Handbook of Research on Energy Entrepreneurship 1848445512, 9781848445512

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HANDBOOK OF RESEARCH ON ENERGY ENTREPRENEURSHIP

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Handbook of Research on Energy Entrepreneurship

Edited by

Rolf Wüstenhagen University of St Gallen, Switzerland and

Robert Wuebker University of Utah, USA

Edward Elgar Cheltenham, UK • Northampton, MA, USA

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© Rolf Wüstenhagen and Robert Wuebker 2011 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library Library of Congress Control Number: 2010934014

ISBN 978 1 84844 551 2

02

Typeset by Servis Filmsetting Ltd, Stockport, Cheshire Printed and bound by MPG Books Group, UK

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Contents

List of contributors 1

An introduction to energy entrepreneurship research Rolf Wüstenhagen and Robert Wuebker

PART I

2

3

4

6 7

8 9

21

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INTERNATIONAL ENERGY ENTREPRENEURSHIP

Entrepreneurial opportunity and the formation of photovoltaic clusters in Eastern Germany Matthias Brachert and Christoph Hornych The rise of Chinese challenger firms in the global solar industry Gabrielle Meersohn and Michael W. Hansen International entrepreneurship in the offshore renewable energy industry Nicolai Løvdal and Arild Aspelund

PART III

1

THE ROLE OF START-UP FIRMS IN ENERGY ENTREPRENEURSHIP

Market failure, market dynamics and entrepreneurial innovation by environmental ventures Elizabeth Garnsey, Nicola Dee and Simon Ford Prolonged gestation and commitment to an emerging organizational field: energy efficiency and renewable energy businesses in Minnesota, 1993–2009 Alfred Marcus, Marc H. Anderson, Susan Cohen and Kathleen Sutcliffe Entrepreneurial learning in energy technology start-ups: a case study in the biogas market Petra Dickel and Helga Andree

PART II 5

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83 104

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ENERGY ENTREPRENEURSHIP AND LARGE INCUMBENT FIRMS

Photovoltaic business models: threat or opportunity for utilities? Jean-Marc Schoettl and Laurence Lehmann-Ortega Why corporate venture capital funds fail: evidence from the European energy industry Tarja Teppo and Rolf Wüstenhagen

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PART IV 10 11 12

Business angels and energy investing: insights from a German panel study Dietmar Grichnik and Christian Koropp Venture capital investment in the greentech industries: a provocative essay Martin Kenney How do business models impact financial performance of renewable energy firms? Moritz Loock

PART V 13

14 15

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197 214

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COMMERCIALIZING ENERGY INNOVATION

Interfirm relationships in a new industry: the case of fuel cell technologies Stefano Pogutz, Angeloantonio Russo and Paolo Migliavacca Challenges of doing market research in the new energy market Roland Abold Path dependence, path creation and creative destruction in the evolution of energy systems Raimo Lovio, Per Mickwitz and Eva Heiskanen

PART VI

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FINANCING ENERGY ENTREPRENEURSHIP

249 262

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ENERGY ENTREPRENEURSHIP, INSTITUTIONS AND PUBLIC POLICY

Making, breaking, and remaking markets: state regulation, entrepreneurship, and photovoltaic electricity in New Jersey David M. Hart International entrepreneurship and technology transfer: the CDM situation in China João Aleluia and João Leitão Incentive prizes to stimulate energy innovation and entrepreneurship Neil Peretz and Zoltan Acs

Index

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Contributors

Roland Abold works as senior project researcher and consultant at GfK Market Research in Nuremberg, Germany. As deputy manager of the Energy and Environment Division he works for German and international companies in the energy sector. His major research topics are customer loyalty, market segmentation and brand positioning in the energy market. Before joining GfK in 2007 he worked as assistant professor for the Department of Social Sciences at the University of Bamberg, Germany. He holds a degree in political science and gained his PhD from the University of Bamberg in 2007. His research topic was ‘Computer simulation of individual voting behaviour’. Zoltan Acs is a Professor at the School of Public Policy and Director of the Center for Entrepreneurship and Public Policy, George Mason University, Fairfax, VA, USA. He is also a Research Scholar at the Max Planck Institute for Economics in Jena, Germany, and Scholar-in-Residence at the Kauffman Foundation. He is coeditor and founder of Small Business Economics, the world’s leading entrepreneurship and small business publication. João Aleluia holds an MSc in engineering and industrial management from the Instituto Superior Técnico, Technical University of Lisbon, Portugal. He also holds an executive master’s degree in energy management from the Institut Français du Pétrole (Paris), ESCP-EAP European School of Management (Paris), and BI Norwegian School of Management (Oslo). He has worked as a management consultant for Arthur D. Little, and he is currently the Managing Director of Beijing Tian Di Da Yuan, a CDM consultancy and advisory company operating in China. He is also an international business developer for HØST AS, a Norwegian technology provider engaged in the waste-toenergy sector. Marc H. Anderson is Assistant Professor of Management at Iowa State University’s College of Business, Ames, IA, USA. Helga Andree has been working for several years as an agricultural engineer at the University of Kiel, Germany, in the area of process engineering, environmental issues and renewables. Besides teaching, her research focused on process monitoring technologies in agricultural applications. Her experience in applying near-infrared spectroscopy for online monitoring and process control in biogas plants provided the basis to spin-off the TENIRS company in 2006. After the pre-commercial developments, her activities now strongly concentrate on marketing the TENIRS system. Arild Aspelund is Associate Professor in Marketing at the Norwegian University of Science and Technology (NTNU), Trondheim, and the leader of the focus area Global Production and Communication under NTNU’s Globalization Program. His primary vii

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research interests are in the fields of international marketing and entrepreneurship, and he teaches marketing management, industrial marketing, and international business development. He is also coordinator for specialization in Strategy and International Business Development. He received his PhD from NTNU in April 2005 with his thesis: ‘Small International Firms: The Emergence of International New Ventures’. Matthias Brachert is a PhD student at the Otto-von-Guericke University, Magdeburg, Germany, and research associate in the Department of Structural Economics, Halle Institute for Economic Research (IWH). He studied economics at the universities of Halle-Wittenberg and St. Denis (La Réunion). His main research interests are the evolution of spatial structures in new high-tech industries, the effects of industrial clusters on regional growth and the effects of structural change in transition economies. His doctoral thesis deals with the emergence of spatial structures and impact of technological progress on the German photovoltaic industry. Susan Cohen is Associate Professor of Business Administration at the Jospeh M. Katz Graduate School of Business, University of Pittsburgh, PA, USA. Her research and teaching focus on global management and entrepreneurship. She holds a PhD in strategic management from the University of Minnesota (1998). Nicola Dee is an embedded researcher at the University of Cambridge, UK, Institute for Manufacturing, Centre for Technology Management. Her doctoral research focused on how new ventures manage the opportunities and obstacles to development in the sustainable energy industry. She also managed a number of research and consultancy engagements for new ventures, RDAs, government departments, and European projects, and spearheaded a new business creation competition in Cambridge to stimulate support for student social and environmental businesses. Petra Dickel received her PhD from the Christian-Albrechts-University of Kiel, Germany. Her dissertation investigates market-based learning processes of academic spin-offs and their impact on new product performance. Her research interest focuses mainly on entrepreneurship, innovation and knowledge management. Before joining Kiel University she worked as brand manager in business-to-business marketing and key account management at Kraft Foods Germany and Austria. Since 2005 she has been a consultant and trainer on strategy, marketing and innovation-related issues. Simon Ford joined the Centre for Technology Management at the University of Cambridge, UK as a Research Associate in January 2006. His current work focuses on industrial emergence and technology acquisition. From 2006 to 2009 he was an AIM Research Fellow working on the Innovation and Productivity Grand Challenge (IPGC). His research focused on how established firms generate breakthrough innovations, either through new organizational regimes or through supporting intrapreneurs. Elizabeth Garnsey is Reader in Innovation Studies in the Centre for Technology Management, University of Cambridge, UK. She obtained her doctorate at the University of California, Berkeley, and worked in the Department of Applied Economics,

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Cambridge, before taking up her lectureship in management studies at the Judge Institute of Management and Engineering Department at Cambridge. She has been an advisor to the Bank of England, HM Treasury and the Confederation of British Industry on hightech enterprise, as well as an Expert Witness on the subject to parliamentary committees. She is a founder member of the Greater Cambridge Partnership, along with being the founder and academic organizer of the first Cambridge Enterprise Conference in 1997. Her research interests include the university–industry interface and the emergence, commercialization and evolution of new technologies. Dietmar Grichnik is Director of the Institute for Technology Management, and holder of the Chair for Entrepreneurship and Technology Management, University of St. Gallen, Switzerland. Michael W. Hansen is Associate Professor in the Department of Intercultural Communication and Management, Copenhagen Business School (CBS), Denmark. He is also affiliated with CBS’s Center for Business and Development Studies. His research is focused around the strategy of multinational corporations (MNCs) in developing countries and emerging markets, on linkages between MNCs and local firms in developing countries, and on foreign direct investment and the environment, with a particular focus on Asia. David M. Hart is Associate Professor of Public Policy at George Mason University (GMU) and Director of GMU’s Center for Science and Technology Policy, at Arlington, VA, USA. His research focus is to understand how public policy influences scientific knowledge and technological innovation. He is currently working on major projects in the areas of high-skill migration, energy technology, and entrepreneurship. Prior to joining GMU, he taught for a decade at Harvard University’s Kennedy School of Government. Eva Heiskanen is Research Professor at the National Consumer Research Centre, Helsinki, Finland, and Adjunct Professor (Docent) at the Aalto University School of Economics. She has a PhD in organization studies and an MSc in consumer economics. Her research focuses on the social impacts of technology, on social aspects of energy and environment, and on sustainable innovation. Christoph Hornych is a PhD student at the Martin-Luther-University Halle-Wittenberg, Germany, and research associate at the Halle Institute for Economic Research (IWH), Department of Urban Economics. He studied economics at the universities of Rostock, Helsinki and Halle-Wittenberg. He also holds a master’s degree in empirical economics and public policy research. His main research interests are in the fields of regional and urban economics, the evolution of clusters, and particularly the emergence of inter-industrial networks. His doctoral thesis deals with the emergence of cluster structures and the importance of network relationships for innovation in the German photovoltaic industry. Martin Kenney is a Professor in the Department of Human and Community Development at the University of California, Davis, and Senior Project Director at the Berkeley

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Roundtable on the International Economy, University of California, Berkeley, CA, USA. Christian Koropp is manager of the Competence Center for Technology Entrepreneurship and post-doctoral researcher at the Chair for Entrepreneurship and Technology Management, University of St. Gallen, Switzerland. Laurence Lehmann-Ortega is Affiliate Professor and EMBA Academic Coordinator at Écoles des Hautes Études Commerciales (HEC), Paris. She previously worked as Associate Professor at Groupe Sup de Co in Montpellier (France), where she was teaching strategic management and doing research on strategic innovation and business models. João Leitão is Head of Management and Administration at the University of Beira Interior (UBI), Covilhã, Portugal, and invited coordinator professor at the Polytechnic Institute of Portalegre, Portugal. He holds a PhD in economics (2004: UBI), specializing in market dynamics and entrepreneurial pricing. He is a research fellow of the Center for Innovation, Technology and Policy Research, IN+, Technical University of Lisbon. He is external research affiliate at the X-ENT group of the Max Planck Institute of Economics, Jena, Germany. He is also a member of the board of directors of the European Council for Small Business and Entrepreneurship – Policy area. His main topics of research are macro-determinants of technological entrepreneurship, entrepreneurial marketing, entrepreneurial behaviour and management of SMEs. Moritz Loock is a Research Associate at the Good Energies Chair for Management of Renewable Energies and a PhD candidate at University of St. Gallen, Switzerland. He holds an MA in cultural studies from the Berlin University of Technology and studied classical music at the Berlin University of Arts. His research focuses on business models for renewable energy firms and investor decision making. Nicolai Løvdal is a Research Fellow at the Center for Entrepreneurship at the Norwegian University of Science and Technology (NTNU), Trondheim, and one of the co-founders of the International Network on Offshore Renewable Energy (INORE). He previously worked as the coordinator of the Ocean Energy Research Program at Statkraft New Energy. Raimo Lovio is Professor of Innovation and Environmental Management at the Department of Management, Aalto University School of Economics, Helsinki, Finland. In recent years he has studied energy sector development and innovations from the point of view of climate change and creative destruction. His current work focuses on competition between different energy technologies, the strategies of old and new companies in the energy sector, and on innovations and entrepreneurship in new emerging renewable energy technologies. Alfred Marcus is a Professor in the Department of Strategic Management and Organization, Carlson School of Management, University of Minnesota, Minneapolis,

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MN, USA. He teaches and conducts research in strategic management, macroeconomics, business ethics, and business and the natural environment. He has been chair of the Carlson School’s Strategic Management and Organization Department, Director of the Carlson School’s Strategic Management Research Center, and a Visiting Professor at MIT’s Sloan School of Management and at the Norwegian School of Management. He earned a PhD from Harvard University. Gabrielle Meersohn graduated from the Copenhagen Business School, Denmark, with a CEMS Master in International Management in 2008. After working at CBS as a research associate, she recently joined Colexon Energy AG as an International Project Developer. Per Mickwitz is a Research Professor at the Finnish Environment Institute: he is also an Adjunct Professor of Environmental Policy at the University of Tampere, Finland. He has studied and published extensively, especially on the theory and practices of environmental policy evaluation for reflexive governance. Recently the focus of his research has shifted to energy and climate policy issues, in particular to issues related to stability and change in energy systems and the role of innovation and climate policy integration for these processes. Paolo Migliavacca is lecturer of Management at Bocconi University and the University of Turin, Italy. He obtained his PhD from the Catholic University, Milan. He is a fellow of the CSR Unit and the SPACE Research Center, Department of Management, Bocconi University. He serves as an independent director in some private and public organizations. He has been appointed CEO of the VITA Publishing Group. His research interests are mergers and acquisitions, strategic alliances, innovation finance, renewable energies, sustainability and social entrepreneurship. Neil Peretz is the Chairman of XRscience LLC. He is also a trial attorney with the Civil Division of the US Department of Justice. He holds a JD from the UCLA School of Law, an LLM from Katholieke Universiteit Leuven, and BS and MS degrees from Tufts University. He is a former investment banker, technology industry executive, and foreign service officer. Stefano Pogutz is Tenured Researcher and Professor of Management, Department of Management, Bocconi University, Milan, Italy. He is the Director of Bocconi’s firstlevel master’s degree on ‘Energy and Environmental Economics and Management’ and chair of the CEMS-MIM Faculty Group ‘Business and the Environment’. He is senior researcher at SPACE, the European Research Centre on Risk, Security Occupational Health and Safety, Environmental and Crisis Management, Bocconi University. His research interests are sustainability and innovation, green technologies and renewable energies, environmental management and corporate social responsibility. Angeloantonio Russo is Associate Professor of Management at LUM University, Casamassima (BA), Italy. He obtained his PhD in business administration and management from Bocconi University, Milan, Italy, where he is also senior researcher at the SPACE Research Center and research fellow of the CSR Unit, Department of

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Management. His research interests are mergers and acquisitions, strategic alliances, environmental management, renewable energies, sustainability and corporate responsibility. Jean-Marc Schoettl is Associate Professor of Strategy at CEROM Business School (Groupe Sup de Co Montpellier), France, and holds a PhD in management science from the University of Paris IX Dauphine. He was a visiting scholar at the University of San Ignacio de Loyola in Peru. He published results from his doctoral research in peerreviewed journals such as Gestion 2000 (1996) and Revue Française de Gestion (1981). He has an extensive background as a consultant: he was a senior consultant in the ABC Group (Spin-off from McKinsey), associate consultant for AEC-Partners and is currently manager of JMS Consultants in Paris. Kathleen Sutcliffe is Associate Dean for Faculty Development and Research; Gilbert and Ruth Whitaker Professor of Business Administration; and Professor of Management and Organizations at the University of Michigan’s Stephen M. Ross School of Business, Ann Arbor, MI, USA. Her research is devoted to understanding the fundamental mechanisms of organizational adaptation, reliability, and resilience. She holds a PhD from the University of Texas at Austin. Tarja Teppo completed her dissertation in 2006 in the Department of Industrial Engineering and Management, University of Technology (HUT), Helsinki, Finland, on the role of venture capital for cleantech market creation. She previously worked in the corporate venturing division of a major telecommunications company in Finland and the USA. In 2005, she co-founded Cleantech Invest Oy, which operates a cleantech seed fund and provides cleantech investment advisory services in the Nordic market. Her main research interests are sustainable entrepreneurship, venture capital and corporate venturing. Robert Wuebker is a Postdoctoral Fellow at the Department of Management, University of Utah, Salt Lake City, UT, USA, where he teaches entrepreneurship and strategy at the David Eccles School of Business. He holds a PhD in Management from Rensselaer Polytechnic Institute (RPI) in Troy, New York, where he held a National Science Foundation fellowship under the Integrative Graduate Education and Research (IGERT) programme. He holds an MBA from EDHEC-Institut Theseus and a BA (Hons) in Philosophy from the Ohio State University. His research interests include entrepreneurship, new venture strategy, entrepreneurial finance, and organizational theory. He has been a founder or early-stage participant in several start-up companies, and worked as an advisor to several private equity firms. Rolf Wüstenhagen is the Good Energies Professor for Management of Renewable Energies and a Director of the Institute for Economy and the Environment at the University of St. Gallen, Switzerland. He has held visiting faculty positions at the University of British Columbia, Wilfrid Laurier University and Copenhagen Business School. His research focuses on decision making under uncertainty by energy investors, consumers and entrepreneurs, and how such choices are influenced by energy policy. He embarked on his academic career after retiring from one of the leading European energy venture capital funds.

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An introduction to energy entrepreneurship research Rolf Wüstenhagen and Robert Wuebker

1

INTRODUCTION

Why an entire volume on energy entrepreneurship research? Who stands to benefit from this collision? What theoretical insights can entrepreneurship scholars gain from conducting research in this particular context? How will the energy community benefit? These are the questions we asked ourselves before starting this project. Curiously, our ‘answers’ to these questions – and thus our ‘rationale’ for this volume – has evolved substantially over the course of its development. Today, we believe – based in part on our discussions about whether to take on this project, and in part as a result of the experience of reviewing submissions, editing accepted chapters, and discussing the emerging domain at the authors’ retreat that we hosted – that we have better answers to these questions today than we had when we began. Our introduction, therefore, is an attempt not only to set the stage and to make a case for the inclusion of this volume into the entrepreneurship canon, but also to share with you how we got to where we are. Apart from the obvious intellectual fascination of exploring a new domain of academic research, we believe that readers will also share the contributing authors’ excitement for energy entrepreneurship as a topical and extremely relevant research context. The rich menu of research questions that have been examined in this volume provides ample evidence that the world is in the midst of a major energy transition that some observers call the ‘next industrial revolution’. The energy opportunity space is expansive, and we invite readers of this book – both academics and practitioners – to join us on a fascinating journey highlighting entrepreneurial activities spanning from harnessing the sun to the power of the oceans; from clusters of innovation in industrialized countries to the new geography of global entrepreneurship in emerging markets; from the venture capital community of Silicon Valley to financiers of innovation in incumbent firms; and all of this being shaped by fundamental shifts in customer preferences and policy frameworks. The rest of this introduction is a detailed exposition of what we state here in brief: that several strands of scholarly research stand to benefit from the collision of literatures, theoretical perspectives, methods, and research programs presented in this volume; and that understanding the drivers of entrepreneurial activity in the emerging new energy sector (along with exploring the specific challenges faced by energy entrepreneurs) has tremendous practical relevance.

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POSITIONING THIS VOLUME IN THE ENTREPRENEURSHIP RESEARCH LANDSCAPE

Small Firms, Large Firms, and Entrepreneurship Over the past half-century, our understanding of the role of entrepreneurship in society has changed dramatically. Fifty years ago a generation of scholars systematically documented and supported the conclusion of Schumpeter, who argued that ‘the large scale establishment . . . has come to be the most powerful engine of progress and in particular of the long-run expansion of output’(1942: 106). Today, however, our understanding of the role of entrepreneurship in society has largely reversed (Audretsch et al., 2006). A previous generation’s belief in the ‘dynamism, organizational innovation, and boldness’ of the corporate form (Servan-Schreiber, 1968) has given way to a new perspective, that of the high-impact entrepreneur (Acs, 2008) as the primary engine of economic development (Acs and Armington, 2006; Schramm, 2006; Audretsch, 2007). Our understanding of the role of the natural world and its ability to support or constrain economic development has also evolved. Concepts like climate change and peak oil have entered the public discourse, and while the particulars of what will occur economically and socially during the transition away from high-carbon fuel sources is subject to debate, it is clear that regions and nations are carefully considering these issues when building relationships with other nation-states, setting public policy, and how and when to project power. The end of cheap, abundant high-carbon energy is clearly a challenge. But it is also an opportunity. Where opportunities arise, one finds entrepreneurs. It has become apparent that the magnitude of the energy-related challenges we face will require more than incremental changes to existing patterns of production and consumption. Entrepreneurs are likely to play a significant role in this discontinuous change, as they are – to quote Schumpeter, again – the ‘promoters of new combinations’, individuals who can see both new possibilities and assess market needs. While research on corporate sustainability management – with its interest in the connection between the natural environment and various organizational levels of analysis – has gained significant sophistication and legitimization, the role of entrepreneurs in this process remains relatively unexplored. Yet a growing body of work from science and technology studies, strategy, and entrepreneurship suggests that the innovation process may be at its most potent when harnessed to entrepreneurial activity – either by new ventures or by established firms – and supported by robust internal and external capital markets and well-conceived institutional and policy frameworks. It is therefore important to consider the role of entrepreneurial activity in the development and commercialization of breakthrough energy technologies in both start-up and established firms (Moore and Wüstenhagen, 2004; O’Rourke and Parker, 2006; Wüstenhagen and Teppo, 2006). This volume is the result of our joint interest in these topics, and our belief that entrepreneurial action will play a significant role in the transition to a low-carbon, sustainable world. In the case of established firms, well-established theoretical perspectives have been extensively employed to examine innovation-driven transformation at the level of the industry. In fact, the starting point for most theories of innovation is the established firm, taken as a given (Baldwin and Scott, 1987; Dosi, 1988; Cohen and Levin, 1989),

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and conventional wisdom has long held that large enterprises able to exploit at least some market power will serve as the engine of technological change. In this view, large enterprises are uniquely endowed to exploit innovative opportunities because market dominance allows these enterprises to undertake the risks and uncertainties associated with innovation. The possibility of acquiring quasi-rents is the catalyst for large-firm innovation, as development is costly and that cost can only be borne by a firm with the resources associated with considerable size (Galbraith, 1956). In addition to the ‘who’ of innovation, the ‘how’ – for example, transformation processes – has also been an area of longstanding scholarly interest. Here, again, insights from the broader literature in strategic management have been employed (Nelson and Winter, 1982; Anderson and Tushman, 1990), with the traditional perspective arguing that the emergence of breakthrough technology leads to the destruction of existing competences (Schumpeter, 1939; Tripsas, 1997). These insights have not been lost on the current crop of sustainability scholars, who extensively employ these perspectives on research in corporate sustainability and the dissemination of clean technology innovation (Hart, 1995; Hart and Sharma, 2004; Moore and Wüstenhagen, 2004). Relatively under-represented in this literature, however, is an understanding of the role of new firms in this process, despite an explicit attempt in the existing literature to understand how to apply Schumpeterian-style creative destruction to the simultaneous benefit of firms, society and the environment (for example, Hart and Milstein, 1999; Wüstenhagen et al., 2008). Further, the inherent advantage of established firms in the innovation process has been cast into doubt by the profusion of empirical work that documents the crucial role of small enterprises in innovative activities (Jovanovic and Lash, 1989; Hobijn and Jovanovic, 2001; Jovanovic, 2001; Aghion et al., 2006). An emerging body of work by scholars at the intersection of entrepreneurship, social and environmental studies provides a theoretical starting point, detailing how opportunities related to sustainability and energy might arise through market imperfections (Cohen and Winn, 2007), discussing the role of entrepreneurship in the resolution of emerging environmental problems (Dean and McMullen, 2007), and addressing the nature of opportunity recognition in contexts of industry transformation (Monllor and Attaran, 2008). These emerging contributions – all of which hew closely to the research questions and perspectives familiar to entrepreneurship scholars – will certainly help to generate a richer and more nuanced perspective on the entrepreneurial process for energy and sustainability-related endeavors. Yet, it seems to us that other research contributions targeting more fundamental questions – how, why, and when do entrepreneurial firms come into being? – has the potential to contribute greatly to the energy and sustainability research program as it has been enacted in environmental management, strategy, and organization literatures. Knowledge, Entrepreneurship, and Creative Construction The ‘knowledge spillover theory of entrepreneurship’ (KSTE) (Acs et al., 2006) and the process of creative construction (Agarwal et al., 2007) provide a theoretical frame from which to conceptualize and incorporate the role of both emerging and established firms in the diffusion of industry-transforming innovation. Taken together, they provide a potentially fruitful perspective from which to examine questions of interest to energy and

