustering provides information. If I see that my neighbors are doing it, I can reason that the solution will work for me. The devices work, the sun is strong enough where we live, it works okay with the utility company, and so on and so forth. And basically I get the feeling that it's a good deal.

"The non-rational interpretation is that this is something akin to herding behavior, where we have this instinct of doing what other people are doing. And the moment we see the other people behaving together in a certain way, we take this as being the right standard of behavior. We adopt it, we take it in, and then we continue acting in this way going forward."

This works for rooftop solar and electric vehicles -- now, how can we get it to work for less visible purchases such as energy efficiency improvements?

Finally, I asked Dan why he thinks clean energy investment dollars have been drying up even as the macro need for new clean energy, etc., has become so much clearer over the last few years. 

"I think it basically has to do with the impatience of investors. Investors have been used to thinking about maybe ten year windows in the past, then it became a five year window, now it's even shorter. And they're basically thinking that this is what they should aim for, this shorter time horizon. With clean energy, it's very hard to imagine something paying off within a time horizon of five years or even ten years. And I think because of that it's very tough to convince them to invest in this sector."

Well, Dan, that's one thing we're going to be talking about at NextWave -- how we can now see the path to nearer term returns from investments in the sector, done in new ways. We're going to be hearing from some of these next wave investors how they're seeing success from new approaches. And we'll be hearing from some of the next wave entrepreneurs who are tackling big problems in smart new ways.

Because Dan's right -- we need to start putting some runs on the board. No matter how much LPs may agree with the logic of the long-term investment opportunity in cleantech, this needs to start to look like a near-term win before anyone will want to come back in.

Photo Credit: Cleantech Irrationality/shutterstock