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Energy Innovation For Emerging Markets

Energy and clean technology investing has proven to be disastrous for venture capitalists. Capital allocated to clean tech fell to less than half in 2013 from the $3.7 billion invested in 2012, and new clean tech-focused funds were able to raise less than $1 billion last year, compared to $4.5 billion raised in 2012.

High-profile flameouts like Solyndra, A123 Systems, Konarka, Miasole, Better Place and Fisker Automotive have, appropriately enough, made investors very wary. Billions of dollars of equity has evaporated. Successes, such as Tesla Motors and Nest Labs, have been extremely rare.

Clean tech and energy, once touted as a fecund sectors for entrepreneurship alongside software, life sciences and the Internet, are no longer mentioned in the same league. Risk capital has dwindled dramatically, with prominent venture investors either winding down energy investing teams or retrenching significantly, content only with managing existing investments and not making new ones.

But why has clean technology blown a hole in investor’s pockets?

From questions about the suitability of cleantech for the venture capital investing model, to heated debates about the validity of climate change itself, which became a moral basis for the promotion of clean technology, many a rationale has been offered for why clean tech didn’t succeed in delivering investment returns. There is still no clear answer to why companies led by top-notch entrepreneurial operators and commercializing promising technologies met with spectacular failure.

It could be something more prosaic: clean technology companies and energy innovators have been in the wrong geographical market. Investors have unwittingly violated one of the maxims enunciated by venture capital pioneer Eugene Kleiner, who said; “Make sure the dog wants to eat the dog food.”

Take any metric – energy demand, fuel consumption, pollution, power generation growth, electrical grid development or water demand. Over the last decade, North American and European countries don’t figure on the list of the fastest growing markets for any of these.

Yet, clean technology companies have focused almost exclusively only on these developed world markets. The economies that have witnessed the highest growth in energy- and resource-related consumption are in emerging Asia, South America and Africa. Countries and cities in these regions also top global rankings for being the most polluted.

Does it make any sense to build windmills in Scandinavia or solar plants in Germany and California, when those regions already have relatively low levels of pollution and are fully electrified? As Europe is discovering, moralistic grandstanding cannot become the basis for innovation. This discrepancy represents a fundamental misallocation on a global scale of both human capital and financial risk capital.

The difficulty of commercializing innovation is compounded thanks to the cultural challenge innovators in developed economies face when working in emerging economies, which also inevitably have very different business climates.

Frequently, the geographical markets that are amenable to innovation in clean technology have regulatory risks and present far more challenging conditions for building businesses, as evidenced by their low rankings in the World Bank’s ease of doing business study.

This is an advantage “virtual world” businesses that are in consumer-focused Internet and mobile sectors have over others in that they have to contend with a lot less friction in developing markets.

Consider China’s situation. Tens of thousands of environmental protests are reported annually, millions of consumers live in extreme pollution and smog is destroying visibility – so it is easier to make the case for higher rates for electricity.

India’s growth has so far been predominantly services-driven. Manufacturing output has collapsed and saw negative growth because of unprecedented economic mismanagement by the current national government. This isn’t socially sustainable – as India promotes manufacturing and heavy industry to employ tens of millions of its youth, it’s inevitable that problems with pollution and environmental degradation will be exacerbated.

These are markets where one needn’t be moralistic about why clean technology is required. As the prospect of unlivable communities and unbreathable air looms large even in the most important urban centers, the economic logic for clean technology is self-evident.

Innovators outside these economies should take them a lot more seriously and find ways to overcome the cultural and business pitfalls of operating in emerging markets. There is also an unprecedented opportunity for inventors and entrepreneurs in emerging markets to build companies in clean technology.

A reallocation of financial risk capital and human capital towards where the clean technology and energy innovation markets are would go a long way towards solving the world’s sustainability challenge – and in the process, would also deliver far better returns for investors.

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