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sustainability scholars. Given the role of small firms in catalyzing industry transformation, and the capability of established firms to either support or hinder the shift to new technologies for their own gain, these theoretical insights have great practical application for the field (Hockerts and Wüstenhagen, 2010). Building on insights from the knowledge-based view of the firm (Teece et al., 1997) which proposes that competitive differences between firms are the result of the creation of privately held and tacit knowledge, the KSTE explores more fully the implications of the incomplete transformation of scientific/industrial knowledge by an incumbent firm into ‘economic knowledge’ (Arrow, 1962). That is, a substantial portion of the knowledge created by an incumbent firm languishes, unexploited. However, this knowledge is distinct from other resources, given its characteristics as a public good. It is non-rival and non-excludable – thus creating opportunities for knowledge spillovers. The KSTE proposes that the firm is created endogenously through the agent’s effort to appropriate the value of his/her knowledge through innovative activity. An important insight of the KSTE is that the opportunity for entrepreneurs to exploit new knowledge is related to (i) the ability of the incumbent firm to exploit that knowledge completely, and thus reap the rewards and (ii) the cost and benefit to a prospective entrepreneur in exploiting that knowledge. The greater this ‘knowledge filter’ (Carlsson et al., 2007), the greater the gap between new knowledge and economic knowledge. It is this knowledge filter that creates a space for the entrepreneur to bring new innovations to market. As Arrow (1962) notes, knowledge is valued differently by different actors. If the gap in the valuation of the expected return between the incumbent firm and the inventor is sufficiently large, and the barriers involved with starting a new business sufficiently low, the employee may decide to leave the incumbent organization and establish a new firm. Thus, knowledge spillovers from new technology give rise to new opportunities (Shane and Venkataraman, 2000; Casson, 2003), and institutional constraints result in a subset of these opportunities not being exploited by incumbent firms, leaving a role for the entrepreneur (Acemoglu et al., 2005). The entrepreneurship literature has extensively documented the fact that small firms are often born when a researcher in a large firm sees the power and utility of an undervalued innovation. Both Jaffe (1989) and Acs et al. (1992) document spillovers from university laboratories that have contributed to the generation of commercial innovations by private enterprises. Thus, whatever debate that may exist concerning the innovative capacity of small firms, we conclude that entrepreneurial enterprises play an important role in the commercialization of that innovation – whether in an existing firm or born out of a university research center. Entrepreneurship, Institutions, and Public Policy From our point of view, the energy context provides entrepreneurship scholars interested in the relationship between entrepreneurship, innovation and economic growth a fruitful research setting to explore the impact of institutions and policies on the commercialization process. An extensive literature has detailed the influence of various policy regimes (for example, the presence and absence of subsidies and feed-in tariffs) on innovative activity (for example, the deployment of wind turbines) in countries around the world (Jacobsson and Lauber, 2006; Wüstenhagen and Bilharz, 2006; Breukers and Wolsink,

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2007; Lipp, 2007; Toke et al., 2008). Much of this literature in the energy policy research community is agnostic as to whether the outcome of such policies is actually the consequence of the activities of de novo firms or the activity of incumbent firms as long as the desired outcome (change in the overall energy mix) is achieved. Some authors, however, suggest that the effectiveness of energy policies in bringing about these changes actually hinges on providing the right incentive to entrepreneurs in small and large firms, and raises questions concerning the underlying assumption that as long as the outcome is achieved, the approach taken was ‘successful’. This challenge is underlined by anecdotal evidence of failure of ‘large corporate’ approaches to energy innovation, such as the early attempts by a consortium of German industrial establishment to commercialize the GROWIAN large wind turbine (Pulczynski, 1991; Wüstenhagen and Bilharz, 2006). Along similar lines, Garud and Karnøe (2003) show how the ‘breakthrough’ approach of US research policies on renewable energy technologies led to inferior long-term results compared to the ‘bricolage’ approach pursued by their Danish counterparts. These findings suggest that energy policy aimed at supporting the transition to a post-fossil-fuel era may be more effective if it comes with an entrepreneurial flavor, or – as Hockerts and Wüstenhagen (2010) put it – what may be needed is an ‘ambidextrous innovation policy for sustainability’. One important feature of such policies, which would equally support both ‘Davids’ and ‘Goliaths’ in their entrepreneurial efforts rather than focusing implicitly or explicitly on innovation in large firms, would be that they effectively reduce risk, so that small firms and their financiers can actually successfully enter the new market (Mitchell et al., 2006; Bürer and Wüstenhagen, 2009). Some exciting emerging research has been conducted at the nexus of entrepreneurship and energy policy – including some of the chapters included in Parts II and VI of this volume – but it is fair to say that the relationship between policy regimes and the broader entrepreneurship and strategy literature remains relatively understudied. We plan to explore these issues in future research, and hope to draw a community of interested scholars into this interesting and valuable area for entrepreneurship research. Financing Energy Entrepreneurship: The Role of Venture Capital While the widespread adoption of renewable energy technology depends on a constellation of actors, and (as detailed previously) management and sustainability literatures have tended to focus on the role of established firms in this process, other literatures – most notably those concerned with energy policy and science and technology studies – have extensively examined the role of institutions and policy regimes. But that is not the end of the story. The adoption of renewable energy technology – especially breakthrough innovation brought to market by innovative, high-growth firms – also depends on a set of actors that have been understudied to date: namely, the capital market actors that finance this innovative activity. Surprisingly, the strategy and innovation literatures take the allocation of capital as a given, and the relationship between the capital markets and innovative activity is relatively understudied outside of the entrepreneurship literature. In entrepreneurship scholarship, a growing body of work suggests that private equity investment (in particular professional and corporate venture capital) may play an important role in the commercialization of breakthrough sustainable energy technologies (Moore and Wüstenhagen, 2004; Wüstenhagen and Teppo, 2006; O’Rourke and Parker,

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2006; Bürer and Wüstenhagen, 2009). Understanding these actors and their role in energy entrepreneurship is, in our view, an opportunity to contribute to our understanding of an evolving innovation process. Further, the renewable energy context highlights emerging challenges in the practice of venture investment, which have not yet been completely understood or incorporated into the scholarly research program. An important contribution of the entrepreneurship literature to scholarly conversations about renewable energy is the role of professional venture capital as a catalyst for renewable energy innovation and a structure supporting its successful diffusion. We also suggest that renewable energy provides a fertile context in which to examine open (and emerging) questions in venture capital scholarship. However, we still know relatively little about the role that contextual factors play in shaping perceptions of opportunity, risk, and reward (Petty and Gruber, 2011) and we know little about the impact of these factors on the financing and performance of start-ups or the venture capital firms that fund them. Yet studies using renewable energy investment as the research context suggest that contextual factors significantly influence investment decision making (Bürer and Wüstenhagen, 2009). Examining early-stage investments in areas in which venture capital investors are familiar and contrasting those investment decisions with ones made in emerging industries may provide a fruitful context in which to examine (or, reexamine) venture capital decision criteria and processes. While interviews with venture capital investors have provided great insight into the criteria used for evaluating individual investments in industries familiar to venture investors (Sahlman, 1990) these criteria have not been found to map cleanly to decision making in emerging industries (Christensen et al., 2009). In an emerging industry, investment best practices have yet to be delineated, markets have yet to mature, and a dominant design has yet to emerge. Thus investing in a new industry sector requires overcoming the tremendous uncertainty inherent in the financing of early-stage firms, and is compounded by the need to resolve these additional challenges. Research has documented in great detail idiosyncratic due diligence and processes venture capitalists employ to resolve the former but scholars have had much less to say about the latter. More work is required. Our understanding of the role that corporate venture capital plays in the diffusion of breakthrough innovation may also change as a result of the collision with the world of renewable energy. Corporate venture capital – the investment of corporate funds directly in external start-up companies (Chesbrough and Tucci, 2004; Dushnitsky and Lenox, 2005, 2006) – is conceptualized as a complement to other knowledge-generating activities such as internal research and the formation of external alliances, employed to enable incumbent firms to tap into know-how developed inside another organization (Dushnitsky and Shaver, 2009). Corporate venturing programs – in contrast to professional venture capital investment – are intended to capture both strategic and financial benefits (Chesbrough, 2002; Dushnitsky and Lenox, 2006; Ivanov and Masulis, 2007). To succeed at their dual mission of generating both strategic and financial returns, corporate venture capital investors must master a set of skills distinct from those employed in professional venture investment (Hellmann, 2002; Dushnitsky and Lenox, 2006). In the same way that professional venture capital firms have evolved specialized knowhow and idiosyncratic structural and contractual mechanisms optimized for capturing financial gains accruing from early-stage investment (Sahlman, 1990; De Clercq et al.,

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2006) successful corporate venture capital programs have developed specialized knowhow that supports external knowledge search, evaluation and integration. Thus, given careful planning, organizing and structuring, a corporate venturing program can become a useful resource that firms can use to conceive of and implement their strategic objectives, becoming an important firm-specific asset in its own right (Porter, 1981; Barney, 1991). Our conjecture is that corporate venture capital programs may in fact be a source of significant advantage for incumbent organizations, although we acknowledge that the jury is still out as to how many incumbent energy firms will actually master the inherent tensions of corporate venturing activities successfully. While evidence for failure is abundant (Teppo and Wüstenhagen, ch. 9, this volume), the upside for those who succeed may be a recipe for survival in the emerging low-carbon economy. The New Geography of Innovation In the good old days of entrepreneurship, geography mattered a great deal: entrepreneurial activity appeared to occur around geographically distinct clusters of innovation, and policy makers trying to enhance the competitiveness of their nation-state seemed to have a clearly addressable audience. In fact, innovation policies around the world were often modeled to mirror the legendary success stories of high-tech hotspots, such as Silicon Valley or Route 128 in the North-Eastern US, hoping to create equally vibrant areas of entrepreneurial activity. While the success and failure of such policies is also subject to debate, we can clearly state that the world has changed. The phenomenon that is at the center of this book, energy entrepreneurship, occurs in an age of globalization, and this fact may have important consequences for entrepreneurial firms, as well as their financiers and policy makers. Research has traditionally conceptualized the relationship between a start-up firm and its investor as an inherently local business, and the geographic concentration of both venture capital organizations and start-ups tends to support this depiction. The observed preference for local investment is conceptualized as the result of the tremendous information problems associated with investment in early-stage entrepreneurial ventures (Gompers and Lerner, 2004). The reliance on local networks of trusted partners (Shane and Stuart, 2002; Hochberg et al., 2007) are a crucial part of how a venture capital firm resolves those information problems. However, the spread of entrepreneurship globally, the development of breakthrough innovation in new nations, the migration of talent to new regional clusters, and the attendant need to participate in emerging growth markets have encouraged venture capital firms to develop global strategies and make offshore investments. Today, venture capital investment occurs in a ‘post-American world’ (Zakaria, 2008), one in which innovation, entrepreneurial opportunity, and talent are distributed globally. Companies are increasingly sourcing and using top-tier science and engineering talent in globally dispersed locations (Antras and Helpman, 2004; Manning et al., 2008; Lewin et al., 2009) that correspond to the development of new regional clusters located in or around emerging urban centers (Howells, 1999; Bresnahan et al., 2001; Florida, 2005; Carlsson, 2006). It has become more difficult for the United States to retain the world’s best and brightest (Lieberthal and Lieberthal, 2003; Chanda and Sreenivasan, 2005; Zweig, 2005; Saxenian, 2006). These individuals are the high-impact entrepreneurs of

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the future, and venture capitalists depend on them to start innovative, high-growth firms (Saxenian, 2002; Lee et al., 2004; Acs and Armington, 2006; Shane, 2008). The innovative activity that attracts venture investment has evolved as well (Cantwell, 1995; Engardio and Einhorn, 2005; Ernst, 2005). Less than five years ago, the conventional wisdom was that the information and biotechnology fields – the core business of venture capital investors – would continue to be dominated by US firms, and that no other field would displace those sectors in the near future in size and speed of capital gains generation. This perspective is now at odds with the facts on the ground, as global-class technology is being developed all over the world (Reddy, 1997; Zhou and Leydesdorff, 2006). In the case of certain technologies, to be on the cutting edge one relocates to Haifa, Berlin, or outside Beijing (Ernst, 2002). And, for a number of promising technologies, including renewable energy, the United States is no longer the clear technical or market leader. There are more than 1,500 renewable energy start-ups operating worldwide, the majority of which are located outside the United States (Friedman, 2008). The intersection between energy and venture investment may be a fertile context for scholars interested in capability development, organizational change, or the internationalization process of both entrepreneurial firms and the venture capitalists that back them.

3

ENERGY ENTREPRENEURSHIP: THE CONTRIBUTION OF CHAPTERS IN THIS VOLUME

The Handbook of Research on Energy Entrepreneurship provides a distinctive and multidisciplinary starting point for scholars interested in energy and sustainability as a primary domain, as well as entrepreneurship and strategy scholars seeking an opportunity to make an impact in a field of growing academic and social interest. Across the different sections, the book provides a variety of insights on theoretical, conceptual and methodological approaches that may be fruitfully applied to the emerging research field on energy entrepreneurship. Given the many different directions and approaches there is a need to provide a reference work in this field. Each chapter offers a carefully presented summary of its area and discusses future research needs for different topics. Part I, ‘The Role of Start-Up Firms in Energy Entrepreneurship’, addresses a perspective that is very popular in entrepreneurship research, namely the role of new firms in bringing about energy innovation. Three chapters are adopting this start-up perspective, each from its own unique angle. Chapter 2 by Garnsey, Dee and Ford combines a theoretical approach with case studies to investigate some of the underlying fundamental questions of the relationship between market failures, market dynamics, and entrepreneurial opportunities in environmental markets, including renewable energy technologies. They argue that while market failures can be seen as a starting point for sustainable entrepreneurial opportunity (for example, Dean and McMullen, 2007), they can also create significant barriers to entrepreneurial activity. The authors illustrate their theoretical considerations with empirical evidence from environmental ventures in the UK, and conclude that an evolutionary economics perspective might be more powerful in explaining entrepreneurial innovation by environmental ventures than the neoclassical concept of market failure.

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Chapter 3 by Marcus, Anderson, Cohen and Sutcliffe provides yet another illustration for how reality may differ from traditional models of innovation and entrepreneurship as a linear process from opportunity recognition to successful commercialization. Their contribution looks at a phenomenon they call ‘prolonged gestation’, referring to entrepreneurial ventures for whom market success remains elusive long after being founded. They study this phenomenon in the context of energy entrepreneurial firms in Minnesota in the 1990s. Their longitudinal case study design allows them to answer some interesting questions about what determines entrepreneurs’ sustained commitment to building companies in a new market, despite significant challenges. Chapter 4 by Dickel and Andree takes a learning perspective on entrepreneurship. They attempt to advance entrepreneurial learning theories by advocating a dynamic learning model, concluding that different forms of learning (personal and codified learning and knowledge integration) apply in different stages of development of start-up firms. Their chapter is one of four in this book deriving their findings from the vibrant German renewable energy market, and the only one that investigates the biogas sector. The common thread of the three chapters in Part II, ‘International Energy Entrepreneurship’, is that they add a distinct geographical dimension to the debate and address some of the topical questions of how innovation and entrepreneurship occur in today’s globalized world. The first two – Chapter 5 by Brachert and Hornych and Chapter 6 by Meersohn and Hansen – provide complementary perspectives on the same market, namely the emerging industry for solar power generation (photovoltaics, PV). Brachert and Hornych look at the German PV industry as an interesting case study for cluster formation in an industrialized country, and find it a fruitful context to explore the concept of ‘windows of locational opportunity’ (WLO; Scott and Storper, 1987; Storper and Walker, 1989). Another highlight of their chapter is to investigate the role of social movements in laying the institutional foundations for entrepreneurial opportunities, a theme that is explored further in Part VI. In the following chapter, Meersohn and Hansen take the reader’s attention from Germany further East – towards the rising sun, so to say – focusing on the phenomenal rise of Chinese challenger firms in the solar energy industry. They show how this case contrasts sharply with the well-established conventional theories of firm internationalization, and propose theories of latecomer firms (Tolentino, 1993; Mathews, 2006; Buckley et al., 2007) as a fruitful alternative framework. Given the relatively short history of the phenomenon that they are studying, the authors successfully overcome data availability challenges by combining industry-wide data with three in-depth case studies of leading Chinese producers of solar panels. Chapter 7 by Løvdal and Aspelund, takes the discussion of the previous two chapters on firm internationalization yet a step further by focusing on international new ventures (INVs), or ‘born globals’, in energy entrepreneurship. Based on a unique dataset of born globals in the offshore renewable energy sector (wave, tidal and offshore wind energy), the authors investigate a number of propositions on the founder, firm and context levels. Taken together, these propositions provide a highly interesting context for advancing our understanding of energy entrepreneurship in a globalized world. Similar to the previous chapter, the way the authors triangulate data from a variety of sources may provide some methodological inspiration to energy entrepreneurship scholars struggling with data availability issues.

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While many of the above chapters have focused on small firms, thereby arguably reflecting a popular emphasis in entrepreneurship research in general, Part III, ‘Energy Entrepreneurship and Large Incumbent Firms’, looks explicitly at the other end of the spectrum. Chapter 8, by Schoettl and Lehmann-Ortega, reprises one of the popular themes of this book, namely solar photovoltaic (PV) technology as a particularly disruptive example of energy innovation, and asks how energy incumbents can overcome some of their legendary challenges in addressing radical innovation. The solution they are offering is to take a closer look at possible business models for PV, of which some are more adequate for electric utilities to adopt than others. In particular, they find it useful to deconstruct the PV value chain so as to identify those areas of the newly emerging industry that are competence enhancing rather than competence destroying from the incumbent’s perspective. As a conclusion, the authors identify a number of specific business models that allow incumbents to move from a perception of PV as a threat to their existing business to one of it being an opportunity to create future revenue streams. Somewhat in contrast to the basically optimistic tone of Schoettl and LehmannOrtega’s contribution, Chapter 9 by Teppo and Wüstenhagen provides a more sobering perspective of innovation in large incumbent energy firms. Using the emergence and subsequent decline (‘sudden death’) of corporate venture capital funds in the European energy industry as a research context, their qualitative empirical research gives rich evidence of the challenges that incumbent firms face in trying to create a fertile ground for entrepreneurial activity, especially in the midst of a major technological transition. The authors point to differences in organizational culture between parent firms and their corporate venturing units as a possible factor to explain failure. On the methodological side, while somewhat unusual when compared to the plethora of research that focuses on success stories and factors, we believe that this chapter’s focus on cases of failure can provide energy entrepreneurship researchers with some inspiration to strive for a more balanced account of the possible outcomes of entrepreneurial activity. Following up on Chapter 9’s introduction into the world of (corporate) venture capital, Part IV, ‘Financing Energy Entrepreneurship’, delves deeper with three chapters that nicely cover the full spectrum of entrepreneurial finance. Chapter 10 by Grichnik and Koropp starts the series at the earliest stage of the financing cycle, namely the role of business angels in funding early-stage energy technology firms. By drawing on data from a panel study of German business angels, the authors portray energy as an area of great interest to business angels. They also show, however, that there continues to be a significant gap between investors’ stated preferences for going into this sector and their actual behavior. The descriptive analysis by Grichnik and Koropp might provide an interesting starting point for future research that explores the causal mechanisms of how early-stage investors adapt to new opportunities in emerging industries, and the barriers they face in doing so. In a variation of the optimistic versus pessimistic pair of chapters in the previous part, Kenney elaborates further on those barriers in Chapter 11, taking a skeptical point of view on venture capital investment in the energy sector. By contrasting some of the characteristics of the venture capital model of financing innovation with the realities of the green technology sector, the author identifies a number of challenges that raise the question whether that model is actually suitable for the context at all. The author underlines his argument with data about investment flows in green technology, which he shows to

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be highly correlated with the volatile oil price, and qualitative data from venture capitalist interviews. Chapter 12 by Loock rounds off the discussion of financing energy entrepreneurship by moving to stock markets as a means of providing expansion capital to innovative clean energy firms. He, too, uses the business model concept as a conceptual framework, and conducts an empirical analysis of how different business models relate to the financial performance of growth firms in the wind and solar industries. While the author does not provide investors among our readership with a performance guarantee for implementing his findings, this is yet another example of a chapter that is of direct relevance for investment practitioners, although Loock acknowledges the crucial role of timing in interpreting his findings. His analysis provides a number of interesting contributions to the business model literature, especially by linking different business model configurations to firm performance. From an energy perspective, the chapter provides an interesting snapshot on where the two sectors (wind and solar) are located on their way to full maturity, with wind having a head start of a few years over solar. Part V, ‘Commercializing Energy Innovation’, provides three different perspectives on topics not neatly fitting any of the other boxes, but highlighting fruitful avenues for exploring energy entrepreneurship. Chapter 13 by Pogutz, Russo and Migliavacca investigates the role of strategic alliances and networks in the commercialization of fuel cell technologies. They use social network analysis to visualize and explore the centrality of different organizations in the emerging fuel cell industry. A small number of North American firms are shown to be at the heart of the fuel cell innovation network, but – particularly telling about the specifics of the energy sector – their centrality is even topped by a government agency, namely the US Department of Energy. The authors outline several routes for further research, and it is obvious that the current energy transition offers a variety of emerging energy technology sectors in which such analysis may be fruitfully applied beyond the case of fuel cells. A different perspective is introduced by Abold in Chapter 14, looking at market research challenges in the new energy market. His chapter reminds us that the customer actually matters in the energy industry, and provides some insights into the ways in which professional market research agencies help their customers make sense of the new energy realities. He highlights two areas in which the behavior of residential energy customers poses particular challenges to market research: understanding customer loyalty, and identifying promising target groups for energy innovation. He points out that energy has traditionally been a low-involvement product, so any attempts to market specific products have to be preceded by overcoming significant inertia on behalf of the customers. Lifestyle typologies can be a promising way to address the second challenge, and provide for marketing efficiency. Another insight from this chapter is that conceptualizing the energy market as a single monolithic entity is not accurate; instead, energy innovators in small and large firms are faced with a complex set of markets ranging from electric utility services through oil and gas to building technologies and beyond. Carefully delineating their target market and investing in a proper understanding of customer needs should therefore be a priority for energy entrepreneurs, and this chapter provides two specific starting points for doing so. Lovio, Mickwitz and Heiskanen offer yet another perspective in Chapter 15, and the common denominator with the previous chapter may be the observation of inertia.

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Lovio et al. do not look at this on the level of individual customers, but instead change the level of analysis and explore path dependence in energy systems. They start out with the observation that energy systems are slow to change due to path dependence, but then take Garud and Karnøe’s (2001) idea of path creation and Schumpeter’s seminal work on creative destruction to ask whether and under what conditions energy systems change in the face of fundamental innovation. The authors illustrate their conceptual considerations with empirical evidence from the Finnish energy system, and conclude by pointing to the importance of new institutions in path creation. Institutions are also one of the central themes of Part VI, ‘Energy Entrepreneurship, Institutions and Public Policy’. Chapter 16 by Hart sets the stage with a look at how public policy shapes the market for new energy technologies. His research context is carefully chosen: among the portfolio of new energy technologies that have recently been the focus of entrepreneurial attention, the solar photovoltaic sector is probably one of the most affected by policy. Apart from Germany, Spain and Japan, the US is a particularly promising market for solar energy, and more than federal policy, it is statelevel policy that has had most influence on renewable energy growth (or its absence) in the US. Hence the New Jersey market is a promising context to study the relationship between policy, entrepreneurship and the emergence of new markets. Like the Teppo and Wüstenhagen, and Kenney chapters, above, Hart’s contribution reminds us that energy entrepreneurship consists of more than just plain success stories, and that policy cannot only make, but also break markets. Fortunately, the New Jersey case shows that policy makers have learned their lessons from trial and error, and the market is about to be remade. The author also touches upon another popular theme of this book, which is the differential role of start-up firms and large incumbents in energy entrepreneurship, by discussing how partnerships between entrepreneurial new entrants and established utilities could help overcome some of the current market challenges. From the clearly defined state-level policy setting of New Jersey, Chapter 17 by Aleluia and Leitão takes us back into the world of international entrepreneurship, but this time with a policy perspective. The authors investigate one of the instruments of global climate policy, the clean development mechanism (CDM), and how it is being applied in China. This chapter makes a number of contributions to entrepreneurship scholarship: not only does it provide a handy overview of the full menu of international climate policies, but it also links those to the literature on international entrepreneurship and technology transfer. Finally, the chapter reiterates the theme of ‘making and breaking markets’ outlined by Hart in the previous chapter, by pointing out that the reality of policy making around energy and climate issues is anything but straightforward, and that the messy nature of those policy frameworks creates both opportunities and challenges to energy entrepreneurs. If traditional policy is messy, then other institutions might take their role, some may argue. The final chapter by Peretz and Acs (Chapter 18) can provide some insights into one such ‘other institution’. It focuses on the role of incentive prizes – which may be offered by government agencies, but also by private foundations, universities or businesses – on promoting energy innovation and entrepreneurship. The chapter reviews empirical evidence from a number of prizes in the US renewable energy and energy efficiency sector. Based on a careful review of the experience with such prizes, the chapter provides a compact summary of what works well and what does not work so well, hence

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providing important implications for policy makers – or perhaps more precisely, institution makers. In addition to a healthy dose of hands-on advice for practitioners, the chapter also touches upon some of the more fundamental questions of entrepreneurship research, including the issue of entrepreneurial motivation, and points out that the prestige associated with winning an incentive prize may be worth more than money.

4

PROMISING AVENUES FOR FURTHER RESEARCH ON ENERGY ENTREPRENEURSHIP

While we have done our best to put together an insightful collection of early research contributions on energy entrepreneurship, we believe that this can only be a starting point and the field clearly deserves more scholarly attention in the future. Among the multitude of aspects touched upon in this book, we would like to specifically point out four main areas for further research. First, we believe that the current transition from a fossil-fuel-based energy economy to a cleaner energy future creates a rare opportunity for entrepreneurship scholars to study the emergence of a new sector of entrepreneurial opportunity, perhaps similar to the rise of biotechnology entrepreneurship two or three decades ago. Because major industry transitions have tended to occur rather infrequently, today’s entrepreneurship scholars would be well served to seize this opportunity as it unfolds (as our predecessors seized the opportunity to examine in detail the transition from large- to small-firm innovation 20 years ago). Arguably, a large part of this research opportunity concerns aspects that could perhaps collectively be coined as ‘institutional’, in that the research questions tend to transcend the level of the firm. How do venture capitalists and other investors adapt to an emerging opportunity outside their ‘home turf’? How does entrepreneurial talent migrate from one industry to another? What role do behavioral factors and cognitive biases play in the strategic choices involved? How can evolutionary perspectives, such as concepts of path dependence and path creation, improve our understanding of these issues? How do entrepreneurs and policy makers collectively try to create appropriate institutional frameworks to support the transition? In our view these are all interesting research questions and perspectives, for which the current nascent state of the ‘new energy economy’ provides a valuable window of opportunity for research. Second, we think that there is more scope for specific research on entrepreneurial marketing. The marketing–entrepreneurship interface tends to be a somewhat understudied area, and so is the marketing–energy interface. We admit that part of this assessment is a personal preference for a world in which customers matter over one where energy suppliers conceive of them as ‘ratepayers’, but ultimately for an entrepreneurial venture to survive, it needs to provide solutions that create value for its customers (and other stakeholders). And just as Bhidé (2006) argues that ‘venturesome consumption’ of its inhabitants can help the United States maintain a competitive advantage in times of globalization, our diagnosis is that unleashing the power of the consumer in the energy market can pave the way for renewable energy innovation, given widespread public preference for clean, low-cost energy sources. Creating great technologies is a crucial first step; but, it is only a first step. Therefore, further research on entrepreneurial marketing in the energy sector could focus on identifying unmet customer needs, and on marketing

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strategies and business models to fulfill them. When it comes to marketing clean energy innovation, researchers will be faced with the twin challenge surrounding an analysis of customer preferences for (i) new and (ii) sustainability-related products. When it comes to new, innovative products, some of the established marketing research methods work less well because customers are inexperienced with the research object, and hence their preferences for certain product features, pricing schemes and so on may be undeveloped. When it comes to sustainability-related products, the issue of social desirability becomes a concern, for example when it comes to assessing willingness to pay for environmental features. Successfully addressing those challenges requires an adequate set of methods, such as focus groups (for example, Kaenzig and Wüstenhagen, 2008), conjoint experiments, or test markets. Third, even if this were not intentional, we realize that almost all of the chapters in this book interpreted energy entrepreneurship as entrepreneurial activities related to renewable energy technologies (or ‘cleantech’). We share the view that this is an area of particularly substantial opportunity, but it might also be worth exploring entrepreneurial activities and the development of new capabilities (or the absence of their development) in the existing energy business. Also, while many observers see particular potential in an increase of energy efficiency in areas such as industry, buildings and transportation, energy efficiency-related entrepreneurship has received relatively scant attention by scholars. So investigating how entrepreneurial solutions can improve the market diffusion of energy-efficient technologies might be a rewarding research endeavor. Fourth, we believe that a particular feature of energy entrepreneurship is the fact that it occurs in a heavily politicized industry. The chapters in this volume provide a starting point for investigating the policy–entrepreneurship interface, but more could be done. It is important to note that more than one area of policy making is of relevance here. First, energy entrepreneurs are entrepreneurs, and as such are likely to be influenced by general research, technology and innovation policies, as well as specific energy policies. Second, though, because energy is a cross-cutting issue, entrepreneurial activity in this area can also be supported or hindered by a whole set of other policy areas, including environmental, climate, agricultural, transportation and defense policy to name but a few. Energy entrepreneurs and their investors are well advised to specifically consider ways of managing these policy risks (Bürer and Wüstenhagen, 2008), or transforming them into opportunities. This is probably an area where interdisciplinary research between entrepreneurship scholars and experts in political science looks particularly promising. Fifth, energy systems are capital intensive and bound to substantial infrastructures. This will have implications for energy entrepreneurship, perhaps in a larger role of large corporations in bringing about the energy transition. Only two chapters in this volume explicitly address corporate venturing, but this is certainly an area for further investigation. Why do incumbent firms differ in their approach to embracing the clean energy opportunity? What explains such differences both between subsectors of the energy industry and between countries? How should corporate venturing models be adapted to fit the specific circumstances of the energy industry with its long lead times, capital intensity and geopolitical considerations? And what can be learnt from studying the power relationships that have historically been associated with control over energy resources, and that might be threatened by energy entrepreneurs?

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Sixth and finally, while we have some geographical diversity by studying energy entrepreneurship in North America, Europe and China in this book, there is scope for taking this theme to new geographical horizons. Energy entrepreneurs in developing countries, for example, may face specific opportunities (unmet demand for energy, no competition from existing grids) and challenges (financing, political risk). Therefore, studying energy entrepreneurship (and its financing, for example through microfinance) in developing country contexts could generate new insights that could be transferred back North.

5

CONCLUSION

We started out in this introduction by pointing out the double excitement that energy entrepreneurship provides both as an area for scholarly investigation, and as a real-world phenomenon that combines tremendous market opportunities with a wider societal impetus. In our empirical work with energy entrepreneurs and investors, we felt that the sheer scale of the current energy transition, as well as the fact that entrepreneurial solutions in this area provide entrepreneurs and investors with the opportunity of doing well while doing good, or being part of the solution to what some observers consider to be an existential threat to humankind, provides an exceptionally motivating environment. We came across people who had pursued outstanding professional careers in developing innovative new ringtones for mobile phones, marketing the latest hairspray to yet another consumer group, or were among the high potentials in their enterprise resource planning firm – and yet they felt at least equally satisfied, if not more, after giving their career a new spin and ending up participating in the energy transition. We hope that our readers share some of this positive energy, on either side of the real-world–academia nexus, or perhaps even both sides – an experience that the authors of this introduction have found to be particularly enriching.

REFERENCES Acemoglu, D., S. Johnson and J.A. Robinson (2005), ‘The rise of Europe: Atlantic trade, institutional change and economic growth’, American Economic Review, 95 (3), 546–79. Acs, Z.J. (2008), ‘Foundations of high impact entrepreneurship’, Foundations and Trends in Entrepreneurship, 4 (6), 535–620. Acs, Z.J. and C. Armington (2006), Entrepreneurship, Geography and American Economic Growth, Cambridge: Cambridge University Press. Acs, Z.J., D.B. Audretsch, P. Braunerhjelm and B. Carlsson (2006), ‘The knowledge spillover theory of entrepreneurship’, CESIS Electronic Working Paper Series. Acs, Z.J., D.B. Audretsch and M.P. Feldman (1992), ‘Real effects of academic research: comment’, American Economic Review, 82 (1), 363–7. Agarwal, R., D. Audretsch and M.B. Sarkar (2007), ‘The process of creative construction: knowledge spillovers, entrepreneurship and economic growth’, Strategic Entrepreneurship Journal, 1 (2), 263–86. Aghion, P., R. Blundell, R. Griffith, P. Howitt and S. Prantl (2006), ‘The effects of entry on incumbent innovation and productivity’, NBER Working Paper 12027, National Bureau of Economic Research, Cambridge, MA. Anderson, P. and M. Tushman (1990), ‘Technological discontinuities and dominant designs: a cyclical model of technological change’, Administrative Science Quarterly, 35 (4), 604–33. Antras, P. and E. Helpman (2004), ‘Global sourcing’, Journal of Political Economy, 112 (3), 393–418. Arrow, K. (1962), The Rate and Direction of Inventive Activity, Princeton, NJ: Princeton University Press.

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Audretsch, David B. (2007), The Entrepreneurial Society, New York: Oxford University Press. Audretsch, D.B., M.C. Keilbach and E.E. Lehmann (2006), Entrepreneurship and Economic Growth, Oxford: Oxford University Press. Baldwin, W.L. and J.T. Scott (1987), Market Structure and Technological Change, New York: Harwood. Barney, J. (1991), ‘Firm resources and sustained competitive advantage’, Journal of Management, 17 (1), 99–120. Bhidé, A. (2006), ‘Venturesome consumption, innovation and globalisation’, paper presented at the CESifo and Centre on Capitalism and Society conference, Venice, July 21–22, available at: http://www.cesifo.de/ link/vsi06_ep_bhide.pdf (accessed October 15, 2010). Bresnahan, T., A. Gambardella and A. Saxenian (2001), ‘“Old economy” inputs for “new economy” outcomes: cluster formation in the new Silicon Valleys’, Industrial and Corporate Change, 10 (4), 835–60. Breukers, S. and M. Wolsink (2007), ‘Wind power implementation in changing institutional landscapes: an international comparison’, Energy Policy, 35, 2737–50. Buckley, P.J., Chengqi Wang and Jeremy Clegg (2007), ‘The impact of foreign ownership, local ownership and industry characteristics on spill-over benefits from foreign direct investment in China’, International Business Review, 16 (2), 142–58. Bürer, M.J. and R. Wüstenhagen (2008), ‘Cleantech venture investors and energy policy risk: an exploratory analysis of regulatory risk management strategies’, in Wüstenhagen et al. (eds), pp. 290–309. Bürer, M.J. and R. Wüstenhagen (2009), ‘Which renewable energy policy is a venture capitalist’s best friend? Empirical evidence from a survey of international cleantech investors’, Energy Policy, 37 (12), 4997–5006. Cantwell, J. (1995), ‘The globalisation of technology: what remains of the product cycle model?’, Cambridge Journal of Economics, 19 (1), 155–74. Carlsson, B. (2006), ‘Internationalization of innovation systems: a survey of the literature’, Research Policy, 35, 55–67. Carlsson, B., Z.J. Acs, D.B. Audretsch and P. Braunerhjelm (2007), ‘The knowledge filter, entrepreneurship, and economic growth’, Jena Economic Research Paper 2007-057, available at: http://ssrn.com/ abstract=1022922 (accessed October 15, 2010). Casson, M. (2003), ‘Entrepreneurship, business culture and the theory of the firm’, in Z.J. Acs and D.B. Audretsch (eds), Handbook of Entrepreneurship Research, Boston, MA: Kluwer Academic Publishers, pp. 223–46. Chanda, R. and N. Sreenivasan (2005), ‘India’s experience with skilled migration’, in C. Kuptsch and E.F. Pang (eds), Competing for Global Talent, Geneva, Switzerland: ILO International Institute for Labour Studies, pp. 215–56. Chesbrough, H. (2002), ‘Making sense of corporate venture capital’, Harvard Business Review, 80 (3), 90–99. Chesbrough, H. and C. Tucci (2004), ‘Corporate venture capital in the context of corporate innovation’, DRUID Summer Conference, Copenhagen, June 14–16. Christensen, E., R. Wuebker and R. Wüstenhagen (2009), ‘Of acting principals and principal agents: goal incongruence in the venture capitalist–entrepreneur relationship’, International Journal of Entrepreneurship and Small Business, 7 (3), 367–88. Cohen, B. and M.I. Winn (2007), ‘Market imperfections, opportunity and sustainable entrepreneurship’, Journal of Business Venturing, 22 (1), 29–49. Cohen, W.M. and R.C. Levin (1989), ‘Empirical studies of innovation and market structure’, in R. Schmalensee and R.D. Willig (eds), Handbook of Industrial Organization, New York: North-Holland. De Clercq, D., V. Fried, O. Lehtonen and H. Sapienza (2006). ‘An entrepreneur’s guide to the venture capital galaxy’, Academy of Management Perspectives, 20 (3), 90–112. Dean, T.J. and J.S. McMullen (2007), ‘Toward a theory of sustainable entrepreneurship: reducing environmental degradation through entrepreneurial action’, Journal of Business Venturing, 22 (1), 50–76. Dosi, G. (1988), ‘Sources, procedures, and microeconomic effects of innovation’, Journal of Economic Literature, 26 (3), 1120–71. Dushnitsky, G. and M.J. Lenox (2005), ‘When do incumbents learn from entrepreneurial ventures? Corporate venture capital and investing firm innovation rates’, Research Policy, 34 (5), 615–39. Dushnitsky, G. and M. Lenox (2006), ‘When does corporate venture investment create firm value?’, Journal of Business Venturing, 21 (6), 753–72. Dushnitsky, G. and J.M. Shaver (2009), ‘Limitations to inter-organizational knowledge acquisition: the paradox of corporate venture capital’, Strategic Management Journal, 30 (10), 1045–64. Engardio, P. and B. Einhorn (2005), ‘Outsourcing innovation’, Business Week, 21 March, 84–94. Ernst, D. (2002), ‘Global production networks and the changing geography of innovation systems: implications for developing countries’, Economics of Innovation and New Technology, 11 (6), 497–523. Ernst, D. (2005), ‘Complexity and internationalization of innovation: why is chip design moving to China?’, International Journal of Innovation Management, 9 (1), 47–73. Florida, R. (2005), The Flight of the Creative Class: The New Global Competition for Talent, English edn, London: Harper Collins Business.

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Friedman, T. (2008), ‘Flush with energy’, New York Times, August 10, p. WK11. Galbraith, J.K. (1956), American Capitalism, Boston, MA: Houghton Mifflin. Garud, R and P. Karnøe (eds) (2001), Path Dependence and Creation, London: Lawrence Earlbaum. Garud, R. and P. Karnøe (2003), ‘Bricolage versus breakthrough: distributed and embedded agency in technology entrepreneurship’, Research Policy, 32, 277–300. Gompers, P. and J. Lerner (2004), The Venture Capital Cycle, 2nd edn, Cambridge, MA: MIT Press. Hart, S.L. (1995), ‘A natural-resource-based view of the firm’, Academy of Management Review, 20 (4), 986–1014. Hart, S.L. and M.B. Milstein (1999), ‘Global sustainability and the creative destruction of industries’, Sloan Management Review, 41 (1), 23–33. Hart, S.L. and S. Sharma (2004), ‘Engaging fringe stakeholders for competitive imagination’, Academy of Management Executive, 18 (1), 7–18. Hellmann, T. (2002), ‘A theory of strategic venture investing’, Journal of Financial Economics, 64 (2), 285–314. Hobijn, B. and B. Jovanovic (2001), ‘The information technology revolution and the stock market: preliminary evidence’, American Economic Review, 91, 1203–20. Hochberg, Y.V., A. Ljungqvist and Y. Lu (2007), ‘Whom you know matters: venture capital networks and investment performance’, Journal of Finance, 62 (1), 251–301. Hockerts, K. and R. Wüstenhagen (2010), ‘Greening Goliaths versus emerging Davids – theorizing about the role of incumbents and new entrants in sustainable entrepreneurship’, Journal of Business Venturing, 25 (5), 481–92. Howells, J. (1999), ‘The location and organization of research and development: new horizons’, Research Policy, 19 (2), 133–46. Ivanov, V. and R. Masulis (2007), ‘Corporate venture capital, strategic alliances, and the governance of newly public firms’, University of Kansas Working Paper. Jacobsson S. and V. Lauber (2006), ‘The politics and policy of energy system transformation: explaining the German diffusion of renewable energy technology’, Energy Policy, 34, 256–76. Jaffe, A.B. (1989), ‘Real effects of academic research’, American Economic Review, 79 (5), 957–70. Jovanovic, B. (2001), ‘Fitness and age: review of Carroll and Hannan’s Demography of Corporations and Industries’, Journal of Economic Literature, 39, 105–19. Jovanovic, B. and S. Lash (1989), ‘Entry, exit, and diffusion with learning by doing’, American Economic Review, 79 (4), 690–99. Kaenzig, J. and R. Wüstenhagen (2008), ‘Understanding the green energy consumer: evidence from Swiss homeowners’, Marketing Review St. Gallen, 4-2008, 12–16. Lee, S.Y., R. Florida and Z.J. Acs (2004), ‘Creativity and entrepreneurship: a regional analysis of new firm formation’, Regional Studies, 38 (8), 879–91. Lewin, A.Y., S. Massini and C. Peeters (2009), ‘Why are companies offshoring innovation? The emerging global race for talent’, Journal of International Business Studies, 40, 901–25. Lieberthal, K. and G. Lieberthal (2003), ‘China tomorrow: the great transition’, Harvard Business Review, October, 70–81. Lipp, J. (2007), ‘Lessons for effective renewable electricity policy from Denmark, Germany and the United Kingdom’, Energy Policy, 35, 5481–95. Manning, S., S. Massini and A. Lewin (2008), ‘A dynamic perspective on next-generation outsourcing: the global sourcing of science and engineering talent’, Academy of Management Perspectives, 22 (3), 35–54. Mathews, John A. (2006), ‘Dragon multinationals: new players in the 21st century globalization’, Asia Pacific Journal of Management, 23, 5–27. Mitchell, C., D. Bauknecht and P.M. Connor (2006), ‘Effectiveness through risk reduction: a comparison of the renewable obligation in England and Wales and the feed-in system in Germany’, Energy Policy, 34, 297–305. Monllor, J. and S. Attaran (2008), ‘Opportunity recognition of social entrepreneurs: an application of the creativity model’, International Journal of Entrepreneurship and Small Business, 6 (1), 54–67. Moore, B. and R. Wüstenhagen (2004), ‘Innovative and sustainable energy technologies: the role of venture capital’, Business Strategy and the Environment, 13, 235–45. Nelson, R.R. and S. Winter (1982), An Evolutionary Theory of Economic Change, Cambridge, MA: Belknap Press. O’Rourke, A. and N. Parker (2006), ‘The Cleantech Venture Capital Report 2006’, Cleantech Venture Network LLC, Toronto. Petty, J. and M. Gruber (2011), ‘In pursuit of the real deal: A longitudinal study of VC decision making’, Journal of Business Venturing, 26 (2), 172–88. Porter, M.E. (1981), ‘The contributions of industrial organization to strategic management: a promise beginning to be realized’, Academy of Management Review, 6 (4), 609–20. Pulczynski, J. (1991), ‘Interorganisationales Innovationsmanagement. Eine kritische Analyse des Forschungsprojektes GROWIAN’, Kiel.

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Reddy, P. (1997), ‘New trends in globalization of corporate R&D and implications for innovation capability in host countries: a survey from India’, World Development, 25 (11), 1821–37. Sahlman, W. (1990), ‘The structure and governance of venture capital organizations’, Journal of Financial Economics, 27, 473–521. Saxenian, A. (2002), ‘Silicon Valley’s new immigrant entrepreneurs’, Economic Development Quarterly, 16 (1), 20–32. Saxenian, A. (2006), The New Argonauts: Regional Advantage in a Global Economy, Cambridge, MA: Harvard University Press. Schramm, C.J. (2006), The Entrepreneurial Imperative, New York: Collins. Schumpeter, J.A. (1939), Business Cycles. A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, New York: Harper. Schumpeter, J.A. (1942), Capitalism, Socialism, Democracy, New York: Harper. Scott, A.J. and M. Storper (1987), ‘High technology industry and regional development: a theoretical critique and reconstruction’, International Social Science Journal, 112, 215–32. Servan-Schreiber, J.J. (1968), The American Challenge, New York: Atheneum. Shane, S. (2008), The Illusions of Entrepreneurship, New Haven, CT: Yale University Press. Shane, S. and T. Stuart (2002), ‘Organizational endowments and the performance of university start-ups’, Management Science, 48 (1), 154–70. Shane, S. and S. Venkataraman (2000), ‘The promise of entrepreneurship as a field of research’, Academy of Management Review, 25 (1), 217–26. Storper, M. and R. Walker (1989), The Capitalist Imperative: Territory, Technology, and Industrial Growth, Oxford and Cambridge, MA: Basil Blackwell. Teece, D., G. Pisano and A. Shuen (1997), ‘Dynamic capabilities and strategic management’, Journal of Strategic Management, 18 (7), 509–33. Toke, D., S. Breukers and M. Wolsink (2008), ‘Wind power deployment outcomes: how can we account for the differences?’, Renewable and Sustainable Energy Reviews, 12, 1129–47. Tolentino, Paz Estrella (1993), Technological Innovation and Third World Multinationals, London: Routledge, pp. 61–85. Tripsas, M. (1997), ‘Unraveling the process of creative destruction: complementary assets and incumbent survival in the typesetter industry’, Strategic Management Journal, 18, 119–42. Wüstenhagen, R. and M. Bilharz (2006), ‘Green energy market development in Germany: effective public policy and emerging customer demand’, Energy Policy, 34, 1681–96. Wüstenhagen, R. and T. Teppo (2006), ‘Do venture capitalists really invest in good industries? Risk-return perceptions and path dependence in the emerging European energy VC market’, International Journal of Technology Management, 34 (1/2), 63–87. Wüstenhagen, R., J. Hamschmidt, S. Sharma and M. Starik (eds) (2008), Sustainable Innovation and Entrepreneurship, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Zakaria, F. (2008), The Post-American World, New York: W.W. Norton. Zhou, P. and L. Leydesdorff (2006), ‘The emergence of China as a leading nation in science’, Research Policy, 35 (1), 83–104. Zweig, D. (2005), ‘Learning to compete: China’s efforts to encourage a “reverse brain drain”’, in C. Kuptsch and E.F. Pang (eds), Competing for Global Talent, Geneva: ILO, International Institute for Labour Studies, pp. 187–214.

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PART I THE ROLE OF START-UP FIRMS IN ENERGY ENTREPRENEURSHIP

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Market failure, market dynamics and entrepreneurial innovation by environmental ventures Elizabeth Garnsey, Nicola Dee and Simon Ford

1

INTRODUCTION

Entrepreneurial innovation is now recognized as an engine of change in the economy. Yet new entrant firms have made little innovative impact in utilities, construction, transport and heavy industry sectors, the major contributors to carbon emissions. Nor have larger companies in these sectors been able to innovate radically in the face of pressures to maintain short-term rates of return on capital.1 There is new interest from investors2 and policy makers3 in environmental ventures as changes unfold in the environmental arena. Academic work reflects awareness of these changes. For example, it has been argued that the prevalence of market failure provides a basis for viewing high carbon sectors as fertile with opportunities for entrepreneurs (Dean and McMullen, 2002, 2007; Cohen and Winn, 2007). This attention to environmental ventures is promising and suggests a new research agenda. But the neoclassical theory on which this recent work draws does not distinguish between market failures that obstruct entrepreneurs and those that provide a source of opportunity: both are attributed to the failure of perfect competition. To understand whether and how market failure provides business opportunities from environmental innovation, evidence is needed on the experience of enterprises launching innovative environmental technologies. Evidence can help operationalize constructs by showing what instances of market failures they encounter and how these affect their prospects. To have an impact on carbon emissions and their mitigation, a new company must not only commercialize environmental technology but grow the business sufficiently to achieve market penetration. This study explores evidence from a database of 73 UK environmental ventures, summarizing the opportunities they targeted and the constraints they reported. Illustrative data is provided on the experience of energy innovators and that of small and medium-sized enterprise (SME) innovators in other sectors of the environmental goods and services industry. From this evidence we are able to trace the impact of specific instances of market failures: many such instances were reported as obstacles rather than opportunities. A key question is therefore how entrepreneurial firms responded to instances of market failure. This question is explored from case studies of innovative environmental enterprises, which throws further light on the concept of market failure. We draw on literature in the field of entrepreneurial innovation, as well as that on market failure, to guide the inquiry.

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Prior Work on Entrepreneurial Innovation4 Early literature on innovation showed that entrepreneurial firms realize opportunities by configuring their resources so as to match changing market needs (Penrose, 1960; Freeman, 1982). Recent work on entrepreneurship has diverted attention from this entrepreneurial matching process to the entrepreneurial pursuit of opportunities, which has been proposed by recent scholars as the defining feature of entrepreneurial activity (Venkataraman, 1997; Shane and Venkataraman, 2000; Shane, 2004).5 The focus of recent entrepreneurship studies is the genesis of the business idea and its translation into a business model that can attract investment. But the questions on entrepreneurial innovation addressed here require a more Schumpeterian perspective on how innovations are conceived, resourced, launched and diffused in distinctive ways. This question requires a concept of the entrepreneurial process which encompasses new business development. The Entrepreneurial Means–Ends Calculus Entrepreneurs are said not only to improve the means to achieving ends, but to think up completely new means to achieve business ends (Kirzner, 1973; Shane, 2004). The application of new ‘means–ends frameworks’ has been identified as distinctively entrepreneurial behaviour (Shane and Venkataraman, 2000; Shane, 2003). In particular, entrepreneurial alertness to opportunity is said to lead them to recognize the deficiency of current price signals (Kirzner, 1973; Casson, 1982). Economists who have addressed the role of entrepreneurs in the economy have focused on the improved resource allocation which results from their putting resources to better use in this way. As Casson explains, an entrepreneurial discovery occurs when someone makes the conjecture that a set of resources is priced too low, given the likelihood that the output from their combination could achieve a better price through a different allocation (Casson, 1982). A return to best use provides welfare benefits idealized in the Pareto equilibrium (Dean and McMullen, 2002).6 However there has been little use of evidence to operationalize the concepts of the entrepreneurial means–ends framework or market failure as business opportunity. In this study, we sought evidence that can show whether (and how) the means and ends pursued by entrepreneurs makes it possible for some of these to turn certain situations that can be characterized as market failure into opportunities. Market Failure as a Source of Opportunity? Welfare economics traditionally views malfunctioning markets (market failures) as a barrier to entrepreneurial activity (Pigou, 1932). When there are no incentives from private returns, services may not be provided to protect public goods7 or render them more useful (Samuelson, 1954; Coase, 1974; Jaffe et al., 2003). But market failures have recently been identified as providing sources of opportunities for entrepreneurs. Information asymmetries (Eckhardt and Shane, 2003) and externalities (Carlaw and Lipsey, 2002) have been described as specific instances of market failure that provide the entrepreneurial firm with opportunities. The same argument applies to inefficient competitors and flawed pricing mechanisms (Cohen and Winn, 2007). Market failures have also been identified as creating opportunities because public goods and monopoly power

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can be a stimulus to government intervention (Dean and McMullen, 2002, 2007).8 These authors have pointed to the various means by which entrepreneurs can address market failure: the introduction of property rights, backing new institutions, altering subsidies and stimulating anti-monopoly measures. All these involve government intervention. The course of action identified by Dean and McMullen (2007) for environmental entrepreneurs that does not require recourse to government action is for them to remedy the imperfect information available to suppliers, and/or customers. The idea that entrepreneurial opportunities are opened by market failures has interesting implications, but the conceptual apparatus of market failure creates difficulties.9 Factors that bring about disparities between supply and demand and prevent market clearing, whether those that stimulate or those that inhibit market dynamics, are viewed as creating market failure in orthodox theory because perfect competition would prevent these disparities. Metcalfe considers it curious terminology to characterize the very conditions that generate change and innovation as market failures (Metcalfe, 1998, 2004). From an evolutionary perspective, changes that result in demand outgrowing supply, and innovative supply available where a market does not yet exist (which represent failures of perfect competition), are the very factors that bring about market evolution; they are the basis of market dynamics. The term ‘market failure’ is used to refer to conditions that lead to potentially transient discrepancies that can be remedied by entrepreneurial innovation. But it is also used to refer to more entrenched and persistent failures of market functioning, as identified by earlier economists (Pigou, 1932). These include conditions in need of institutional remediation as set out by Dean and McMullen (2002). Where supply–demand disparities are attributed to market imperfections there is no clear basis for distinguishing between market failures that obstruct entrepreneurs and those that provide a source of opportunity. To explore factors stemming from market failure that systematically impede business development in entrepreneurial ventures, we turn now to evidence from a database and survey. We then go on to examine evidence that informs us of the relationship between market opportunities, market failure and entrepreneurial practices through case studies of environmental enterprise.

2

EVIDENCE ON IMPEDIMENTS TO ENVIRONMENTAL ENTERPRISE

Methodology To explore the concept of market failure as a source of business opportunity for environmental entrepreneurs, we sought evidence on opportunities pursued by environmental enterprises, evidence on obstacles they encountered, and on how these related to market failure. Our aim was to use evidence to explore and elucidate concepts of market failure and entrepreneurial means and ends. As these had not been operationalized, data testing was premature. Moreover, no formal hypotheses had been offered by adherents of the thesis that market failure constitutes business opportunity. We explored evidence from databases, surveys and business case histories. We had a particular interest in enterprises

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launching renewable energy technologies but for purposes of comparison, we included firms in other activities within the environmental goods and services sector (as defined by the UK Department of Trade and Industry (DTI)10). We conducted an exploratory analysis of a DTI database on environmental enterprises in the UK. We followed up a sample of these firms in a telephone survey in order to find out what constraints were perceived by managers of these firms. Since we found many instances of market failure cited as obstacles, a key question was how innovative entrepreneurial firms have turned such obstacles into opportunities. To this end we conducted case studies of 21 international firms with environmental innovations. The Environmental Innovations Unit of the UK DTI compiled a cross-sectoral database in 2005 of firms pursuing innovations in the environmental domain. This database included 288 organizations with the aim of identifying a significant proportion of the UK’s environmental organizations. From this government database we derived a dataset of SMEs. We removed firms whose core business proved not to be based on environmental technologies, or for which there was incomplete data.11 This resulted in a sample of 73 SMEs for which we obtained further information from telephone interviews. Sectors of activity chosen by these environmental SMEs provided evidence of opportunity recognition; these were the sectoral markets in which they hoped to realize business opportunities. The classification system used was that of the Joint Environmental Market Unit (JEMU) of the UK DTI.12 The largest category, comprising 30 companies, was the JEMU category ‘Renewable and low carbon energy’; in this sector we distinguished between stationary and transportation applications. Thus the market opportunities targeted by the majority of SMEs in the database could be classed in five categories: ● ● ● ● ●

cleaner technologies and processes (largely pollution prevention products); renewable and low carbon energy – stationary; renewable and low carbon energy – transport; recovery and recycling; and water and wastewater treatment.

The telephone survey analysis of the sample dataset firms revealed perceived market opportunities (from the description of barriers to commercial exploitation) and business development obstacles self-reported by the respondents. This inquiry revealed how serious were the various developmental difficulties experienced in young environmental firms and pointed to contrasts between the sectors (Table 2.1). Nine companies were selected from the 73 respondent firms, comprising a crosssection of environmental technology sectors. Follow-up research by questionnaire and telephone interviews was conducted to gain more detailed findings on obstacles and opportunities than were available in the survey. To see how market failures and other challenges have been addressed by entrepreneurs, we turned to case studies. Issues of theoretical interest that cannot readily be quantified can be illuminated by qualitative evidence from case studies. These aim to present theoretically interesting, rather than representative, evidence. For this purpose we carried out more detailed case studies of 11 new entrants that had found innovative ways to get past difficulties of the kind reported in the survey.13 These provided a more international perspective than the UK survey,

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Market failure, market dynamics and entrepreneurial innovation Table 2.1

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Dominant issues facing UK environmental enterprises developing and commercializing environmental innovations, by sector (N = 73) (%)

Sector

Cleaner technologies and processes

Recovery and recycling

Issue reported as obstacle 1. Contacts with 19.4 14.3 customers/partners 2. Funding for 16.7 9.5 certification 3. Funding for 11.1 9.5 commercialization 4. Funding for R&D 2.8 14.3 5. High capital costs 19.4 0 6. Operating costs 5.6 4.8 7. Proof of product 11.1 33.3 8. Lack of national 0 4.8 standards 9. Lack of public 11.1 4.8 procurement 10. Regulatory 2.8 4.8 uncertainty Totals 100 (n – 36) 100 (n – 21)

WasteRenewable Renewable water and low and low carbon energy carbon energy treatment – transport – stationary 12

16.7

15

4

5.6

15

12

16.7

10

40 0 4 12 0

33.3 5.6 0 11.1 5.6

20 0 0 30 0

4

0

0

12 100 (n – 25)

5.6 100 (n – 18)

10 100 (n – 20)

while the inclusion of some older companies offers a view of early challenges of environmental ventures from a longer-term perspective than do studies of recent start-ups. Development and Funding Difficulties Reported by Surveyed Firms In the survey, firms were asked for their views on the obstacles they faced: ‘What is the biggest barrier your firm faced in 2006?’. The unprompted replies were coded and categorized for this analysis into seven types of issue, summarized in Table 2.1. From Table 2.1, we see that many firms reported a lack of finance for development but others did not view this as a current obstacle. The sectoral differences may relate to different stages of sector maturity, technology costs and stage of development of the companies. Thus capital development costs had not yet been encountered by renewables companies which were mainly engaged in research and development (R&D). But in sectors where new companies are ready to compete with established industrial companies and need scale economies to make their activities viable (pollution-prevention technologies), obtaining funds to cover capital costs was more frequently reported to be an obstacle. Among the companies with cleaner technologies and processes, 20 per cent reported that high capital costs were a barrier, a problem reported by 5 per cent of the companies with renewable and low carbon technologies for transport, most of which were still mainly at the R&D stage.

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Other sources of finance included government grants which companies reported as playing a critical role in the early development of their businesses. There was difficulty accessing bank credit because banks expected revenue streams and collateral: ‘We approached banks because we were looking to invest in capital equipment, so they might have something to secure loan against. [We] also thought we might apply for small firms loan guarantee, however banks won’t invest unless there is already an income stream to repay their loan’. Companies that had obtained venture capital raised concerns about equity dilution, early exit pressures and a loss of control by founders over their companies. They viewed investors’ knowledge of environmental technologies as deficient.14 As one respondent put it: ‘To date difficulties centred on too early stage, modest revenues and difficulty of some potential investors in supporting technology they don’t understand’. The Problem of Creating Value Recognized by Customers Barriers to market entry were also associated with R&D costs and delays (Table 2.1). Many firms with new technologies in low carbon energy are developing products such as fuel cells or urban wind machines. However, most of these technologies are not yet market ready and require further R&D. In this study, 40 per cent of such firms reported difficulties funding R&D: 30 per cent of renewables firms with transport applications reported problems of obtaining funding for R&D. Funding for commercialization of their technology was experienced over and above the need for R&D funding, since commercialization involves costly scaling up, and requires a different skill set from design. The market failure represented by information asymmetry operated in combination with entry cost barriers. Information asymmetry prevailed when innovators were in ignorance of customer needs and customers of technology potential. These small companies needed to prove to customers that their product worked, through testing, trials and endorsement, before they could attract customers. It was difficult to achieve endorsed testing and certification because of cost and lack of testing equipment and trial sites. These deficiencies in the value chain or business ecosystem denote varieties of market failure since the market was not providing facilities for which there was demand. The needs to prove their product and to pay to have it certified were the most frequently cited causes of problems to the companies in this study. Renewable energy companies cited this problem to a lesser extent. Most had products that were not yet market ready. This may have limited their awareness of testing requirements in technical assessment costs. There was greater awareness of the need for funding among pollution prevention and waste and water treatment companies, where products were nearer to market readiness. A further barrier to entry was the innovators’ inability to meet existing technical and building standards because the standards were not intended for their new designs. For environmental ventures, attracting private finance and partners was difficult without endorsed test data to demonstrate that their product was approaching certification. Only six firms cited barriers to entry from the reluctance of public sector purchasers to consider their products as an issue. But this is because the remaining companies in the study did not view the public sector to be worth approaching as customers for SMEs in the UK. Information asymmetries underlie many of the barriers to market entry. For a new

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and especially a discontinuous product, the innovator may have to prove to the sceptical customer that this will be a source of value to them. One reply identified a barrier specifically in: ‘The conservatism of the construction industry, leading to resistance to change and a very long and tortuous process between product specification and actual sales’. Until a demonstration product and trials are available it will be difficult to elicit a customer response (Aldrich and Fiol, 1994; Florin et al., 2003). Recognition of innovations by regulatory authorities or standards bodies lags behind innovations by ventures (Faulkner, 2009). The innovating new firm that proves its ability to create value depends on early-innovator customers (Rogers, 1995; Moore and McKenna, 1999). The new firm may not achieve access to such customers when oligopsonist retailers control the channels to market. These market failures do not provide opportunities for entrepreneurs. Market Failures that Impact on the Appropriation of Returns Evidence from surveys of the kind cited above is still very limited. But undoubtedly, realizing business opportunities requires scaling up to the minimum level of efficiency required for profitability. Problems of scale up are commonly underrated for innovations, even in large companies.15 Typically, only 0.05 per cent of UK venture capital investment in clean technology enterprises has been devoted to expansion (Library House, 2005). The young firm that does achieve expansion of its revenues attracts attention from imitators who may grind down the innovator’s margins before start-up and development costs have been amortized, as Schumpeter (1928) anticipated. Well-entrenched companies with traditional substitute technologies have often proved able to lower their costs on the incumbent technology faster than the new company can scale up its innovation. This is the reason for deficient markets for emerging technologies. Investors are also deterred by the prospect that a new entrant investee could not afford to fight off imitators, should companies with deep pockets infringe their patents.16 Few of the companies in the study were yet profitable. Returns were still to come, but so were expansion costs. The few environmental companies in this study citing operational costs as a problem suggests that many of these companies were immature operationally or intended to license their technology; alternatively they had not factored in the operational costs of scaling up that lay ahead. New processes are emerging, such as a new metal purification process offered by a university spin-out company, Metalysis. Such cases revealed both the potential for lowering costs and the difficulty of cost reduction without prior expansion. Information asymmetry can be remedied by learning by doing. But the ability to estimate scale-up costs for emerging technologies depends on pilot projects providing learning by doing for the industry. When short-term market incentives limit the motivation to set up pilot projects for emerging technologies this creates an obstacle to market evolution. Implications of findings for market failure explanations of entrepreneurial innovation Many of the obstacles to enterprise identified in the survey can be categorized as stemming from market failure (the absence of perfect competition together with inappropriately regulated markets). This evidence supports the traditional welfare economic view

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that market failure inhibits new entry (Pigou, 1932) rather than providing openings for new entrants (Dean and McMullen, 2007). Obstacles of this kind persist when conditions reinforce and maintain asynchronies of supply and demand. Such obstacles are prevalent in conservative, carbon-intensive sectors of heavy industry, transport, construction energy and other utilities. In these sectors, attempts at corporate venturing by large firms have so far met with failure as the incumbent firms themselves have raised the barriers to market entry and prevented the new ventures from competing effectively (for example, Shell Solar in India, E.ON Venture Partners). These obstacles explain why entrepreneurs have not played the role they have performed in other sectors. However, some gaps between supply and demand provided opportunities for the companies studied; the case profile evidence reveals how they were able to realize these opportunities. It has been recognized since the time of Say (1803) that gaps between supply and demand provide openings for entrepreneurs. This idea is overlaid by the concept of market failure drawn from equilibrium economics, which sees such discrepancies as the results of market imperfections. This use of the concept of market failure obscures an important distinction between supply–demand discrepancies that reflect structural and institutional rigidities, and the way leads and lags in supply and demand are features of the operation of market dynamics. In non-equilibrium conditions, market dynamics include supply bottlenecks that invite breakthroughs and demand delays that stimulate novel approaches. Such discrepancies between supply and demand are critical mechanisms of market evolution.17 Changes in different sectors are interlinked; thus advances in transport lead to demand for innovations in communication, and greater ease of communication increases mobility and furthers the demand for innovations in transport (Rosenberg, 1994). Entrepreneurs excel at detecting opportunities that unfold through market evolution (Nairn, 2002). But they cannot realign supply and demand where rigidities prevent innovation. To trace the way unusually innovative ventures succeeded in providing new sources of supply or altering demand, we turn from the survey to evidence from case histories that can capture perceptions, responses and feedback processes in environmental ventures. How Environmental Innovators Realize Opportunities for Enterprise While obstacles arising from market failures were revealed in the survey evidence, case histories are needed to reveal ways in which entrepreneurs addressed constraints, including market failures. Table 2.2 lists the experience of seven of our cases, each of which is summarized in a brief case profile. These cases were selected not as representative firms, but as exemplars of entrepreneurial innovation taking place in the face of a variety of market failure constraints, including the shortage of investment capital, deficient sources of new components in factor markets, barriers to consumer access and discrimination against new firms by government procurement managers. Some entrepreneurs provide innovative technologies that meet customers’ needs and simultaneously address environmental problems, sometimes taking advantage of a change in regulations that altered cost structures. These environmental entrepreneurs aimed to turn waste materials of little or negative utility into a source of value. Their emerging high-tech technologies could in the future contribute to a major shift in the current techno-regime:

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Market failure, market dynamics and entrepreneurial innovation Table 2.2

Entrepreneurial innovation among seven case study companies

Case study

Bio-fuels

EnVal

Apaclara

UK

UK

UK

x x x

x x

x x x

x x x

x x x

x

x x x

x x x

x x

x x x

x x x

x x x

x x

x x

x

x

x

x

x

Country Opportunity Newly detected Created Reconfigured Resources Newly detected Created Reconfigured Business model Reconfigured

1.

2.

3.

29

x

Power and Sun

Solar Cell

Ballard Power

Hyflux

Sri Lanka Switzerland Canada Singapore

The founder of Bio-fuels, Martin Brook, found an opportunity in the lack of market for oil wastes. The UK government announced a reduction in fuel duty on biodiesel in 2002, a change in fiscal policy that provided the potential for biodiesel to become cost competitive with fossil-based fuels in the UK. This was the trigger for Brook to see a business opportunity to address two environmental issues simultaneously. He saw from the frequent presence of drain-clearing vans that waste oil was causing expensive drainage problems at schools and elsewhere as it was not being disposed of correctly.18 Many years before, he had remarked on the potential for use of vegetable oil as a fuel for vehicles in Africa. The local school agreed to provide their waste oil to Brook since this removed a disposal problem and other organizations followed suit. Brook commissioned development work from chemical engineers on a device to improve the processing of vegetable oil for vehicle use. His initial idea was to run a fleet of buses on tax-free biofuel, but he later reconfigured his plans to aim his business at national rather than local markets. There was no market for used-drinks cartons in Western Europe, where 650,000 tonnes of this waste was disposed of in landfill sites. Composed of thin layers of a variety of plastics, paper and aluminium, such Tetra Pak-style cartons are designed to preserve freshness but create difficulties for recycling. This results in a loss of 40,000 tonnes of valuable aluminium per year, significant as landfill costs and aluminium prices are rising. Chemical engineering professors at the University of Cambridge have patented and developed a continuous prototype based on microwave-induced pyrolysis to recover this aluminium and set up a new company, EnVal, to commercialize the technology. Success in a university business plan competition in 2005 provided access to private investors who helped them commercialize their recycling process to generate industrial grade aluminium. Apaclara was founded to address deficiencies with supply of fresh waste. It aimed to use nanotechnology to extract fresh water from seawater. Globally, over 1.1 billion people lack access to sufficient drinking water, but desalination technologies are currently very costly. Apaclara’s technology will decrease the costs of

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Handbook of research on energy entrepreneurship water purification using a process known as ‘forward osmosis’ (FO), which holds the promise of lowering the energy requirements and costs for membrane seawater desalination, along with increasing source water recovery. Initial economic models comparing traditional seawater reverse osmosis and forward osmosis found the cost of water would be around 30 per cent less for FO. Apaclara’s innovative use of macromolecules generates osmotic pressure to drive a membrane purification process, but the macromolecules can be separated using a field gradient to provide pure water. The company is currently supported by development grant revenue and is working in partnership with Cascade Designs of Seattle, Washington to develop a prototype unit. Apaclara will start generating product revenue by licensing the use of its materials, but there is a longer-term opportunity to develop and manufacture high-performance systems-based materials technology developed at Bath and Bristol universities. Apaclara is establishing an entry market in military and disaster relief activities.19

If entrepreneurs who created new markets for waste illustrate the reconfiguration of resources, entrepreneurs also altered their perception of opportunity in the light of experience, thereby turning constraints to their advantage. This creative process is revealed in the next case profiles of companies that discovered new opportunities arising from the obstacles they faced: 1.

2.

3.

Entrepreneurial engineers in Sri Lanka developed an experimental solar powered water pump for the irrigation of agriculture land. When the prototypes were demonstrated to farmers, it emerged that the pump’s capacity was too small for the farmers’ water requirements. But the farmers helped the company’s founders identify their more pressing need: electricity for lighting and entertainment. The founders reoriented the business and technology to develop rural solar home systems for Sri Lanka. When civil unrest prevented the work of their sales and servicing staff, the company trained local village youth who were paid on a commission basis. The diffused rural network created by Power and Sun’s agents was to prove critical for the sales and maintenance of solar home systems in remote rural areas. The company was acquired by Shell International in 1999. In a Swiss solar cell company, the high cost of licensing a solar cell technology led the founders to use their research network to find ways to negotiate a licence on better terms. But difficulties with development work on the solar cell shifted their business idea to providing materials and services to other licensees rather than developing the technology themselves. As barriers to commercializing the licensed technology became more widely recognized, their services became less attractive. However, by then the entrepreneurs had developed competencies which could be applied to other technologies and markets. Overcoming a series of barriers led the entrepreneurs to build competencies which opened opportunities for a new solar cell product in the high margin aerospace market. Ballard Power was founded by the Canadian Geoffrey Ballard who wanted to contribute to a new energy paradigm. One means of doing so was through advances in fuel cell technology, for which defence funding was becoming available. However, this involved a long-term effort when the business needed immediate revenues. These

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they obtained from their existing lithium batteries project, on which they developed competences relevant to fuel cell technology. Over the next few years the founders diverted funds from the revenue-earning lithium battery division of Ballard into fuel cell development. When the lithium battery division required an infusion of capital to build manufacturing capabilities they were able to attract a venture capitalist whose real interest was in fuel cells. He helped the team recruit an experienced CEO and to transform their company from a contract research business into a world leader in the fuel cell industry. An entrepreneur in Singapore turned to international markets to overcome local barriers to entry (Lloyd-Smith, 2004). Olivia Lum, then a young graduate working at a multinational company, decided to address the growing global problem of a shortage of clean drinking water and at the same time remove waste water from the environment. She set up Hydrochem in Singapore in 1989 with seed capital of US$12 thousand, based on a new membrane technology to tackle and recover value from waste. But potential customers in Singapore were not attracted by an innovation supplied by an unknown producer with no track record. Lum turned to small firms in Malaysia and persuaded them that her company could deliver the value they needed, based on the precision engineering of their technology and stringent project management. Having built a reputation for reliability, the company was ready to penetrate a larger market by 1993. Lum approached friends and raised US$580 thousand as development capital for Hydrochem and an office in Shanghai. Their first customers in China were Singapore companies setting up manufacturing facilities there, but they rapidly built up business with Chinese companies. Within a decade, the company, renamed Hyflux, had been transformed from an unknown start-up to an established name in Malaysia and China. Now an international company of repute, Hyflux was awarded the tender to meet some 10 per cent of Singapore’s water needs in 2003, a project valued at around US$200 million. The company was ready for entry into the Middle East market with a strategic alliance to build a seawater desalination plant in Dubai.

Discussion The case study evidence revealed environmental entrepreneurs facing market failures that may be insuperable without the kinds of institutional and government backed change identified by Dean and McMullen (2007). Entrepreneurs do engage in lobbying to alter regulations that affect their viability or profitability and to help set up appropriate regulatory or standards bodies, as illustrated by the case profile of Hyflux. But recourse to government support is not a remedy that is distinctively entrepreneurial. Policy pressure can be exerted more easily by large established companies. The voice of the small firm is seldom heard in time-consuming government consultation processes.20 More specifically entrepreneurial is the way these firms continually readjusted their means–ends calculus to identify new means and new objectives (new resources and new opportunities), often by realigning their emergent strategies as they learned more about the regulatory and business environment.

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3

IMPLICATIONS FOR THEORY

In this section we re-examine the issue of market failure and the issue of entrepreneurial ends and means. We show that both issues are related to supply–demand discrepancies that provide opportunities for environmental innovation. Ends and Means Reassessed The case studies showed that the entrepreneurial means–ends framework is not limited to price signals as assumed in economic theories of the role of the entrepreneur (Casson, 1982; Shane, 2004). Instead as we have seen, entrepreneurs use signals other than price to explore possibilities where future value and prices are unpredictable. They identify potential uses of a neglected resource which inform them of an opportunity, while detected opportunities help entrepreneurs to recognize what could become a resource.21 This modus operandi makes them receptive to serendipity and to exploiting the unexpected.22 By reconfiguring their calculus of ends and means, entrepreneurs can reconceptualize opportunities and the means needed to realize them. Resource-constrained entrepreneurs are so often thwarted that the entrepreneurial process must encompass iterative attempts at problem solving.23 When founder–entrepreneurs cannot obtain the resources they need to implement their idea and develop the business, they revise their business model, coming up with further new ideas. This reconfiguration of ends and means to overcome obstacles is much less likely to occur in established firms where planning and budgeting follow a predetermined path and where adjustment to new circumstances takes longer to effect. Entrepreneurs’ continual reassessment of both means and ends may be an accelerated version of rational decision making as embodied in recommendations to specify the main goal to be achieved, identify and select appropriate means and pursue each of these means as subgoals to the predetermined end (March and Simon, 1958). However, intuition and serendipity often play a larger part than rational planning in effecting the experiments that give rise to entrepreneurial innovation. Further evidence confirming the experimental modus operandi of entrepreneurs is available from a variety of authors who have recognized the trial and error manner in which entrepreneurs proceed (Nicholls-Nixon et al., 2000); This mode of operation has been termed ‘strategic flexibility’ or ‘improvisation’ (Bhidé, 2000), ‘bricolage’ and ‘entrepreneurial contingency’ (Sarasvathy, 2001; Garud and Karnøe, 2003). The trial-anderror approaches of entrepreneurs involve them in continual interaction with partners who provide resources at the time when they are needed – in return for a future share in the appropriation of value to come. Through this mode of activity, the new technology firm connects itself to complementary technological developments from which it might be closed off by self-sufficiency. Investors often attempt to turn entrepreneurial ventures into managed projects, and in doing so restrain rash decisions. But controls of this kind may also reduce decisionmaking flexibility and the responsiveness of the entrepreneurial firm to gaps in supply and to shifts in market opportunity. Entrepreneurs who have decision-making autonomy can be continually alert to serendipities and involved in experiments with new solutions whereby they match resources to emerging market needs (Hugo and Garnsey, 2004).

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Market failure, market dynamics and entrepreneurial innovation Table 2.3

33

Neoclassical versus evolutionary perspectives

Neoclassical view of market failure The market allocates resources with optimum efficiency The market is automatically self-adjusting. Market power reflects consumer preferences No distinction offered between market failures that inhibit innovation and those that encourage innovation Perfect competition prevents market failure arising from externalities, information asymmetries, entry barriers, etc. Market failures can be addressed by entrepreneurs, in particular by lobbying government to ensure market competition

Evolutionary view of supply and demand asynchronies Supply and demand are continually moving out of synchrony through the leads and lags that propel market evolution Asymmetries of market power are path dependent and can prevent innovations that readjust supply and demand Asynchronies between supply and demand offer opportunities for innovation where selection forces are favourable Selection forces of the economy include market structure and power, financial conventions, institutions and regulations. Policy inertia maintains the current selection regime

Opportunities Arise from Entrepreneurial Responses to Market Dynamics Attention to supply and demand in dynamic interaction, and to rigidities that prevent change, can offer a more holistic perspective on entrepreneurial innovation than can the notion of market failure. Some have argued that environmental ventures can seize opportunities to remedy market failure by lobbying government for the institutional change needed to promote competitive markets (Dean and McMullen, 2007). Yet lobbying government is a remedy that is not distinctively entrepreneurial, and, indeed, is particularly difficult for such firms to achieve given their limited resources. In contrast, traditional welfare economics views market failures as obstacles to entrepreneurial innovation (Jaffe et al., 2003). Neither approach identifies what is distinctive about entrepreneurial innovation. Our case profiles show that this involves responsiveness to market dynamics and the ability to shift markets by introducing innovations that change the nature of supply and elicit new forms of demand. Table 2.3 summarizes the differences between the neoclassical approach to market failure and the evolutionary persective offered here. As an example of the limited perspective of the market failure thesis, externalities have been viewed as obstacles to innovation. This is because investment in new entrants may be deterred where investors do not gain exclusive returns from investment (ibid.). Externalities are a form of market failure in equilibrium economics: they represent costs incurred by, or benefits conferred on, parties other than their originators. Under the conditions of perfect competition where market failure would not occur, externalities would be avoided. However in this world of perfect competition, the new knowledge created by technical entrepreneurs would not spill over to the benefit of co-producers, suppliers, complementary producers and distributors. In theory this would suit investors who want to capture exclusive returns. But it would inhibit entrepreneurial innovation, which operates by building support through ‘spillovers’ – or benefits to a variety of parties beyond

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the firm itself. The focus on individual firms and investors inherent in the concept of externalities as market failure obscures how such open innovation processes operate. The concept of market failure offers a limited perspective on returns when it is focused on short-term returns to a specific company and its investors. This view does not recognize the way entrepreneurs operate as market makers, their innovations altering value chains, tapping into latent demand and changing flows of risk capital. The case profiles showed how entrepreneurial companies with decision-making autonomy used multiple means to match supply to effective and latent demand in new ways. The argument that there are opportunities in market failure is undermined by its underlying assumptions. If market failures were abolished, conditions of perfect competition would be in place. Information would be symmetrical between buyers and sellers, benefits would be internalized within the firm – but in consequence there would be no opportunities for entrepreneurial innovation. In neoclassical analysis of the market, preoccupation is with price and quantity of output together with consumer preference in a static context. This overlooks the forces of institutional and market power governing exchange and the transformative impact of innovation. To recognize this is to shift focus from market failure as a set of discrete obstacles to perfect competition onto the way supply and demand continually move in and out of synchrony. Accordingly, asynchronies between supply and demand provide opportunities for innovation, while asymmetrical market power and entrenched structural and institutional barriers inhibit innovation. Policy guidance is not provided by the idea that ‘market failure provides entrepreneurial opportunities’ since this cannot distinguish between market failures that encourage and those that inhibit innovation. For example, monopoly pricing as a market failure can be beaten by cost-reducing entrepreneurial innovations but monopoly control of consumer outlets constitutes a barrier to entry that is difficult for new firms to surmount. The focus should be on whether the market failure in question allows or prevents market dynamics, for it is market dynamics that offer opportunities for innovation, not market failure as such. But in consequence, the concept of market failure may be redundant for policy purposes. In brief, the equilibrium-based concept of market failure was used in this study as an analytical starting point for examining opportunities and obstacles for environmental entrepreneurs. Its limitations are tied to its equilibrium connotations. In contrast, entrepreneurs can be seen to make a key contribution to market dynamics by shifting the innovation landscape (Beinhocker, 2006), for example, by altering value chains and activating latent consumer preferences. This is the perspective of evolutionary theory, which seeks to understand the impact on innovation of selection forces (Metcalfe, 1998). These are shaped not only by market competition, but also by path-dependent institutional and cultural conditions which policy inertia perpetuates. There is scope for entrepreneurs to alter selection conditions, perhaps by lobbying government, as Dean and McMullen advocate, but more profoundly, by altering the arena of exchange. In the economy, selection is not a blind process. Economic actors – here entrepreneurs – who understand and respond to the selection forces they currently face, may alter the economy’s selection regime.24 Entrepreneurs with environmental innovations that challenge the established carbon-intensive energy paradigm can only alter market dynamics in favour of a less carbon-intensive economy once their

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innovations reap economies of scale. This study has identified many obstacles to innovative enterprises aiming to achieve this goal. They will prosper only in a regulatory regime more favourable to their growth and innovative activity. This requires institutional change ending the structural rigidities of the current selection regime that promote carbon-intensive activity.

NOTES 1. 2. 3. 4.

5. 6. 7. 8. 9. 10. 11. 12. 13. 14.

15. 16.

This applies so long as returns from the current activity of established firms are high under current institutional arrangements and their contribution to the social costs of carbon (Stern, 2006) are low (Simms et al., 2006). Investor interest in environmental enterprises in the US and the UK’s alternative market (Library House, 2005) has resulted in some very high market valuations in relation to level of business development. The Asia-Pacific Partnership on Clean Development and Climate (AP6) has been promoted as a stimulus to innovative cleaner technologies (http://www.asiapacificpartnership.org/). Criticisms by environmentalists are summarized on http://news.bbc.co.uk/1/hi/sci/tech/4602296.stm. We use terms as follows: ‘entrepreneurial practices’ constitute entrepreneurship; ‘enterprise’ is entrepreneurial activity; ‘an enterprise’ is the business founded by entrepreneurs; ‘a venture’ is an immature business (usually pre-profit). ‘Firm’ is the term for an enterprise used in economics, ‘company’ is used in legal language, ‘business’ in ordinary usage. Terms are interchanged for stylistic variety. An ‘environmental enterprise’ refers to one that pursues business opportunities in addressing environmental problems. ‘Incremental innovation’ makes step changes within existing technological approaches, which may cumulatively be very significant. ‘Radical innovations’ involve discontinuities in technology and achieve depth of impact while ‘generic technologies’ have breadth of applications. See Maine and Garnsey (2006) for further definitions of types of innovation. Venkataraman specified that entrepreneurship as a scholarly field ‘seeks to understand how opportunities to bring into existence ‘future’ goods and services are discovered, created and exploited, by whom and with what consequences’ (1997, p. 120). There are situations in which the only way to make one person better off is to make someone else worse off. In Pareto equilibrium, this point has been reached on all dimensions of exchange. By Samuelson’s (1954, p. 387) definition, a public good is one ‘which all enjoy in common in the sense that each individual’s consumption of such a good leads to no subtractions from any other individual’s consumption of that good’. It is granted by these authors that theirs is neither an exhaustive nor a mutually exclusive list of market failures. Others include spillovers (for example, unpaid for facilities), poor service or monopoly pricing. The term is at variance with ordinary usage in which a market failure refers to a firm as the unit of analysis rather than to the market as the unit of analysis. This contrast between lay usage and neoclassical terminology contributes to confusion in public discussion of related issues. DTI became BERR (Department for Business, Enterprise and Regulatory Reform) in June 2007, which has since merged with the Department for Innovation, Universities and Skills (DIUS) to become the Department for Business, Innovation and Skills (BIS) – July 2009. The cases removed because of deficient data entry in the government survey were similar in size and age to those included, resulting in a sample dataset not unrepresentative of the SMEs in the larger database. This was the dominant classification scheme used at the time. JEMU has since been subsumed into other government activities. Further information on the case studies is available in Dee et al. (2008). In support of this opinion, a recent UK study reported that very few venture capital investors have repeat investments in clean technology (Library House, 2005). Investors may be deterred from repeat investments for a variety or reasons: investments may not have performed as expected, investment opportunities may be lacking, investors may lack the experience to identify investment opportunities, or the experience of investing may highlight the need for sector-specific competences to inform clean technology investments. Investment in clean technology is still dwarfed by investment in other sectors despite recent investor interest. In 2007 energy technology investments formed 9.1 per cent of total venture capital investments in US-based companies, compared to 5.9 per cent in 2006 (Makower et al., 2008). Other examples of the costs of scale up are provided in Maine and Garnsey (2006) and in Lim et al. (2006). The company from which Apaclara originated provides an example of this (see case studies).

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17.

Metcalfe finds it inappropriate that the term ‘market failure’ is used to refer to the very features of dynamic markets that make possible innovation and renewal (Metcalfe, 2004). Waste oil is classed as a hazardous waste and requires collection in specialist containers for controlled disposal. This is a paid service which is rarely sought. Information supplied by the CEO, Dr Eric Mayes. See, for example, the dominance of large organizations and absence of SME perspectives in the consultation process undertaken by the DTI over the European Emissions Trading Scheme (http://www.defra. gov.uk/news/2006/060515a.htm). However, the recent UK Budget (2008) has recognized that government procurement could provide more opportunities for SMEs, as a result of lobbying in favour of SMEs. That entrepreneurs create opportunities as well as discovering them is recognized by writers on entrepreneurship who take a Schumpeterian rather than a Kirznerian perspective (Ardichvili et al., 2003). This requires tolerance of ambiguity in committing to a line of action and yet shifting to another if the first proves fruitless. Entrepreneurs are very diverse in personality, but need for achievement and tolerance of ambiguity are common traits (Bhidé, 2000). The analytic distinction between pre-venture (nascent enterprise) and post-venture activity in some of the entrepreneurship literature (for example, Reynolds and White, 1997) does not accommodate the extent to which opportunities arise through efforts to resource their exploitation. The pharmaceuticals and telecommunications sectors, for example, were rendered more favourable to entrepreneurial innovation by institutional and regulatory change brought about in part through the proactive behaviour of entrepreneurial ventures.

18. 19. 20.

21. 22. 23. 24.

REFERENCES Aldrich, H.E. and C.M. Fiol (1994), ‘Fools rush in? The institutional context of industry creation’, Academy of Management Review, 19 (4), 545–670. Ardichvili, A., R. Cardozo and R. Sourav (2003), ‘A theory of entrepreneurial opportunity identification and development’, Journal of Business Venturing, 18, 105–23. Beinhocker, E. (2006), The Origin of Wealth: Evolution, Complexity and the Radical Remaking of Economics, Cambridge, MA: Harvard Business School Press. Bhidé, A.V. (2000), The Origin and Evolution of New Businesses, Oxford: Oxford University Press. Carlaw, K.I. and R.G. Lipsey (2002), ‘Externalities, technological complementarities and sustained economic growth’, Research Policy, 31 (8), 1305–15. Casson, M. (1982), The Entrepreneur, an Economic Theory, Aldershot: Gregg Revivals. Coase, R. (1974), ‘The lighthouse in economics’, Journal of Law and Economics, 17, 357–76. Cohen, B. and M.I. Winn (2007), ‘Market imperfections, opportunity and sustainable entrepreneurship’, Journal of Business Venturing, 22, 29–49. Dean, T.J. and J.S. McMullen (2002), ‘Market failure and entrepreneurial opportunity’, Academy of Management Proceedings ENT, F1–F6. Dean, T.J. and J.S. McMullen (2007), ‘Toward a theory of sustainable entrepreneurship: reducing environmental degradation through entrepreneurial action’, Journal of Business Venturing, 22, 50–76. Dee, N., S.J. Ford and E.W. Garnsey (2008), ‘Obstacles to commercialization of clean technology innovations from UK ventures’, in S. Sharma and M. Starik (eds), Sustainability, Innovation and Entrepreneurship: New Perspectives in Research on Corporate Sustainability, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 97–118. Eckhardt, J.T. and S. Shane (2003), ‘Opportunities and entrepreneurship’, Journal of Management, 29 (3), 333–49. Faulkner, A. (2009), ‘Regulatory policy as innovation: constructing rules of engagement for a technological zone of tissue engineering in the European Union’, Research Policy, 38 (4), 637–46. Florin, J., M. Lubatkin and W. Schulze (2003), ‘A social capital model of high-growth ventures’, Academy of Management Journal, 46 (3), 374–84. Freeman, C. (1982), The Economics of Industrial Innovation, London: Pinter. Garud, R. and P. Karnøe (2003), ‘Bricolage versus breakthrough: distributed and embedded agency in technology entrepreneurship’, Research Policy, 32, 277–300. Hugo, O. and E. Garnsey (2004), ‘Problem-solving and competence creation in the early development of new firms’, Managerial and Decision Economics, 26, 139–48. Jaffe, A.B., R.G. Newell and R. Stavins (2003), ‘Technological change and the environment’, in K.G. Mäler and J.R. Vincent (eds), Handbook of Environmental Economics, Vol. 1, Amsterdam: Elsevier, pp. 461–516. Kirzner, I.M. (1973), Competition and Entrepreneurship, Chicago, IL: University of Chicago Press.

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Library House (2005), ‘Investment trends in U.K. clean technology. A study commissioned by the Carbon Trust’, Cambridge. Lim, L.P.L., E. Garnsey and M. Gregory (2006), ‘Product and process innovation in biopharmaceuticals: a new perspective on development’, R&D Management, 36 (1), 27–36. Lloyd-Smith, J. (2004), ‘The moisture merchant: dealing in liquid assets’, Time Magazine, available at: http:// www.time.com/time/2004/innovators/200404/story.html (accessed October 17, 2010). Maine, E. and E. Garnsey (2006), ‘Commercialising environment of advanced materials ventures’, Research Policy, 35 (3), 375–93. Makower, J., R. Pernick and C. Wilder (2008), Clean Energy Trends 2008, Clean Edge, San Francisco Bay Area. March, J.G. and H.A. Simon (1958), Organizations, New York: John Wiley. Metcalfe, J.S. (1998), Evolutionary Economics and Creative Destruction, London: Routledge. Metcalfe, J.S. (2004), ‘Policy for innovation’, ESRC Centre for Research on Innovation and Competition (CRIC), University of Manchester. Moore, G.A. and R. McKenna (1999), Crossing the Chasm: Marketing and Selling High Technology Products to Mainstream Customers, New York: Harper Collins. Nairn, A. (2002), Engines that Move Markets, New York: John Wiley & Sons. Nicholls-Nixon, C.L., A.C. Cooper and C.Y. Woo (2000), ‘Strategic experimentation: understanding change and performance in new ventures’, Journal of Business Venturing, 15 (5–6), 493–521. Penrose, E. (1960), ‘The growth of the firm – a case study: the Hercules Powder Company’, Business History Review, 34 (1), 1–23. Pigou, A. (1932), The Economics of Welfare, London: Macmillan. Reynolds, P. and S. White (1997), The Entrepreneurial Process: Economic Growth, Men, Women and Minorities, London: Quorum Books. Rogers, E.M. (1995), Diffusion of Innovations, New York: Free Press. Rosenberg, N. (1994), Exploring the Black Box: Technology, Economics, and History, Cambridge: Cambridge University Press. Samuelson, P.A. (1954), ‘The pure theory of public expenditure’, Review of Economics and Statistics, 36, 387–89. Sarasvathy, S.D. (2001), ‘Causation and effectuation: toward a theoretical shift from economic inevitability to entrepreneurial contingency’, Academy of Management Review, 26 (2), 243–88. Say, J.-B. (1803), A Treatise on Political Economy, New York. Schumpeter, J.A. (1928), ‘The instability of capitalism’, Economic Journal, 38 (151), 361–86. Shane, S. (2004), Academic Entrepreneurship: University Spin-offs and Wealth Creation, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Shane, S. and S. Venkataraman (2000), ‘The promise of entrepreneurship as a field of research’, Academy of Management Review, 25 (1), 217–26. Simms, A., D. Woodward, P. Kjell and J. Leaton (2006), Hooked on Oil: Breaking the Habit with a Windfall Tax (the UK Exchequer’s Dependence on Fossil Fuel Income), London: New Economics Foundation. Stern, S.N. (2006), Stern Review: The Economics of Climate Change, London: HM Treasury, UK Government. Venkataraman, S. (1997), ‘The distinctive domain of entrepreneurship research: an editor’s perspective’, in J. Katz and R. Brockhaus (eds), Advances in Entrepreneurship, Firm Emergence, and Growth, Vol. 3, Greenwich, CT: JAI Press, pp. 119–38.

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Prolonged gestation and commitment to an emerging organizational field: energy efficiency and renewable energy businesses in Minnesota, 1993–2009* Alfred Marcus, Marc H. Anderson, Susan Cohen and Kathleen Sutcliffe

1

INTRODUCTION

Not all businesses pass smoothly through stages of introduction, growth, and maturity, or are propelled forward by increases in sales (Porter, 1980). Some show promise but fail to take off. Some remain stagnant for long periods – neither gaining momentum nor expiring. To move from initiation to take-off, critical mass and momentum are needed, a process that can be of lengthy duration (Van de Ven and Garud, 1989). Klepper and Grady (1990) found some businesses which moved from origin to take-off in just two years while others took more than 50 years (Aldrich and Fiol, 1994). The average movement from initiation to take-off was 29 years and the standard deviation 15 years, suggesting that the range of take-off time is great (Klepper and Grady, 1990). Founders and entrepreneurs need considerable commitment if they are to succeed. Between start-up and take-off commitment is especially needed, since it is in this interval that founders may give up. Their interest wanes, they lose patience, and lack the determination and resolution to deal with setbacks. In this chapter, we consider the evolutionary pattern among energy efficiency and renewable energy (EERE) businesses, starting in the 1990s, a time when these businesses made progress but did not take off. Although EERE businesses floundered in the 1990s many of them did not give up. The question we consider is why they did not give up. While many studies of entrepreneurs exist (Shane and Venkataraman, 2000), little attention has been paid to the factors that affect their commitment to ongoing businesses that show promise but fail to fully take off. Businesses are supposed to move from introductory stages in which they overcome initial buyer resistance to growth stages when buyers rush to the market (Hofer, 1975; Porter, 1980; Anderson and Zeithaml, 1984; Hambrick and Lei, 1985). However, the duration of these stages varies from business to business. Businesses often fail to progress out of the early stages. They do not evolve from embryonic stages to more mature ones. Despite building some momentum, they do not take off. They remain in a state of persistent promise without rapid growth. The literature has yet to adequately describe businesses that are in a state of prolonged gestation (Porter, 1980; Marcus et al., 1993). A question that needs investigation is how these businesses manage while they remain in a state of ‘prolonged gestation’. Unlike other promising sectors of the time (for example, personal computers), EERE businesses did not fully take off. Some of the factors that kept them in a prolonged state 38

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of gestation were relatively low energy prices for conventional fuels starting in the 1980s, a pullback in government subsidies that occurred around the same time, and partially, as a consequence, a relatively low level of demand from consumers. Other factors were performance uncertainties, high costs, and insufficient development of infrastructure and supporting industries that might have supplied valuable inputs and assisted in manufacturing, distribution, marketing, sales and/or service. We describe the prolonged gestation of EERE businesses based on surveys of their owners and managers in Minnesota. The surveys use a cognitive approach to the study of organizational strategy (Fombrun and Zajac, 1987; Porac and Thomas, 1990; Reger and Huff, 1993). Our purpose is to elicit the mental models of the decision makers and to show how they coped with a condition of prolonged gestation by taking actions to influence significant stakeholders. These actions to influence stakeholders reinforced their beliefs about the attractiveness of their businesses, the superiority of their products and services, and the likelihood of disruptive exogenous changes. In this chapter, we also report on a survey we carried out in 2009, when this sector was more mature, which describes the current evolution of ‘green’ businesses in Minnesota.

2

ENERGY EFFICIENCY AND RENEWABLE ENERGY BUSINESSES

Population ecologists (for example, Hannan and Freeman, 1977) and industrial economists (for example, Caves, 1977) have done notable studies of industry evolution and have definitions of what an industry is, yet EERE businesses, not being a fully developed industry, do not easily fit within their conceptualizations. They are a broad and not easily classifiable group. They have developed products and services that help consumers save or replace traditional forms of energy such as oil, coal, natural gas and nuclear power. They include manufacturers of products and services that save energy in residential or commercial buildings (for example, energy efficient windows, lighting components, insulation materials and appliances); save energy in industrial processes or settings (for example, process controls, thermostats, heat recovery systems and ventilators); reduce energy use in commercial buildings or industrial settings (for example, demand-side management programs, energy audits, training and software for energy systems); and/ or produce renewable energy or alternative fuel products (for example, photovoltaic products, wind power and whole tree biomass systems). While many are new firms, others are new businesses within larger, more-established firms, but even new businesses within larger firms represent entrepreneurial ventures that are subject to similar forces that affect start-ups. Creating a simple, yet comprehensive definition of EERE businesses is difficult. What unifies them and sets them apart is that they compete with established suppliers of fossil-fuel and nuclear energy. The products and services they provide advance only at the expense of the products and services that fossil-fuel and nuclear power industries provide. Recent definitions of EERE businesses extend the category to nearly all ‘green’ businesses including those that focus on reuse, recycling, air quality improvement, greenhouse gas reduction, water improvement, and reductions in hazardous waste (Marcus et al., 2009). These definitions go so far as to include in the category of green businesses

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those that support local and organic foods and sell fair-trade products. What EERE businesses share with these other green businesses is a potential to reduce human impact on the environment. How do those who participate in these green business categories understand the field in which they are operating (Porac and Thomas, 1990)? Although there is a continuum and a wide assortment of these businesses at different stages of market evolution, most participants and observers would concur that in the 1990s the sector was still in an introductory phase of its development. Its main challenge was to convince buyers to purchase products and services that it offered. Buyers were often confused because of the many different types of products and services offered and a lack of strong quality standards. During the 1990s, it was hard to predict how these businesses would evolve. Some of the factors affecting the evolution of these businesses were (Porter, 1980): 1. 2.

3.

The cost and quality of substitute products and services Only if energy prices (fossil fuel/nuclear) were relatively high, was growth likely to take off (Marcus, 1992). Government If national and local governments failed to provide sufficient incentives, then the prospects of take-off were unlikely. Government influence was strong on such key factors as entry into the industry, competitive practices, and profitability. Government effects also were felt via procurement, environmental, product quality and safety regulation, tariffs on foreign investment, tax, and research and development (R&D) policies. Consumer demand Consumer demand had to pick up for these businesses to grow. The 1990s were characterized by uncertainty about the potential size of the market, the type of products and services that would be offered, the likely buyers and how to reach them, and whether technological advances would satisfy them.

Many obstacles stood in the way of these businesses. It was not always clear who the early adopters would be and whether product and service performance uncertainties could be reduced. Customer confusion was engendered by a variety of product offerings and service approaches. Customers also were concerned about rapid obsolescence. They reasoned that if they waited for a new generation of products and services then their needs for greater reliability and lower cost would be better met. Green businesses had to counter the doubts customers had with price and performance advantages they could not always deliver. They had to deal with other factors that deterred customers including high capital costs, high engineering and R&D costs, and high costs that customers would incur if they modified their existing processes. If a product or service was entirely new and replaced an existing product or service, the burden of proof on these businesses was especially high. Customers might not make a purchase because of unstable interest rates, the risk that expected returns over time would not match expectations, and high information and transaction costs, including lenders’ inexperience in the area (Sawhill and Cotton, 1985, p. 11). In the 1990s, established non-EERE companies that provided substitute products fought back in the marketplace with aggressive pricing. Politically, they tried to take away the subsidies that EERE businesses received from government. These companies were better able to manage price wars and had the means to invest in marketing or R&D to further differentiate their products and services. EERE products and services had a

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hard time taking off against completion from these powerful established companies. Many challenges had to be overcome if EERE businesses were to move from prolonged gestation to a more complete take-off, including: handling the problem of erratic government support, establishing a committed group of early adopters, reducing product and service uncertainties, countering continued customer doubts, halting retaliation from threatened substitutes, and overcoming image and credibility problems. Progress for EERE businesses in the 1990s was slow and uneven. They did not move forward at the same pace as other promising sectors of the era such as cell phones or video games, to give but two examples. Although poised and hoping for a take-off, they were stuck in the condition we call prolonged gestation. We conducted two studies of EERE businesses in the early and late1990s and in 2009, and did a follow-up study of green businesses. In the sections that follow we provide our observations.

3

THE EARLY 1990s

Our first set of observations comes from a survey and in-depth interviews that we conducted in 1993–94. The companies we chose for study were obtained from the Alliance to Save Energy, a national organization dedicated to promoting energy efficiency. We asked about the types of energy saved, the number of employees, and where employees were located. Sixty-six completed surveys came from 42 businesses. The survey had questions that covered the external factors that affected business success: the stability and munificence of the business environment; the extent to which key stakeholders influenced the business; and the capacity to predict and influence the actions of stakeholders. In addition questions covered internal factors which bear upon business success: perceptions about threats and opportunities, and beliefs about managerial autonomy, employee identity, and organizational strategy. A final group of questions focused on organizational performance and what the organization could do to enhance its performance: for example, collaborating with other firms and relying upon public policies to facilitate growth. Following the survey, we conducted in-depth interviews with the managers and owners of 20 businesses. The interviews took place at company locations and often lasted two or more hours. The questions were designed to gain a deeper understanding of the firms’ lines of business, customers, competitors, strategies and collaborators. We also asked about the importance and effectiveness of government policies, changes they would like to see in existing government policies, current issues they faced, and their responses to these issues. On this basis, we estimated that EERE business employment in Minnesota in 1992 totaled about 26,000 people (see Table 3.1). The average firm had 878 persons, with 245 of these employees located in Minnesota in 1992. The average 1992 sales of these firms were about $162 million. However, variation across businesses was high. About half the companies had sales under $5 million. Many still faced significant challenges from lowercost, less energy-efficient products and from customers unwilling to pay more for energy efficiency and renewable energy when the payoffs were long term. Our findings suggest that the external factor that most influenced the success of these

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Table 3.1

Energy efficiency and renewable energy businesses employees and sales, 1992

Employees/sales Total number of full-time employees 1–5 6–100 101–1000 1001–5000 >5000 Total number of Minnesota employees 1–5 6–100 101–1000 1001–5000 >5000 1992 sales (in dollars) 0–0.5 million 0.5–5 million 5–100 million >100 million

Percent 40.0 30.0 20.0 5.0 5.0 32.5 42.5 20.0 5.0 0 25.8 29.0 32.3 12.9

businesses was their customers. They felt that their capacity to influence government was limited. Representative comments included: The policy decisions (of the government) are well intentioned but misinformed. We depend on the utilities, our primary customer. Existing energy producers are firmly entrenched and have their hands deep in political pockets. Our business started by responding to federally funded audits, which we were convinced didn’t work. Subsidies are good for our business but bad for industry, e.g. solar tax credits are a boondoggle . . . customers expect freebies, and rewards create procrastination. Subsidies could facilitate growth, but most remaining solar people do not want the incentives again. It only invites flim-flam solar artists to really muck things up. Overly zealous regulation of industry in its infancy will squash it, unless done very judiciously and supportively. Regulation I’m indifferent to; the market is driven by the cost effectiveness of products. If you want to see energy efficiency grow and especially renewable energy then raise the price for conventional fuels.

The managers and owners of EERE businesses that we interviewed felt that greater benefits were attainable through private collaboration than through government

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involvement. They believed that they could achieve more from working together to solve common business problems than from trying to influence the government. To succeed, the managers and owners of these businesses felt that they had to strengthen their ties with their customers, reduce product and service uncertainties, overcome cost disadvantages, and deal with the weak and inconsistent government support which they believed was likely to persist. If these businesses could influence government, most maintained that they would benefit from tax credits, rebates for their customers, and higher energy prices. However, there was skepticism about whether government programs would be adopted and effectively implemented. From the survey and interviews we reached the following conclusions: 1.

2.

3.

4.

While managers and owners of Minnesota EERE businesses reported wide differences in distributor and supplier influences and in sales growth, they agreed that the most important influence on them was their customers. Although managers and owners of Minnesota EERE businesses thought that they might be able to gain from beneficial government policies, they felt that the hardest group for them to influence was government. Because working with government was so difficult, they felt that it made more sense to collaborate with other firms for economic purposes rather than to work with government for political purposes. The reason why they felt that it made more sense to collaborate for business rather than political purposes is that they did not believe that collaboration to influence public policy would be effective.

Many of those we interviewed had been the beneficiaries of past government programs that evaporated with changes in administration and policies. Often, their prior business models had collapsed with the withdrawal of government support. As a consequence they were leery of government. They saw other businesses come and go, to be first drawn into the sphere of EERE because of subsidies and then to abandon it when government subsidies languished. These businesses that entered because of government support did not have sufficiently strong models to compete in the market without these subsidies. They did not have superior products or services but relied instead on government to prop them up. Managers and owners of EERE businesses had pride in what they were doing and a feeling of competence. The strategy most of them followed was to provide unique, energy efficiency products and services to their customers in a timely fashion. The managers and owners we interviewed often considered themselves to be survivors with superior products and services which could stand up to market tests, as opposed to firms and businesses that had fallen by the wayside because of a withdrawal of government support. Very notable was this sense that government support could not be relied upon, that it was erratic and undependable.

4

THE LATE 1990s

We did follow-up surveys of Minnesota EERE businesses in the late 1990s. Again finding a lack of interest in government, we focused on how these businesses related to

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their customers and suppliers, the groups they considered to be their main stakeholders rather than government. The 1998 survey went to managers and owners of 878 firms that a local association called Energy Alley considered to be in EERE businesses. After removing 148 businesses from the initial sample because they no longer considered themselves to be in EERE businesses, had moved, had disconnected phone numbers, or were no longer operating, we were left with a sample of 730, from which we received 197 responses to our survey, for a response rate of 27 percent. These 197 firms employed on average 283 people and had average sales of $72 million. A few very large firms skewed these figures, as more than one-third (36 percent) of the firms in the sample had sales between $1 million and $10 million and a half had sales of $25 million or less. In terms of full- and part-time employees, more than two-thirds (70 percent) employed 50 or fewer people. Consistent with observations that we made earlier in the decade, the 1998 survey showed that participants in this sector believed that the field had potential but the potential was not being fully realized, that development was stalled and not taking place as fast as had been expected. EERE businesses were growing, but not at the pace that the owners and managers had hoped. Their businesses continued to be in a state of prolonged gestation. In our surveys we asked many questions about how the managers and owners viewed the prospects for EERE businesses, how their products and services stacked up against the competition, and the extent to which they felt that external conditions would change to improve the prospects for their businesses. The questions we analyze here are about: (i) the actions these businesses took to educate their customers and suppliers, (ii) the beliefs of the managers and owners about the attractiveness of being in an EERE business, (iii) their beliefs about the superiority of their products or services, and (iv) their beliefs about positive disruptive change. Based on answers we obtained to these questions in 1998, we attempted to determine the extent to which these EERE business managers and owners continued to be committed to the field in 2001. The dependent variable in this analysis – commitment –was operationalized using items that dealt with the level of ongoing and continued dedication and loyalty that the participants felt toward their energy efficiency and renewable energy businesses, including the extent to which the respondents saw EERE to be a core part of their product and services. We included several control variables in the analysis that could have provided alternative explanations for commitment or lack of it. Rather than continuing to maintain commitment because of the factors we hypothesized, the respondents might maintain commitment for economic reasons, including prior business success, or because of superior access to capital (Pfeffer and Salancik, 1978; Castrogiovanni, 2002), or because of their size. We mailed the 2001 follow-up survey to the original 197 businesses who responded to the 1998 survey. As with that earlier survey, we attempted to contact respondents who had not returned the second survey after roughly one month. We found that 30 of the 197 initial respondents had either sold their businesses or gone out of business. In the end, we received 100 responses to the second survey, for a response rate of 60 per cent. We assessed the non-response bias in the second survey with t-tests that showed no significant differences on study variables between businesses responding to the second survey and those that responded to the first survey. When we asked in the telephone contacts

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why some businesses no longer existed, it was usually because the entrepreneur/founder had changed personal circumstances (for example, retirement). Some had sold their businesses, which possibly indicated success (see Bates, 2005). Our analyses and findings suggested that actions, beliefs, and commitment had reciprocally affected each other (Marcus and Anderson, 2002, 2010). They were the foundations upon which cycles of increasing attachment or disengagement to the field were based. Commitment to the organizational field grew when participants took actions to educate key business stakeholders, customers, and suppliers. In the process, those involved changed their own beliefs about the emerging field and their firm’s prospects. The reciprocal influence between action, belief, and commitment was part of a positive cycle of engagement that sustained commitment to the emerging field during a period of prolonged gestation. Overall, government’s role in sustaining commitment was not strong. The managers and owners who maintained their commitment relied on each other and on their interactions with customers and suppliers to sustain their commitment. Government support was perceived to be ephemeral and not deep enough to keep their commitment going. We argue that an enactment theory in which actions and beliefs jointly determined each other in recurring patterns over time helped to explain ongoing commitment (Weick, 1979; Marcus and Anderson, 2002, 2010; Danneels, 2003). The managers and owners of EERE businesses took actions which led them to pursue uncertain opportunities. Because they were more bound to uncertain opportunities, their beliefs became a justification for the actions they took. In this way, their actions shaped their beliefs and bolstered commitment. Actions they took based on beliefs created a reality that altered further beliefs and in turn prompted them to take additional actions. Actions that they took in relation to customers and suppliers strengthened their beliefs in the opportunity’s existence. For their ventures to succeed, participants in this field which was in a state of prolonged gestation needed commitment. Tying our findings to the literature, we make the following additional observations about their commitment: 1.

2.

Commitment to a field in prolonged gestations is bolstered by the existence of new social and economic relations (Porter, 1980; Van de Ven and Garud, 1989; Garud, 1994). Rarely do participants in a field which is in prolonged gestation possess the resources and competencies to sustain commitment on their own (Garud, 1994). A community of ‘symbiotically-related’ entities (Van de Ven and Garud, 1989: 205) has to exist to support them. As Nahapiet and Ghoshal (1998) argue, they gain strength from creating and sharing knowledge in communities of mutual acquaintance and recognition where durable obligations based on structural, relational and cognitive dimensions exist. To believe that the expected value of the opportunity is large enough to compensate for the cost of forgone alternatives (Shane and Venkataraman, 2000), they need strong ties to critical stakeholders such as customers and suppliers (Aldrich and Zimmer, 1986). They must participate in the creation of a complex set of relations with these parties (Garud, 1994). The positive spinning of information increases participant commitment when a field is in prolonged gestation. People who participate must frame the information they have in a positive way and respond optimistically to perceptions of what is possible

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3.

Handbook of research on energy entrepreneurship (Palich and Bagby, 1995; Shane and Venkataraman, 2000). They need an optimistic bias (Keynes, 1936; Gort and Klepper, 1982; Camerer and Lovallo, 1999). They must believe that an opportunity is attractive, that they can see beyond conventional practice (Brouwer, 1991), and that they can set in motion or be part of events that disrupt, destroy and render obsolete established ideas (Schumpeter, 1934; Garud, 1994). In comparison with other people, they believe they have a wider horizon from which to try yet unproven possibilities (Eckhardt and Shane, 2003: 336; Brouwer, 1991). Their commitment depends on an optimistic belief that the new products and services they offer are superior; they have decisive cost or quality advantages because of innovations in technology, sources of supply, types of organization and other factors (Schumpeter, 1934; Kirzner, 1973; Van de Ven and Garud, 1989; Shane and Venkataraman, 2000). Believing that conditions will change for the better increases participant commitment when a field is in prolonged gestation. Participants in such a field have to anticipate that dynamic, disruptive, exogenous factors will alter existing economic conditions and change the current equilibrium (Brouwer, 1991). Rather than economic conditions in subsequent years being like those in previous ones, those committed to a business in prolonged gestation must believe that these conditions will change because of external shocks, disruptions and upheavals that fundamentally alter how the system works (Kirzner, 1979).

To develop a better understanding of what sustains commitments to fields like EERE during periods of prolonged gestation we believe that six propositions are worthy of further testing: Proposition 1: Participants in a field in prolonged gestation who take actions to educate and increase awareness among customers and suppliers will have greater commitment. Proposition 2: Participants who believe in the emerging field’s attractiveness will have greater commitment. Proposition 3: Participants who believe that their products or services are superior will have greater commitment. Proposition 4: Participants who believe that disruptive, exogenous changes will take place will have greater commitment. Proposition 5: Taking actions to educate and increase awareness among customers and suppliers will influence their beliefs that an opportunity is attractive, that a product or service is superior, and positive exogenous change will take place. Proposition 6: Beliefs that the emerging field is attractive, a product or service is superior, and positive exogenous change will take place mediate the relationship between taking actions and commitment.

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‘GREEN’ BUSINESSES IN 2009

By 2009, the sector we had been examining had become more mature and its nature had changed from a focus on energy efficiency and renewable energy businesses to a focus on green business more broadly conceived. The study we conducted in 2009 traces out and maps the relationships among the businesses in this sector as they matured (Marcus et al., 2009). This report was for the Mayors of Minneapolis and St Paul, the Blue Green Alliance, a labor union environmental group coalition, and the Minnesota Department of Commerce. It was part of a multi-phased process to identify the green marketplace in the Twin Cities, the Twin Cities’ strengths in this marketplace, and approaches to support its growth. It encompassed all Twin Cities’ green businesses, not just those in EERE. We compiled a directory of these businesses, carried out a market analysis based on a survey of some of them, and provided recommendations about how to stimulate their growth and development. This study identified 502 Twin Cities businesses that were in the green products marketplace. What is of interest is how the firms in this market were beginning to be organized; this was a spontaneous process, not orchestrated by much more than market forces. In the directory, there were both businesses that manufactured green products such as wind turbines and solar panels and businesses that developed and carried out projects that installed these turbines and panels. The project developers drove projects which then created workforce demand. For example, to install turbines and panels, wind farm developers and architectural design firms were hiring building contractors, cement/ aggregate contractors, and others. Businesses with services were also contributing. They included: energy auditors (such as green house gas audits or carbon foot printing), water auditors, and other consultants that provide measurement and knowledge and affect goal-setting and installation. Contributions also came from business that offered other services including research, development and product design firms that improved product attributes. In putting together the directory, we observed that the different types of green product and service businesses were closely intertwined. For example, while a platinum-level LEED (Leadership in Energy and Environmental Design) certified building was the end product and green building materials were subcomponents, the building was also dependent on service businesses such as those in: research and development, which innovated and developed building materials for insulation and energy efficiency; architectural design, which incorporated these materials and design into the building; and installation/construction, which put together the final building with green products. Another example was renewable wind-based electricity where wind turbines were the product, while the wind electricity providers offered the green service. We therefore classified green businesses in the Twin Cities into five sectors (see Table 3.2): ●

●

Manufacturing/products Companies that produced physical products with a focus on products manufactured either in a sustainable way or in a way that improved sustainability in use. Business/professional services Companies that delivered professional services, including those of architects, engineers, construction workers and installation workers.

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Table 3.2

Green business sector classification, 2009

Category

Product examples

Manufacturing/ products

Insulation Windows & doors Glass/films HVAC (heating, ventilation and air conditioning) systems and controls Lighting Wood products (FSC – Forest Stewardship Council) – Certified Alternative materials Site and landscape materials Adhesives Testing kits Neighborhood electric vehicles (NEVs) Bio-fuels engine systems (parts) Hybrid buses Fuel cells Batteries Wind turbine OEM suppliers – blades, gearboxes, other Green/biochemistry, bio-based products Architecture – LEED design Urban planning Engineering Legal – policy, intellectual property Installation (wind/solar) Construction Energy services (non-utility) Bio-fuels systems – ethanol, bio-diesel, cellulosic possibilities Solar/PV generation Wind generation Pelletization systems Distributed power systems Power distribution Geothermal – pumps Energy-efficient products Lean manufacturing and process improvements Solar-powered hot water heaters Energy management systems Sensors & diagnostic devices Waste recovery/reuse Filtration Water-use reduction Water purification

Business/professional services

Renewable energy/ utilities

Conservation/ efficiency/reuse

Water processing

● ●

Renewable energy/utilities Companies that actually produced energy, energy products, or energy transport. Conservation/efficiency/reuse Companies that recycled goods, improved process efficiency, created reusable solutions, or reduced energy consumption.

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Water processing Companies that focused on water quality, water conservation, and wastewater processing.

We found that the company category with the largest number of firms was business/ professional services (252), with the second most common category being manufacturing (145). These were followed by conservation/efficiency (46 firms), renewable energy (15 firms), and water processing (14 firms). Dun & Bradstreet revenue and employee data were then used to provide more detail, albeit with certain qualifications regarding the use of these data. First, most small, start-up, or private firms were not in that database. Second, there was no simple way to distinguish green from non-green product and service revenue and employees. Third, it was difficult to separate uniquely from non-uniquely Minnesota revenue and employees. Finally, some companies spanned multiple sectors and were represented more than once. For example, 3M Filtration and Donaldson had businesses in both the manufacturing and water-processing categories. With these limitations in mind we researched the green directory firms in Dun & Bradstreet and found that the 105 companies with publicly available data generated more than $33 billion in revenue in 2008. Manufacturing ranked first in revenues, followed by water processing, business/professional services, renewable energy/utilities, and conservation. The employment data showed a similar pattern. Estimated employment levels were highest in manufacturing, while water processing and business/professional services were second. The Dun & Bradstreet data suggested that though the number of business/professional firms was greater, they contributed less to revenue and employment. Instead they played an important and essential supporting role. For further analysis we focused on these two sectors – manufacturing and business/ professional services. We divided the manufacturers into several groups and found that insulation/building materials firms comprised 41 percent of the companies, bio-based products 18 percent, other-unclassified 14 percent, batteries 7 percent, HVAC systems 6 percent, and filtration systems and supplies 4 percent. The subsector percentages for business/professional services were: construction, 33 percent; architecture, 24 percent; engineering, 17 percent; other, 16 percent; energy services, 6 percent; finance, 2 percent; and education, 2 percent. Among the companies in the directory, the dominant focus was in the following areas: building, insulation, construction, and engineering. Bio-based companies were also prominent. Insulation and building materials had a strong foundation with large players such as 3M, BASF, Cardinal Glass and Anderson Windows along with smaller companies such as Gempak, Styrotech and Xerxes. These companies produced a range of products from windows and window coatings that improved efficiency to insulation products and roofing systems. With regard to bio-based products and green chemistry, traditional agricultural-based companies such as Cargill had an interest because these products increased the value of agricultural products; 3M because the products integrated nicely with the company’s chemistry expertise; Ecolab because demand was rising for more eco-friendly chemical products; and Aveda because of its desire to sell more eco-friendly cosmetic products. Bio-fuels and renewable energy also were a big part of the Minnesota landscape. Minnesota had agricultural products useful for biofuels and great resources in wind generation. Many companies focused on biofuels – Global Ethanol, BioCee and Argus Bio-Fuels to name but a few. The young innovative companies in this sector

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included firms such as Segetis, Nature-tec and BioCee. Filtration also was well established and it had the potential for growth. 3M, Donaldson and Pentair were also active, and several medical device companies not included on our list had had years of experience developing battery technologies. To conduct a market analysis, we sent out 352 online surveys to an email address of firms that were likely to be selling green products and services. We received 115 survey responses for a 33 percent response rate. The surveys were sent to the best contact address we had available, usually a CEO or an environmental officer but occasionally to a general email address listed on a company web page. The firms that responded were smaller and more focused on exclusively green products and services than those in the full directory. The firms that responded to the survey reported that they had an average of 16 employees per firm who were working in the green product and service area and that 75 percent of their revenue came from green products and services. A few findings from the survey especially stood out: ● ●

the respondents expected that the three-year growth in employees in the green product and service areas would average about 207 percent; and they expected that the average revenue increase in their green product and service businesses would be 297 percent in the next three years.

The answers we received were just a start for further analysis, but clearly suggested that the respondents believed that their companies were ready for take-off. The managers and owners of the businesses we surveyed no longer perceived themselves to be in a state of prolonged gestation. As indicated, building, insulation, construction and engineering were dominant among the firms in our directory so it is not surprising that over 53 of the surveyed firms were involved with LEED certification or had LEED accredited staff who worked for them. Many of the other firms in the directory were involved in one way or another with certification bodies. For example, many companies were involved with the Energy Star and the MN Green Star programs. Table 3.3 shows the level of certification among the companies surveyed. Certification appears to be an important force in creating momentum for an emerging green market place in Minnesota. The 2009 look at green businesses revealed a sector much closer to take-off than the one we observed in the 1990s, but whether actual take-off would occur was still being determined. Progress had been made regarding how the sector was organized. Concentrated in buildings and construction, it appeared to be as much driven by certifying bodies as by government. A greater degree of organization was striking, particularly with regard to the following: 1. 2. 3.

relationships among the manufacturing and service companies and project developers were high; the activities of large and well-established players as well as start-ups were considerable; and the strong role of certification schemes such as LEED was pronounced.

In the absence of reliable government support, the conclusion might be drawn that businesses had organized themselves into a more coherent constellation of entities

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Green sector certification data, 2009

Number of companies 53

Certifications

4

USGBC/LEED (US Green Building Council) Energy Star from EPA/DOE MN Greenstar *NABCEP (North American Board of Certified Energy Practioners) ISO 14000 family certifications

3 3 3 3 2

Forest Stewardship Council (FSC) Green Seal GREENGUARD Regreen Program *AIA Committee on the Environment

2

Global Reporting Initiative (GRI) G3 Reporting Green Advantage *Green Format Green Label (from Carpet and Rug Institute) *IGSHPA NAHB Green Building Program 1% for the Planet *BPI Biodegradable Products Institute Building Performance Institute (BPI) *Designers Accord *Passive Haus Universal Design Certified Remodeler (UDCR) UPonGREEN Design for the Environment (DfE) from EPA Environmentally Preferred Rating (EPR) Scientific Certification System (SCS) Green Building Certifications

22 14 5

2 2 2 2 2 1 1 1 1 1 1 1 0 0 0

51

Website http://www.usgbc.org/ http://www.energystar.gov/ http://www.mngreenstar.org/ http://www.nabcep.org/ http://www.iso.org/iso/ iso_14000_essentials http://www.fsc.org/ http://www.greenseal.org/ http://www.greenguard.org/ http://www.regreenprogram.org/ http://www.aia.org/practicing/groups/ kc/AIAS074686 http://www.globalreporting.org/ http://www.greenadvantage.org/ http://www.greenformat.com/ http://www.carpet-rug.org/ http://www.igshpa.okstate.edu/ http://www.nahbgreen.org/ http://www.onepercentfortheplanet.org/ http://www.bpiworld.org/ http://www.bpi.org/ http://www.designersaccord.org/ http://www.passivhaus.org.uk/ http://www.nari.org/news/article. asp?ARTICLE_ID=654 http://www.upongreen.com/ http://www.epa.gov/dfe/ http://www.epraccredited.org/ http://www.scscertified.com/ http://livegreenlivesmart.org/certifiedprofessional/trainingindex.aspx

LEED (See USGBC) Note: *Not tested by survey, but added by respondent in ‘Other Certifications’ field. Had we listed this certification on our survey we may have received more responses for it.

that had a better chance of take-off after being in a state of prolonged gestation for many years. Would government stimulus money provide the additional nudge (Thaler and Sunstein, 2008) that these businesses needed for further development? If so, how would this be implemented? Or would lack of government support again

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disappoint EERE businesses and inhibit their additional development? Only time will tell.

6

JUMPSTARTING GREEN BUSINESSES – TIES TO RECENT LITERATURE

It has been a long road for the EERE businesses in Minnesota. At one time they were treated or could be treated separately, but now they are more likely to be incorporated into a broader category of green companies in which various governments at different levels in the US and in other countries throughout the world are showing renewed interest. From struggling in a state of prolonged gestation, EERE businesses are starting to achieve increased recognition and attention if not growth. Again there is hope that they will take off. What further action might still be necessary for them to make more progress? In this conclusion, we provide insights from recent academic literature that may have a bearing on the findings. First, for businesses such as those in the EERE sector to take off they must overcome institutional fragmentation (Marcus and Fremeth, 2009). Theoretically, this may be conceptualized as a collective action problem (Olson, 1965) for which Axelrod’s (1997) solution assumes a type of spontaneous self-organization that reduces or eliminates the need for hierarchy. However, for this solution to be realized a number of special conditions must be in place: relationships must be repeated, the number of players set, the choices binary and somewhat simple, the pay-offs fixed and known in advance, and the players’ moves simultaneous. The players must be rational, self-interested and well-informed, and they must be able to recognize the moves of the other players and have access to the history of the other players’ moves. If these assumptions are relaxed, as shown in numerous experiments and field studies (Ostrom, 2000), institutional fragmentation can persist. Although fragmentation can ultimately be mitigated through ‘dialectical processes’ involving many events over an extended period (Hargrave and Van de Ven, 2006), their persistence can have depressing effects on the development of a business field such as EERE and green businesses more generally. The number and type of supporting organizations needed for these businesses to take off can be quite large and the relationships among these organizations complicated. Mitchell and Welch (2009) list some of the different types of supporting organizations that might be needed: ● ● ● ● ● ● ●

public agencies; quasi-public and public–private ventures; private for-profit and non-profit organizations; task forces and councils; trade offices and/or technical and business assistance organizations; eco-industrial and green business parks; and green zones or incubators.

The activities in which these organizations engage are many. They include providing for consumer education, creating forums for business networking, establishing standards

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for quality, certifying products and services, funding, facilitating supply chain development, engaging in workforce improvement, building reputation and a green brand, attracting dedicated venture capital, and facilitating flexible manufacturing. How many of these organizations have to be in place and what are the optimal ties among them? Which of these activities are most critical? Research by McEvily and Marcus (2005) suggests that the ties among these organizations that are needed in order to facilitate the diffusion of sustainable capabilities are joint problem solving, fostered by trust and information sharing, all of which take time to develop. Second, for businesses to move from prolonged gestation to take-off, positive feedback loops among supporting organizations have to be greater than negative feedback loops. Jacobsson and Bergek (2004) have detailed the conflict between the positive feedback loops (which they refer to as ‘inducement mechanisms’) and the negative feedback loops (‘blocking mechanisms’) in the context of wind and solar energy development in various European countries. Factors that block progress and prevent momentum include market uncertainty, lack of legitimacy, opposition from incumbents, and inconsistent government support. Conflict between inducement and blocking has characteristics such as: ●

●

●

●

●

●

A system that guides and constrains the actors. Within this system, there are firms – primary users and suppliers, providers of services such as engineering, legal and accounting, and financers such as banks and venture capitalists. Other entities take on additional roles such as educating customers and carrying out research and development. Networks among the actors that transfer tacit and explicit knowledge about what is possible and how the future might look. These networks provide venues for knowledge creation and can provide cluster advantage if strong knowledge exchange mechanisms exist. These typically require the presence of effective supplier–customer alliances, licensing agreements, and/or research consortia (Arikan, 2009). Formal institutions of norms and rules that guide, direct and govern behavior. These determine whether interorganizational knowledge exchange can evolve into distinct and effective problem-solving tools. Whether this happens depends on how the institutions are governed, whether they are decentralized and cooperative and have a foundation of dense social ties (Silicon Valley and Route 128 Boston), or whether they are formal hierarchical, and centralized (Bell et al., 2009). Protected niches that overcome cumulative blocking factors. These form spaces where critical exploratory work can be done, testing is possible, and experience is accumulated. Within these niches, sector specialties and subspecialties thrive. Coalitions which campaign for the niches and associated subspecialties. They create positive media images so that citizens are supportive and government subsidies and regulation forthcoming. Chain reactions of success breeding success. Some start-ups enjoy success and stimulate more start-ups. Funding grows. Customer acceptance sets in. The pool of labor expands, and it becomes more qualified and easier to attract.

Jacobsson and Bergek (2004) suggest that long time spans might be needed before green businesses really take off. An underlying wave of market and technological opportunities by itself is insufficient for the blocking factors to be overcome and the field to grow.

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Third, the problems of institutional fragmentation and positive feedback loops point to limitations in governments creating the conditions necessary for take-off. With respect to green commerce in a state of prolonged gestation opposing logics in governments and markets must be harmonized if take-off is to take place (Marcus and Geffen, 1998). Government–market interactions yield unintended consequences, channeling and directing the paths that adoption of sustainable business practices take in surprising ways. York and Lenox (2009) show that in the case of green buildings, government incentives by themselves did not provide sufficient stimulus for take-off. The effectiveness of the incentives rested on a rich set of institutions including ones that were quasi-public and public–private, for-profit and not-for-profit organizations that provided technical and business assistance. These institutions included the American Institute of Architects, the US Green Building Council, and the LEED Accredited Practitioner Program. Fourth, although governments alone may not be able to induce take-off, they can be influential with regard to venture capital (VC) funding (Bürer and Wüstenhagen, 2008). One of the most important factors in preventing venture capitalists from investing in green businesses is perceived risk. Hence, consistent government support over time in the form of regulatory devices, tax incentives, investment credits, public equity, renewable energy goals and standards can lower the perception of this risk. Bürer and Wüstenhagen argue that the German Electric Feed-In Law of 1991 had an especially strong impact in guaranteeing a preferred rate for selling electricity generated in alternative ways. This helped kick-in a virtuous cycle of volume increase and cost reduction. Recognizing the important role of government, Bürer and Wüstenhagen maintain that some VC firms try to influence legislation and in other ways engage in active risk management vis-à-vis government and other VC firms diversify their country and technology portfolios and in other ways engage in passive risk management strategies vis-à-vis government. Fifth, more-advanced firms are likely to relate differently to the opportunity to forge voluntary agreements with governments than less-advanced firms. Delmas and MontesSancho (2010) find that the more-advanced firms which make substantive improvements in their behavior join cooperative ventures with governments such as the US Department of Energy’s Climate Challenge Program earlier than firms mainly interested in the symbolic benefits of this type of arrangement. Sixth, the burden on entrepreneurs to construct markets in nascent fields remains high. Santos and Eisenhardt (2009) detail the difficult tasks in which successful entrepreneurs have to engage in order to construct markets in emerging fields such as EERE. Santos and Eisenhardt understand nascent fields to be those that are incompletely defined and lacking primary definitions about matters as elementary as markets and dominant action logics. Hence, there is great ambiguity, which means that outcomes are hard to predict and development costs largely unknown. To be successful, entrepreneurs must take decisive action, much of it at the symbolic level, to fill this void. In a number of indepth and thoroughly researched case studies Santos and Eisenhardt show that successful entrepreneurs have to engage in processes of claiming, demarcating and controlling market spaces. Mostly they do so by means of alliances and exercising soft power and subtle persuasion to influence the behavior of others in ways that are favorable to them. Seventh, the relationship among incumbents and new entrants is critical in shaping emerging fields such as EERE. Hockerts and Wüstenhagen (2009) describe a dynamic in new green businesses in which high echelon innovation at levels of ‘breakthrough’,

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‘creative destruction’, or the ‘next industrial revolution’ may take place among startups, while incumbent firms respond initially to green challenges by optimizing current business models and tightening up existing systems to improve efficiency. Once start-ups create future market spaces and carve out new customer demand, incumbents switch direction and are apt to follow. Start-ups are not held back by a concern about cannibalizing present business models and are more focused on single issues, which gives them a head start. However, the incumbents are often quick to catch up as they are fast-followers who soon introduce copycat products. The Hockerts and Wüstenhagen argument suggests that the interplay between start-ups and incumbents can provide a dynamic that pushes fields from prolonged gestation to take-off. Eighth, the relationships among incumbents and new entrants are shaped by different types of supporting institutions. Sine et al. (2005) describe the challenge of field emergence as hostile criticism and skepticism from financial backers, suppliers, customers, the general public and employees. Hence, to increase entry and facilitate start-up formation, regulative, cognitive and normative changes have to take place. Otherwise perceived risk will overwhelm the sense of perceived reward. Sine et al. find two processes of legitimization. General institutions legitimate an entire sector and stimulate start-ups across the entire range of the field, but their effect is especially felt among start-ups with novel technologies, while trade-specific institutions legitimate the existing sector of incumbents and established technologies. Ninth, external stakeholders similarly relate to and exert influence on different factions within green firms. Delmas and Toffel (2008) find that when it comes to an environmental demand like ISO 14001, which strongly affects a firm’s relationship with its customers, marketing departments are most likely to become mobilized, but when it comes to an environmental demand like a voluntary agreement with a government agency, legal departments are most likely to become mobilized. Finally, in new fields such as EERE, the extent to which natural capital (the availability of resources such as the wind or the sun) or social movements influence organizational decision making is in dispute. Russo’s (2003) empirical analysis of wind energy generation in California found that an abundance of wind, along with other social and economic factors, determined the rate at which wind projects were undertaken in different locations in California. In contrast, Sine and Lee’s (2009) empirical analysis of wind projects across different states in the US found that large-scale social movements were the main influence on behavior. Social movements help to solve the collective action problems wherein organizations from many sectors must cooperate for new fields to gain traction and take off. They influence governments, consumers, and potential employees and help propagate new cognitive frameworks and norms. Overall, their impact is greater than the existence of high-quality and abundant natural resources such as wind on entrepreneurial behavior in this field.

NOTE *

The original research discussed in this chapter was funded by the McKnight Foundation. Later research discussed in the chapter was funded by the Blue Green Alliance, the cities of Minneapolis and St Paul, and the state of Minnesota. Sincere thanks and immense praise must be proffered to Kevin Triemstra and

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Handbook of research on energy entrepreneurship David Miel whose excellent work was critical for the success of the latter project. The views in this chapter reflect those of the chapter’s authors and should not be construed as representing those of any of these prior funding agencies.

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Entrepreneurial learning in energy technology start-ups: a case study in the biogas market Petra Dickel and Helga Andree

1

INTRODUCTION

Among renewable energy sources the biogas industry has grown at an above-average rate and seems to be particularly promising (Institut für Energetik und Umwelt, 2008). Compared to other energy sources, biogas is still in its infancy. Developing innovative technologies that increase quality and productivity of biogas applications is crucial to keep pace with the fast market development and to achieve competitiveness within the renewable energy sector. However, the commercialization of innovative energy technologies bears considerable risks as both technological and market uncertainties exist. Also, the turbulent environment of renewable energy companies requires that innovators adapt fast to new market conditions and trends. It is argued that a learning-based strategy is particularly appropriate to reduce uncertainty (Lynn and Akguen, 1998) and to cope with environmental turbulence (Glazer and Weiss, 1993). So far, learning research has concentrated on established companies, ignoring the fact that the context of new technology-based firms differs in several aspects (Dickel, 2008). First, start-ups are more prone to failure due to the liabilities of newness (Stinchcombe, 1965) and smallness (Freeman et al., 1983). Typically, new ventures not only lack resources and access to customers and other network partners but also have to deal with legitimation problems (Stuart et al., 1999). Second, technology start-ups often struggle to gather relevant market information as critical knowledge tends to be latent (von Hippel, 1986; Lettl, 2004), is known by only a few people (Zucker et al., 2002) and is thus hard to capture. At the same time, it is crucial to gain and implement market know-how to develop marketable products and to stay abreast of competitors so that the question remains how new ventures should approach this dilemma. Finally, technology-based ventures can often enter different markets with a single technology (Shane, 2000; Ardichvili et al., 2003). However, market attractiveness in terms of volume and profitability of potential applications can differ significantly, so that the decision about which target market to enter is crucial for the venture’s future development and growth (Ardichvili et al., 2003; Riesenhuber, 2008). Accordingly, in contrast to established companies that operate in well-defined markets, new technology-based firms first have to evaluate and define relevant target markets before concentrating on specific business segments (Veryzer, 1998). The case of a biogas innovation is used to analyze the specifics of entrepreneurial learning. Basically, learning in energy technology start-ups does not differ significantly from learning in other technology-based ventures. However, uncertainty and environmental turbulence are particularly distinct within this industry. Uncertainties exist with respect to technological feasibility of the innovation and its future market 58

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acceptance. For instance, users’ lack of experience in product usage of innovative product solutions may result in rejection or at least hesitant adoption (Lettl, 2004). Energy companies also have to cope with high turbulence. During recent years, an increasing number of new firms have entered the energy sector, particularly within renewable energy markets. Simultaneously, a variety of new technological developments have taken place, among others spurred by forthcoming legislation policies such as the German Renewable Energy Act (Institut für Energetik und Umwelt, 2008). Changing market structures in terms of internationalization and conglomeration of firms lead to further ambiguity. Learning poses a major challenge in such a context as changes occur so quickly that information collected at an early stage may be inaccurate or obsolete at the time of a new product launch (Bourgeois and Eisenhardt, 1988; Dickel et al., 2007). Few studies were published before 2000, but entrepreneurship research has recently paid increasing attention to entrepreneurial learning (see Dickel, 2008). Despite broad empirical evidence on the positive effects of learning in new ventures (for example, Peters and Brush, 1996; Zahra et al., 2000, 2007; Yli-Renko et al., 2001), deeper insights into learning in ambiguous contexts are rare. Case studies indicate that learning in innovative projects demands broader information search (O’Connor, 1998) and a rather iterative approach (Lynn et al., 1996). However, as those studies build on data from large, established firms, the findings might not hold for new ventures that cannot afford to spend scarce resources on lengthy learning processes. Above all, only few researchers differentiate between different learning activities (Zahra et al., 2000, 2007). but conceptualize learning on a rather general level (for example, Autio et al., 2000; Nicholls-Nixon et al., 2000; Almeida et al., 2003; Saemundsson, 2005). This relatively static view of learning fails to acknowledge that learning consists of different subprocesses that fulfill different functions (Huber, 1991; Day, 1994). For instance, knowledge acquisition revolves around the question where and how to find relevant information, while knowledge integration primarily concerns coordination and communication tasks within organizational boundaries (Huber, 1991). Also, significant differences exist with respect to the acquisition of tacit and explicit knowledge both regarding complexity and costs of knowledge transfer (Nonaka, 1994; Zander and Kogut, 1995) that so far has not been adequately addressed in entrepreneurship research. Moreover, start-ups typically face different challenges in the course of their development and growth (Ndonzuau et al., 2002; Vohora et al., 2004) that may require different learning strategies to deploy time and resources efficiently. Disregarding those differences entails the risks that scarce resources are wasted, misinterpretations may occur and ventures follow inappropriate market opportunities and fail. We argue that learning should be uncompacted in order to get insights into the effect of different learning processes in the course of new product development. To capture the differences between tacit and explicit knowledge, learning is split between personal knowledge acquisition (gaining privately held knowledge by closely interacting with people) and codified knowledge acquisition (gaining information from impersonal, codified sources). As those two learning processes refer only to knowledge acquisition, we further include knowledge integration to capture the degree of knowledge implementation within the company. This study analyzes which of these learning processes reduces innovation barriers during two development stages, namely technology development

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and the commercialization of an energy innovation. Thereby the study extends learning research as it not only takes into account the specific learning context of new ventures but also sheds light on the effect of learning in different development stages of an innovation. Furthermore, it provides evidence on the effectiveness of different learning activities in the course of time. Start-up founders and managers can benefit from this uncompacted view as it provides guidelines about where to focus learning efforts and resources according to specific context requirements. The remainder of the chapter first gives a theoretical overview on entrepreneurial learning and the concept of innovation barriers and then develops propositions on the relationship between different learning processes and innovation barriers. Finally, the case of a biogas technology venture and its learning activities during technology development and commercialization is presented and analyzed.

2

ENTREPRENEURIAL LEARNING

Learning can be described as ‘a process of improving actions through better knowledge and understanding’ (Fiol and Lyles, 1985, p. 803). Knowledge is the result of learning and can be distinguished in explicit and tacit knowledge. Explicit knowledge can be codified in the form of language, numbers, symbols and figures and is therefore easy to transfer (Zander and Kogut, 1995). Tacit knowledge, on the contrary, depends on context and person, cannot be articulated and is difficult to transfer (Polanyi, 1958; Nonaka, 1994). In the last two decades, learning has become a major topic, particularly in knowledge management (for example, March, 1991; Nonaka, 1994) as well as organizational and strategic management (for example, Cohen and Levinthal, 1990; Huber, 1991; Lane and Lubatkin, 1998). Empirical findings showed that learning fosters new product success (Ottum and Moore, 1997; Li and Calantone, 1998; De Luca and Atuahene-Gima, 2007), innovation (Hurley and Hult, 1998) as well as business performance (Sinkula et al., 1997; Lane and Lubatkin, 1998; Li and Calantone, 1998). Recently, a growing interest in learning can also be noted in entrepreneurship research (see Harrison and Leitch, 2005; Zahra et al., 2006). Entrepreneurial learning generally describes how new ventures learn about their business and environment. Studies showed that new ventures profit from key customer knowledge acquisition (Yli-Renko et al., 2001; Presutti et al., 2007), technological learning and knowledge integration (Zahra et al., 2000), and informal learning methods (Almeida et al., 2003). So far, research on entrepreneurial learning is heterogeneous and fragmented (Zahra et al., 2006). Few studies differentiate between different learning processes of new ventures (for example, Zahra et al., 2000) but analyze learning on a rather general level (for example, Autio et al., 2000; Nicholls-Nixon et al., 2000; Almeida et al., 2003). This view fails to acknowledge that learning involves various subprocesses (Huber, 1991; Day, 1994) and thus risks that different roles that learning plays in the course of product development might be ignored. In this chapter, entrepreneurial learning is modeled as a multi-stage process consisting of knowledge acquisition and integration activities (Day, 1994; Zahra et al., 2000). Knowledge acquisition describes how start-ups gain knowledge from their environment, while knowledge integration refers to the implementation of information and

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P1a / P4a (–)

P1b / P4b (–)

Internal Innovation Barriers

P2a / P5a (–)

Codified Knowledge Acquisition P2b / P5b (–)

P3 / P6 (–)

External Innovation Barriers

Knowledge Integration

Note: P1–P3: technology development stage; P4–P6: commercialization stage.

Figure 4.1

Theoretical framework

know-how within the company. In order to capture the differences between tacit and explicit knowledge, we distinguish between personal and codified knowledge acquisition. Personal knowledge acquisition refers to transferring information and skills that are closely connected to other persons, that is, mainly tacit knowledge, and hence necessitate close personal cooperation (Nonaka, 1994; Peters and Brush, 1996). Codified knowledge acquisition, on the contrary, refers to collecting information from codified sources that are independent of other persons (Daft and Weick, 1984). Several concepts have been proposed to structure and analyze the process in which innovation takes place (see Hauschildt and Salomo, 2007). Brockhoff (1999) describes the innovation process as a four-stage model that comprises research and development, commercialization, diffusion and continuous improvement. This chapter focuses on the two early stages of innovation, that is, technology development and commercialization. For each stage, we investigate whether the different learning processes enable innovation barriers to be overcome. Innovation barriers are any factors that lead to prevention, delay or distortion of the outcome of the innovation process of an organization and can be differentiated according to their origin in internal and external barriers (Mirow et al., 2008). Internal barriers refer to organizational hindrances such as lack of resources and skills or intraorganizational communication and coordination problems (Bitzer, 1990; Wildemann, 2006). External barriers describe challenges that occur in interorganizational exchange situations, such as customer acceptance of new product solutions and market entry barriers in terms of access to complementary technologies, sales channels and suppliers (Walter and Gemuenden, 2000; Bond and Houston, 2003). The study’s research model is summarized in Figure 4.1.

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3

ENTREPRENEURIAL LEARNING IN THE TECHNOLOGY DEVELOPMENT STAGE

Personal Knowledge Acquisition In the context of new technology-based ventures, relevant technological and industry knowledge is typically not publicly available but concentrated on only a few people (Zucker et al., 2002). Close interaction is necessary to access and transfer this tacit knowledge (Nonaka, 1994). As personal knowledge acquisition builds on the face-to-face exchange with external partners, it supports the access to tacit technological and market know-how. The close interaction not only allows the transfer of unique knowledge that is difficult to imitate (Spender, 1996; Lane and Lubatkin, 1998), but it also increases the probability that relevant knowledge is recognized more quickly (Cohen and Levinthal, 1990). Valuable information and skills can be collected from various sources such as users, suppliers, investors, scientific institutions or independent industry experts (Gemuenden et al., 1992; Leonard-Barton, 1995). For example, a close contact to research institutions provides the possibility of exchanging on scientific issues and jointly working on technological challenges that occur during new product development. With respect to potential investors, an early and close exchange helps to convince them of the benefits of the business concept, to smooth out potential misunderstandings and to quickly resolve open issues. Closely interacting with investors not only provides know-how on requirements in raising capital and ensuring that funding is quickly approved, but it also facilitates networking by gaining access to an investor’s typically broad network of policy makers and industry experts. Likewise, potential investors benefit from cooperating with founders as they are interested in the rapid implementation of innovative products as well as minimizing the risk of product failure in order to secure their return on investment. Despite its benefits, personal knowledge acquisition is both cost and time consuming (von Hippel, 1998) which can pose a challenge for the resource-constrained new ventures. However, we believe that a positive effect of personal knowledge acquisition prevails as it provides access to rare technological know-how and skills, as well as financial and other material resources, and thus helps to reduce internal innovation barriers. Proposition 1a: A high extent of personal knowledge acquisition reduces internal innovation barriers during technology development and thereby fosters new product development of energy technology ventures. External innovation barriers may exist in terms of market acceptance, market legitimation or other market entry barriers. In particular, embryonic technologies are characterized by uncertain environments (Lynn et al., 1996; Herstatt, 2003) in which ambiguity about potential target markets prevails (Veryzer, 1998). In these contexts, user needs are mostly latent, difficult to articulate and can hardly be captured by traditional market research (von Hippel, 1986). However, identifying user requirements and market trends during technology development is crucial to evaluate how the technology fits to specific target markets and to estimate the market potential in terms of prospective sales and income – data that are not only required by investors but also form the basis of a sustainable business concept.

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Personal knowledge acquisition from industry experts leads to deeper insights into potential target markets, as these can provide detailed information on prospective users, reliable suppliers, current competitor activities and market trends. As close interaction with external partners stimulates the intensity of knowledge exchange between partners (Yli-Renko et al., 2001), industry experts may also facilitate contact with first customers and other relevant business partners. Even the identification of lead users, that is, innovating users that experience needs for a product innovation much earlier than the majority of users in a market (von Hippel, 1986) may be facilitated. As lead users are able to articulate product requirements that the broader market has not experienced yet, they can be an important source for understanding latent, future user requirements (von Hippel, 1986; Lilien et al., 2002). Industry and technology experts can also be valuable sources for evaluating technological potential with respect to market fit and give advice on market and technological opportunities and threads. Moreover, closely interacting with external partners may aid access to opinion leaders in specific technological areas which in turn can provide valuable know-how and legitimation in the marketplace (Stuart et al., 1999). Thus, personal knowledge acquisition enhances the probability that start-ups gain valuable, tacit market know-how, and establish relationships more easily with relevant business partners so that a weakening effect on external innovation barriers can be expected. Proposition 1b: A high extent of personal knowledge acquisition reduces external innovation barriers during technology development and thereby fosters new product development of energy technology ventures. Codified Knowledge Acquisition In contrast to personal knowledge acquisition, codified knowledge acquisition refers to collecting information independent of other people through codified sources (Daft and Weick, 1984; Peters and Brush, 1996). Accordingly, codified knowledge acquisition only enables us to gather knowledge that is publicly accessible, for example from the internet, professional journals and research publications, or that can be traded, such as market research data. The benefit of codified knowledge acquisition lies in its efficiency because acquiring information from codified sources is less costly and requires less time and effort (Zander and Kogut, 1995). Codified knowledge acquisition is also more effective as it enables us to easily condense, store and transfer an even larger amount of data (Hansen et al., 1999) at a lower cost than personal knowledge acquisition. However, due to the higher transferability of explicit knowledge, information acquired from codified sources is of less value since other parties could also access the knowledge (Lane and Lubatkin, 1998). Among others, codified knowledge acquisition allows a broad scanning of technological developments, for example by researching and analyzing patent databases and scientific publications. Also, the search for potential investors and funding is facilitated as the internet provides a comprehensive information source for public and private funding programs. Thereby codified knowledge acquisition allows us to gather relevant data in a cost-effective way so that a weakening effect on internal barriers can be expected.

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Proposition 2a: A high extent of codified knowledge acquisition reduces internal innovation barriers during technology development and thereby fosters new product development of energy technology ventures. Learning from codified sources may also reduce external innovation barriers. Trade associations or the Chamber of Commerce can, for example, be used to gather data on market characteristics and trends as well as economic, political and legal conditions of potential target markets. Thus, founders can gain a broad overview on potential markets and acquire comprehensive market data at comparatively low cost that could eventually be used for target market evaluation. Furthermore, potential users, suppliers, industry experts and other business partners can be identified, for example by searching internet directories. Thus, information deficits both on market characteristics and potential network partners can be reduced by acquiring data from codified sources. Although these data are explicit and therefore less valuable, a diminishing effect of codified knowledge acquisition on external barriers can be expected because of the breadth of market knowledge that can be transferred and the cost benefits implied in this learning strategy. Proposition 2b: A high extent of codified knowledge acquisition reduces external innovation barriers during technology development and thereby fosters new product development of energy technology ventures. Knowledge Integration In order to become effective, knowledge gained needs to be integrated within the firm (Grant, 1996). Knowledge integration refers to the internal process of knowledge distribution, interpretation and use (Zahra et al., 2000) and as such focuses mainly on internal rather than external barriers to innovation. Accordingly, we only discuss how knowledge integration helps to overcome internal innovation barriers. Knowledge integration ensures that information gained from various knowledge sources is combined and evaluated within an organization (Daft and Weick, 1984; Day, 1994). This is required as the environment of early-stage technologies is often ambiguous (Lynn et al., 1996; Herstatt, 2003). Learning in ambiguous contexts demands a thorough interpretation in order to make sense of the manifold and sometimes even contradictory data (Dougherty, 1990). Prospective markets could, for example, be analyzed by gathering data on user needs in specific target markets and matching those with the technology’s benefits. However, in the case of embryonic technologies, the question of how a technology fits to customer requirements often poses a challenge (Bond and Houston, 2003). Due to missing or unclear data, it can be difficult to define which target market is suitable for a specific business and thus may easily lead to false conclusions. A detailed assessment is required to weigh up inconsistent data and gradually make sense of what has been learnt (Day, 1994). Moreover, not all of the knowledge that is acquired by personal or codified sources is equally relevant for a company’s business activities. Redundant information may exist which necessitates a classification and filtering of information to separate relevant from irrelevant data (ibid.). In contrast, a rash acceptance of information and jumping to conclusions may result in incorrect decisions. For example, not all requirements that are

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articulated by potential users correspond to overall market needs (Brockhoff, 1997). All in all, a thorough interpretation of information is vital to prevent misunderstandings and to derive at internally agreed and well-founded business decisions. Proposition 3: A high extent of knowledge integration reduces internal innovation barriers during technology development and thereby fosters new product development of energy technology ventures.

4

ENTREPRENEURIAL LEARNING IN THE COMMERCIALIZATION STAGE

Personal Knowledge Acquisition Commercialization implies finalizing new product development, selling the product to first customers and getting market feedback – both in terms of customer acceptance and competitor reactions (Hauschildt and Salomo, 2007). At this stage, additional funding is often needed to finance prototyping, market tests or launch supporting sales and marketing activities. Regular face-to-face interaction helps to deepen relationships with investors as well as to extend founders’ networks to additional financing sources which in turn facilitates required funding acquisition. Moreover, network partners can serve as a valuable knowledge source for technological, production and legal know-how (Gemuenden et al., 1992) by providing information on innovations, technological trends and amendments. Ventures that closely collaborate with, for example, users or suppliers can improve their output by detecting and remedying defects in the production process at an early stage, thus realizing cost-cutting benefits (Thomke and von Hippel, 2002). In particular, information advantages of social networks result from the faster access and transfer of current and high-quality information (Burt, 2000; Adler and Kwon, 2002). Face-to-face interaction enhances the acquisition of current know-how as information does not have to be specifically prepared and allocated in storage systems as is the case for learning from codified sources (Rothwell and Robertson, 1973; Dickel et al., 2007). Personal knowledge acquisition thereby supports the implementation of stateof-the-art know-how that may lead to competitive advantage. Due to this quality and time advantage in transferring relevant know-how as well as the prospective chances of obtaining additional funding, we assume that personal knowledge acquisition reduces internal innovation barriers at the commercialization stage. Proposition 4a: A high degree of personal knowledge acquisition reduces internal innovation barriers during commercialization and thereby fosters new product development of energy technology ventures. A number of benefits also arise from personal knowledge acquisition regarding external innovation barriers during commercialization. Above all, successful commercialization requires that user needs are incorporated into new product development (von Hippel, 1986). Joint development activities with customers, for example in the form of joint market tests or pilot studies, lead to gaining detailed customer insights and accessing the

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rather tacit components of customer needs (Lettl, 2004). The close interaction with users also supports the early detection of innovation deficiencies so that costly product adaptations can be avoided or at least reduced (Thomke and von Hippel, 2002). Moreover, faceto-face interaction with users is vital to get feedback on product features and the usage situation, which is key to achieving customer satisfaction and loyalty (Woodruff, 1997). With respect to network partners other than customers, valuable insider know-how on market characteristics and trends can also be allocated from industry and technology experts (Gemuenden et al., 1992). For example, close interaction with opinion leaders within an industry or a technology field not only helps in getting a foot in a specific target market but also provides external visibility and credibility and thus increases legitimacy in the marketplace (Stuart et al., 1999). Accordingly, personal knowledge acquisition provides valuable user and market know-how, access to non-material sources such as reputation and goodwill, and thus helps to reduce external barriers to innovation. Proposition 4b: A high degree of personal knowledge acquisition reduces external innovation barriers during commercialization and thereby fosters new product development of energy technology ventures. Codified Knowledge Acquisition As in the technology development stage, scientific publications and patent data also serve to obtain technological know-how during commercialization. Founders could, for example, scan databases and journals on the latest technological developments as well as on complementary technologies that can be used for new product development. Besides getting technological know-how, codified sources can provide data on funding possibilities for prototyping and launch support. As codified knowledge acquisition enables a broader search for information at lower cost than personal knowledge acquisition, current technological developments and potential investors can be identified while the use of scarce venture resources is kept within reasonable bounds. Therefore, we expect that internal innovation barriers that occur at the commercialization stage would be reduced by codified knowledge acquisition. Proposition 5a: A high degree of codified knowledge acquisition reduces internal innovation barriers during commercialization and thereby fosters new product development of energy technology ventures. Although deeper insights into latent customer needs and tacit industry experience cannot be gained from codified sources, codified knowledge acquisition may provide information on user characteristics, such as demographic data, product portfolios of competitors as well as on political and legal restrictions. Li and Calantone (1998) point out that competitor information plays a crucial role for benchmarking activities. Competitor information can be gathered by internet research, for example by scanning competitor internet sites and online user reports on competitive products. Also, annual reports and sales material, in which new product announcements, product designs and technical details are published, can provide a valuable source of information. With respect to supplier information, data on available products and components can be obtained from

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online and print media sources, providing information on product offerings as well as on contact data for a possible personal approach. Finally, codified knowledge acquisition might be useful to scan for market actors. Thereby, the identification of potential business partners, industry experts and key actors in specific target markets is facilitated, which offers the chance of establishing relationships with external partners more quickly. Altogether, codified knowledge acquisition allows comprehensive data on customers, competitors, suppliers and other potential business partners to be gathered. Although only explicit data can be gained, a weakening impact of codified knowledge acquisition on external barriers is assumed due to its high effectiveness and broad scope of knowledge transfer. Proposition 5b: A high degree of codified knowledge acquisition reduces external innovation barriers during commercialization and thereby fosters new product development of energy technology ventures. Knowledge Integration Thorough knowledge integration is required during commercialization, too, to gain clarity on what has been learnt. For example, market tests may produce a wealth of data on product strengths and weaknesses, usage situations and overall user acceptance. To be able to implement these findings in new product development, founders need to sort, combine and evaluate the information to separate relevant from irrelevant data. Likewise, redundant and/or contradictory information may result from competitor scanning and benchmarking activities. Furthermore, different industry experts can have conflicting views on market segments and trends that require the information provided to be filtered and weighed. Information integration during the commercialization stage of innovative products typically takes place by trial and error, whereby project activities are evaluated step by step (Lynn et al., 1996; Ravasi and Turati, 2005). Lynn et al. (1996) refer to this as ‘probe and learn’. Probe and learn connotes an iterative process, in which a company enters a test market with early product versions or prototypes (probe), gets experience on product usage and acceptance (learn), applies this knowledge for product adaptations and conducts further tests with the revised product or prototype to gain new insights (ibid.). An advantage of this iterative procedure is that founders can successively gain clarity on market conditions and risks. Thereby the innovation can be optimized step by step, which is less laborious than making major product adaptations once in a while. Also, it increases the chance of meeting market requirements and satisfying user needs as feedback is continuously incorporated into product development. A disadvantage of probe and learn is that it is cost and time consuming to develop probes, conduct tests and develop probes again and again. Due to scarce resources, this may pose a significant challenge for new ventures. However, as a thorough evaluation of acquired knowledge is vital to separate the wheat from the chaff, we assume that the advantages of iterative knowledge integration prevail. Proposition 6: A high degree of knowledge integration reduces internal innovation barriers during commercialization and thereby fosters new product development of energy technology ventures.

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5

INNOVATING IN THE BIOGAS MARKET – THE CASE OF TENIRS

To test the propositions on entrepreneurial learning during technology development and commercialization, a case study approach is used. We analyze the case of a new energy technology company that launched an innovative sensor technology for biogas market application. Before the case is described, a short introduction to the biogas market is given to illustrate the function and benefits of the new technology. The Biogas Market in Germany In 2007, renewable energy sources accounted for around 9.8 percent of total energy supplied in Germany, mainly stemming from biomass energy (72 percent), wind power (17 percent) and hydropower (9 percent). Biogas as part of biomass energy only accounted for 7 percent (Bundesministerium für Umwelt, Naturschutz und Reaktorsicherheit, 2008). Incentives to use natural biomass energy sources, cogeneration of heat and power and innovative technologies were set in the Renewable Energy Sources Act from 2004, which led to a strong increase in biogas plants – from 850 in 1999 to 5,260 in 2007 (Institut für Energetik und Umwelt, 2008). The biogas industry has faced radical changes in recent years – both politically and economically. The Renewable Energy Act 2009, for example, again sets stronger incentives for small- and medium-sized biogas plants, and after raw material prices increased dramatically in 2007 they are currently at rock bottom. For the profitability of biogas production, four main factors play a role: the investment cost for the establishment of a biogas plant, raw material costs of the ferment substrates,1 operation costs of the plant and the amount of biogas production. The professionalism of biogas plant construction and operation has increased strongly during the last few years, driven by the growing interest of national and international investors. Technical advances in particular came from measurement and control technology, for example, in the field of substrate feeding or stirring unit application. However, compared to other renewable energy sectors, for example, wind power, the biogas industry is still in its infancy and requires further innovative technological solutions to make the production process more stable and efficient. The fermentation process within biogas plants, for example, resembles a black box, and therefore is difficult to control. This eventually may lead to suboptimal gas exploitation or even plant breakdowns if dysfunctions in the fermenter are not detected in time. So far, there is no method that allows biogas production to be maximized and at the same time costly plant breakdowns to be prevented. This would require a continuous and reliable measurement and control of substrate mixture within the fermenter and to have mechanisms in place that allow automatic adjustments of substrates if necessary. The following subsection describes how TENIRS offers a possible technological solution to this problem.

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measuring head fiber optic

NIR-detector

lamp

sapphire absorption reflection substrate Figure 4.2

Basic principles of NIRS technology

TENIRS – Company Background and Technology TENIRS GmbH was founded in 2006 as a spinoff from the University of Kiel. The core technology of the start-up is based on near-infrared-spectroscopy (NIRS) technology. Figure 4.2 illustrates the basic principle of NIRS. TENIRS is a sensor-based, chemometric technique comprising spectra recording equipment and calibration on the basis of reference analyses. The NIRs technology offers numerous advantages compared to conventional methods: quick, non-destructive measurement in real time, continuous measurements, unlimited sample size, no sample preparation, no consumption of chemicals, versatile calibration (individual analytes, derived properties), high measuring accuracy and long-term stability. The constant measuring process enables continuous process monitoring and optimization. As a result, the user has the potential to cut costs dramatically by using resources more efficiently and automate process control. Potential product applications of TENIRS range from agriculture, renewable energy (biogas) to the food industry. For example, farmers using TENIRS could determine the appropriate nutrient content for an optimal liquid manure fertilizer and adjust the amount of liquid manure during application accordingly. Also, biogas energy is a prospective target market for the innovative sensor technology. The process of biogas production is very sensitive as there are many factors that could negatively affect gas formation. Dysfunctions in the production process often result due to overcharge, wrong feeding or inhibitors; sometimes plant breakdowns may occur, causing considerable costs and loss of production. To prevent such dysfunctions it is necessary to determine

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the ingredients and energy content of substrates. Since the substrates are highly heterogeneous, measurement results may differ with respect to the specific measurement point. Accordingly, there is a high risk of obtaining an unrepresentative sample and not detecting potential dysfunctions. This risk can be minimized by TENIRS, which continuously measures the substrates2 within the fermenter and thus enables control of the biogas production process. Methodology A case study approach is used to investigate entrepreneurial learning in energy technology start-ups. Yin defines a case study as ‘an empirical inquiry that investigates a contemporary phenomenon within its real-life context, especially when the boundaries between phenomenon and context are not clearly evident’ (Yin, 2003, p. 13). Hence, the fine structuring of this method allows the collection of data that cannot or can only partly be captured by standardized questionnaires. Entrepreneurial learning at an earlyventure stage is a complex process that is influenced by various factors, so that a qualitative approach seems to be appropriate. A holistic single-case study design as described by Yin is applied. Among others, Yin recommends the early development of theoretical propositions that are used as guidelines for data collection and interpretation and thereby differs from pure inductive approaches such as grounded theory (for example, Eisenhardt, 1989). The analysis compares and contrasts entrepreneurial learning in the technology development and commercialization stage of the innovation. For each stage, the situation in terms of the organization, technology development status and network is described, followed by a discussion of the internal and external innovation barriers, the start-ups’ main challenges, key learning activities and lessons learnt. The case study builds on longitudinal data from the two measurement periods. In each stage, founders were interviewed on the background of their company, activities and key challenges. Due to their role and involvement in the innovation process, they were able to tell the story of the sensor development and launch, describing target markets, network relationships and problems that occurred in the different stages. Moreover, network partners that were involved from the early-venture stage were questioned on the development and performance of the innovation and founders’ business activities. The interviews with founders and partners lasted from one hour to over three hours. Secondary data in terms of newspaper articles, technical reports and internet publications were used to supplement and validate key informant data. The Case of TENIRS during Technology Development In the technology development stage, the founders still worked as a researcher at the university and a project manager in an IT company, respectively. The idea of the new sensor technology stemmed from various research projects at the Institute of Agricultural Engineering of the University of Kiel in which one of the founders was involved. Founders’ long-term research experience and benchmark studies confirmed their notion that NIRs was a promising technology with unique benefits for process measurement. Due to the founders’ academic background, they could rely on a large scientific network.

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Close cooperation with the research institute and other scientific partners provided access not only to valuable technological know-how and skills but also to technological resources. Among others, TENIRS was able to use part of the institute’s research equipment which led to a massive cost reduction. Despite their strong scientific network ties, relationships outside academia were rather loose. Industry contacts mainly came from the agricultural sector since the institute had a long history of collaborative research projects with manufacturers of agricultural machinery and equipment, and farmers. A prototype for the online measurement of liquid manure fertilizer already existed and the founders were keen to obtain feedback on the technical functionality, capability and economic efficiency of the product. The innovation also found broad recognition outside the university and was awarded first prize for the best business idea in northern Germany. Despite the rapid advances in product development, uncertainty existed with respect to potential customer response, that is, whether farmers or other potential users in agriculture would use their sensor for liquid manure measurement as well as which features they expected from the sensor. Furthermore, the founders were vaguely aware that their technology could be used for various applications but knew little about the market potential of prospective target markets. Besides the well-known agricultural sector, the founders had only few connections to other industries. As one founder put it: ‘We were proud of the technological advances of our innovation but hardly knew where and how to sell it’. To gain further market insights on how the technology fit to market requirements a preliminary market study was carried out. First, internet data and technical publications were used to gather information on market size, current product solutions and technological developments of potential competitors in the prospective target markets. This data helped us to obtain first market characteristics and insights on competitor activities. Among others, it became apparent that food technology was less attractive for TENIRS as competitive intensity in this industry was rather high with many similar technologies already in place. By contrast, agriculture and biogas production showed favorable market entry characteristics, both with respect to competitive situation and technological benefits of the innovation. However, the market study left questions unanswered, such as on specific user requirements and needs in the two remaining target markets. Therefore, potential users in agriculture and biogas production were contacted and interviewed about what they thought of the innovative product solution. From these insights it became more and more clear that agriculture, that is, the industry the founders initially focused on, poses some severe challenges for market entry. In particular, user feedback on the product benefit of measuring liquid manure composition and the willingness to pay a price for such a product was disappointing. ‘There is a German saying “what the farmer doesn’t know, he won’t eat”’, as one of the founders remarked, ‘which basically describes customer reaction to our sensor’. On the basis of these new insights, the founders realized that operator and producer of biogas plants benefited much more from the sensor than was the case in agriculture, because increased competition in the biogas market required putting a greater emphasis on the efficiency of biogas production and exploitation. User feedback from the interviews was also analyzed at a business plan workshop for academic entrepreneurs in which the founders participated. ‘There were people with different backgrounds, from various industries at the workshop’, one of the founders

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explained, ‘discussing the benefits and disadvantages of our technology for the different markets helped us to sort out our ideas on which users we should focus’. Another outcome of the business plan workshop was that the founders got access to a broad network, particularly to business partners in industry, institutions and finance. Through the new contacts, they were able to find a potential investor to finance their outstanding new product development efforts. Summing up, major barriers during technology development stemmed from uncertainty about relevant target markets and the definition of the core business concept with respect to potential customer needs. Although less prominent, internal innovation barriers mainly existed in terms of scarce financial resources for product development. At this stage, the founders benefited in particular from personal knowledge acquisition to overcome external barriers. Connecting and exchanging information with experts from different industries strongly supported identifying suitable markets for the innovative technology as those professionals had a broader view and deeper insights into market-related issues than the technology-oriented founders. Personal knowledge acquisition also helped to overcome internal innovation barriers. Primarily, it was the founders’ business network from which the first investor contact was initiated. Moreover, their scientific partners provided technological resources, such as research equipment, which significantly reduced development costs. For missing technological know-how the founders relied on both their scientific network as well as their own enquiries in scientific publications. Furthermore, codified knowledge acquisition also facilitated the reduction of external innovation barriers. The findings of the market study, for instance, were a valuable basis for narrowing down market opportunities. However, it was the personal customer interviews that finally threw light on where to prioritize when selling the product. Thus, a mixture of codified and personal knowledge acquisition is promising at the technology development stage, as the first process allows a broad market overview to be acquired at low search and transfer costs while the latter enables customer needs to be further investigated. With respect to knowledge integration, joint discussions with technology and industry experts helped to sort out ideas and evaluate potential markets from different angles. Accordingly, a weakening effect of knowledge-integrating activities on internal innovation barriers, such as communication and interpretation barriers, can also be supported. The Case of TENIRS during Commercialization The commercialization stage of TENIRS was primarily characterized by setting up the business in terms of company registration, employee recruitment and so on and above all, testing and launching the product in the biogas market. New product development in this stage was much more concentrated and focused on satisfying the needs and requirements of biogas plant operators and producers. In order to gain deeper market insights, two pilot studies with potential users were initiated. ‘We wanted to prove that the sensor holds what we promised, to get direct feedback from users on the product features and to quickly remedy deficiencies of the prototype.’ As shown by the founder’s statement, legitimation in the marketplace was one of the main concerns at this stage. The founders knew that the demonstration of functionality and advantages of the sensor was critical. As long as the technology lacked proof of concept, that is, could not demonstrate observable, concrete benefits, it would be difficult to find any customer.

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Associated with external legitimation, the search for further strategic partners became a key challenge. Besides the still strong scientific network, commercial partners mainly came from the institutional sector, such as investors, biomass clusters and associations. However, network ties to potential customers and suppliers were rather weak. At this point, founders profited from their existing relationships built up in the technology development stage, as they were able to gain access to new contacts through this network. As some partners were acknowledged technology and industry experts, they helped to convince key players in the biogas market of the sensor’s benefits. Thereby, they not only provided legitimation for the start-up but also enabled founders to get a foot in the door of potential customers and further investors. Among others, through their personal network, a seed fund financing in terms of a silent partnership was established that covered a large part of the start-up’s capital requirements. Testing the prototype at the two pilot users was a first step to extending the network to customers. Both contacts to pilot users were established from the founders’ scientific network. Due to the founders’ technological expertise and the expected benefits of the sensor technology, users agreed to participate in the tests as well as to bear part of the prototype development costs. Results at the end of the testing phase were satisfying. Both pilots stood the test and confirmed an increase in productivity in biogas plants by using the sensor technology. The joint product development with pilot users not only helped to cover the prototyping costs but also to dramatically cut down overall hardware costs. This cost reduction was a critical step for market acceptance as customer feedback indicated that estimated market pricing was far below the initial prototype costs. Furthermore, additional calibration data were gained from the tests which led to an optimization of the overall measurement model. Also, a new measuring head was designed that was lower in maintenance, easier to retrofit and included additional features demanded by customers. With those adaptations the hardware was transformed into a more compact design. A further outcome was that the two plant manufacturers involved in the pilot study announced their interest in cooperating with TENIRS, and thus offered to set up a strategic partnership with large companies that were already established in the biogas industry. By implementing user feedback and testing the revised prototype, founders were able to market their product without having to make major adaptations after the launch. However, the prototype was changed only twice to integrate customer feedback rather than a series of probes and revisions as advocated by probe-and-learn theory. One founder remarked: ‘We certainly could have made further product adaptations before launch, but time was running out so we launched the product after implementing only main customer requirements and hoped that this would do for the overall market’. He continued: ‘But even if we had more time, I doubt if we would have had more development rounds since our financial resources were really limited’. In addition to the pilot study, founders scanned the biogas market for competitors that were developing or already offering similar products. Searching the internet brought only minimal and superficial information on competitor products and technologies. Instead, users from the pilot study and network partners from the biogas industry were a valuable source of information. Their statements indicated that existing products were not yet able to continuously measure and adjust substrate mixture. However, technological developments of other companies aimed at launching similar product

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solutions. Although those were still in the development stage and TENIRS was highly competitive due to its technological advantages in online measurement, the founders realized that timing was crucial to succeed in the marketplace. To realize first-mover advantages their network to commercial partnerships had to be extended. Among others, founders considered cooperating more closely with a hardware supplier as such a partnership would offer the chance for diversification and to achieve economies of scale. Moreover, biogas plant manufacturers, particularly those that offered complete solutions, were considered as prospective partners because of their high interest in optimizing their support and service functions. Cooperating with those manufacturers would provide both access to a large customer base and legitimation in the marketplace. Furthermore, they would profit from the exchange of technical and industry know-how as well as the financial strength of established manufacturers which would make up for their own scarce resources. Summing up, internal innovation barriers mainly derived from financial weaknesses for prototype development and new product launch, while major external barriers concerned market legitimation, user acceptance and time-to-market. Again, strong evidence for the weakening impact of personal knowledge acquisition on both internal and external barriers was found. Among others, TENIRS’ scientific network significantly helped to overcome innovation barriers, especially with respect to credibility of product benefits and functionality. Close interaction with external partners also helped in accessing further investors and gaining additional funding as well as establishing relationships with first customers, suppliers and strategic partners. For instance, contact with pilot users was established with the support of the venture’s scientific network. TENIRS strongly profited from integrating these pilot users into their product development. The personal interaction provided not only instant and detailed insights into user requirements but also information on competitive product solutions and current market trends. Furthermore, the joint development with users helped to radically cut down prototyping and hardware costs. Thereby, founders were able to reduce pricing to a competitive market price. As well, proof of concept was demonstrated by the pilots which was a vital step in improving user acceptance and gaining market legitimation. Finally, the interest of two large plant manufacturers was attracted in the course of the pilots, offering a promising avenue for future strategic partnerships. All in all, personal knowledge acquisition strongly paid off for TENIRS during commercialization. In contrast, collecting data from codified sources was less fruitful. Not only was the study unable to demonstrate that codified knowledge acquisition reduces internal barriers at the commercialization stage, but the results even indicate that this learning strategy might involve some severe drawbacks with respect to external innovation barriers. Both user and competitor information gained from internet sources was very superficial, to a great part obsolete and only marginally reflected actual market characteristics. Without the insights the founders gained from their network partners and the pilot tests, the risks of misinterpreting market requirements would have been rather high. Moreover, the study could only partly support the contention that knowledge integration reduces internal innovation barriers. Contrary to codified knowledge acquisition, the findings indicate that knowledge integration plays a supporting role during commercialization, which is shown by the two product adaptations that resulted from user feedback. However, although the implementation of customer know-how took

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place in a stepwise manner, probe and learn occurred only to a limited extent. This can mainly be accounted for by the cost- and time-consuming process that is involved with repeated product adaptations. In the case of TENIRS, this persuaded the founders to take the risk that their innovation did not fully satisfy market needs. However, this risk was minimized as a great part of customer feedback as well as ideas from network partners were incorporated into product development, which supports our initial proposition.

6

SUMMARY AND IMPLICATIONS

The study strongly supports the idea that learning processes differ according to context. Both relevancy and effectiveness of different learning processes vary at different stages of the innovation process. Table 4.1 summarizes the study’s findings. Among the learning processes that were analyzed in this study, personal knowledge acquisition plays an outstanding role. Founders strongly benefited from close personal interaction during both technology development and commercialization as it not only allowed a deeper understanding of market characteristics and requirements but also facilitated access to a broader network that provided further know-how, resources as well as external legitimation. In contrast, the role of codified knowledge acquisition is less clear-cut. In the technology development stage, learning from codified sources proved useful for obtaining complementary technological know-how as well as an overview of potential target markets which enabled a winnowing out of less prospective applications. However, during commercialization it did not add to further insights either into technologies or into users and competitors and thus failed to reduce innovation barriers. With respect to external barriers at the commercialization stage, the findings even suggest that codified knowledge acquisition is counterproductive as the Table 4.1

Case study results Dependent Variable

Technology development stage

Commercialization stage

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Independent variable (proposed effect)

Internal innovation barriers

External innovation barriers

Personal knowledge acquisition (–) Codified knowledge acquisition (–) Knowledge integration (–) Personal knowledge acquisition (–) Codified knowledge acquisition (–)

P1a supported

P1b supported

P2a supported

P2b partly supported

P3 supported

–

P4a supported

P4b supported

P5a not supported

Knowledge integration (–)

P6 partly supported

P5b not supported (indication of reverse, i.e., positive effect) –

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information acquired can be outdated and misleading. Furthermore, empirical results indicate that comprehensive knowledge integration is key to overcoming internal innovation barriers and thereby advancing product development. This especially concerns the technology development stage which is characterized by uncertainty regarding the fit of the technology to different market requirements. Here, discussing and analyzing the information gained from people of different backgrounds strongly helped to decrease the complexity and ambiguity of information. During commercialization, knowledge integration also played a role in terms of implementing new know-how from pilot studies and network partners. However, although stepwise knowledge integration was observed in the case, probe and learn took place to a lesser extent than expected, which can be accounted for by the start-up’s limited time and resources. Thus, multiple iterations during new product development as described by Lynn et al. (1996) seem to be less characteristic for new technology-based ventures that can neither build on large resource endowments nor risk being outpaced by competitors and losing first-mover advantages. Thus, a combination of personal and codified knowledge acquisition and knowledgeintegrating activities can be recommended to overcome innovation barriers during technology development. While codified knowledge acquisition enables us to get a broad view of prospective target markets at comparatively low costs, and personal knowledge acquisition allows us to dig deeper to gain tacit market insights, knowledge integration is required to filter out irrelevant data and strongly sets the course for further product development. However, the combination of those learning processes does not pay off during commercialization. Contrarily, codified knowledge acquisition during commercialization is ineffective if not counterproductive. Although the findings suggest a positive impact of knowledge integration at this stage, innovation barriers can primarily be overcome by personal interaction. Personal knowledge acquisition reveals a prominent effect at the commercialization stage that can be compensated by neither knowledge integration nor codified knowledge acquisition. From a managerial perspective, the findings indicate that a broad and comprehensive market scanning and use of multiple learning methods are favorable during technology development. Among the different learning processes, personal knowledge acquisition has the most prominent role in both stages. Results underscore the necessity to establish relationships from an early stage, as the close interaction with external partners enables valuable know-how to be gained that otherwise could not be. Internet data and other publications could complete insights, for example, by delivering general information on potential target markets. However, codified information sources do not pay off during commercialization as deeper insights could only be gained by face-to-face interaction. Accordingly, energy technology ventures should systematically search for external partners with complementary know-how, build up close relationships with those and transfer and implement the partners’ know-how in their business activities. Early integration of users is recommended in order to obtain know-how on user requirements and needs as well as feedback on early product versions. Furthermore, founders should intensify relationships to industry and technology experts to facilitate evaluation of market opportunities and risks, acquire marketplace legitimation and achieve multiplier effects by external promotion of the technology. Moreover, thorough interpretation of new information is vital to advance new

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product development. Rather than jumping to conclusions, founders should systematically analyze and evaluate data. In this respect, multifunctional teams could be set up with people from different backgrounds, such as, for example, technical and commercial professionals. External partners should also be included in the innovation process as this supports information interpretation from different angles and fosters critical evaluation of what has been learnt. Open communication within the start-up can be fostered by establishing a culture that inspires constructive dialogue. Moreover, founders can analyze new market and technological information by discussing it with external professionals, for instance by attending industry meetings and symposia. This study is not without its limitations. First, gathering data from personal interviews may involve informant bias which could result in distorted results (Ernst, 2003). In order to minimize the risk of a possible informant bias, a multiple key informant approach is used. Key informants from the start-up and its network partners were chosen according to their appropriateness in hierarchy, function, and involvement as recommended by Ernst. As well, secondary data from various publications was consulted to confirm and complement key informant statements. Furthermore, analysis is based on data from a single case study. Among others, critics point out that case studies are less precise and can hardly be generalized (see Yin, 2003). As this study builds on one single case, its generalizability is certainly limited. However, the objective of case studies is less to produce generalizable results and rather to gain deep insights into complex relationships. As learning is inherently dynamic in nature, relevant knowledge, for example, may change over time, longitudinal data on such complex issues are difficult to capture by quantitative studies that need to abstract and generalize in order to make prescriptions. Overall, quantitative studies bear the risk that significant relationships are overlooked or underestimated due to missing and less detailed data, so a qualitative approach seemed appropriate in our case. While this case study builds on data from the biogas industry, we believe that the results hold not only for energy technology start-ups but also for other technology-based ventures. Accordingly, we recommend that future research create and test data for other industries to see whether the results generalize. Furthermore, researchers could analyze entrepreneurial learning from a dyadic or network perspective, that is, the learning processes between a start-up and its partners. Among others, research could focus on the role of relationship factors in interorganizational learning between asymmetric partners. In this respect, studies could also investigate how new ventures could reduce the risk of unwanted knowledge spillovers to large external partners and thereby complete our current understanding of entrepreneurial learning. Finally, the case study illustrates that learning processes differ, not only with regard to the acquisition of tacit and explicit knowledge, but also regarding their relevancy in different development stages. Briefly, learning does not equal learning, which calls for a differentiated approach to entrepreneurial learning. This implies that future learning research should both break down learning into subprocess and take context into account. Otherwise, a general and oversimplified approach to learning risks missing counterproductive and/or misleading tendencies that might result from learning processes, so that founders may derive false conclusions that hinder successful product development and waste scarce venture resources.

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NOTES 1. The majority of substrates used are animal excrement, for example, liquid manure from cows and pigs. However, the introduction of Nawaro-Bonus in the Renewable Energy Sources Act from 2004 led to a strong decrease of those substrates which are increasingly being replaced by the so-called Nawaros, that is, renewable raw materials such as sweet corn and grain. 2. TENIRS enables a broad measurement of different substrates; besides prevalent substrates it allows the measurement of dry substance content and the corresponding acids, which so far are difficult to measure online.

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PART II INTERNATIONAL ENERGY ENTREPRENEURSHIP

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Entrepreneurial opportunity and the formation of photovoltaic clusters in Eastern Germany Matthias Brachert and Christoph Hornych

1

INTRODUCTION

Research on the spatial distribution of economic activity has focused mainly on identifying conditions that sustain industrial clusters, as these are perceived to be the locus of regional economic growth (Braunerhjelm and Feldman, 2006; Lee and Sine, 2007). However, very little is known about the factors that facilitate the emergence of spatial structures in new industries or its performance implications. To achieve deeper insights into these formation processes, ‘theory must explain how information and resources for entrepreneurial activities come to be disproportionally massed in some places and some times’ (Romanelli and Schoonhoven, 2001, p. 41). In this context, recent developments in institutional economic geography underline the contribution of social movements to institutional change and government action, thus affecting entrepreneurship and entrepreneurial opportunity (Sine and David, 2003; Lee and Sine, 2007). As government actions have a spatial dimension, they can induce windows of locational opportunity (WLOs) supporting the evolution of spatial patterns of new industries (Storper and Walker, 1989; Boschma, 1997; Boschma and van der Knaap, 1999). To date, there has been little research into the role of institutional change and government action in the evolution of new industries or entrepreneurial opportunity (Lounsbury et al., 2003; Sine and David, 2003). With regard to the energy sector, the importance of institutional change seems to hold for the effects of environmental movements, as they were able to give an increased awareness of pre-existing technological solutions (see, in particular regarding alternative sources of energy, Lee and Sine, 2007). Changes within this field – in the past as reactions to oil crises – can now be seen as reactions in response to climate change caused by emissions of CO2. This calls for a rapid rate of diffusion of CO2-neutral energy technologies, so that the shift towards renewable energies results in a series of technological discontinuities in the energy field (Anderson and Jacobsson, 2000). The aim of this chapter is to explain the evolution of the spatial structures of one particular type of renewable energy in Germany – the photovoltaic (PV) industry. We first demonstrate how environmental movements have contributed to institutional change and government action, leading to changes in the legal and regulative structure. We describe how these changes opened up a window of locational opportunity, thus combining the WLO concept with the entrepreneurial opportunity concept. As market entries occurred mainly in Eastern Germany, the chapter also explores the factors leading to a concentration of economic activity related to the new PV industry in this part of the country. Based on the WLO concept, we combine this framework with the industrial dynamics literature by Klepper (2007) to describe the role of routines in the spatial evolution of the PV industry. 83

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The chapter is structured as follows. After a brief introduction to the theory of entrepreneurial opportunity and social movements, Section 2 discusses the WLO concept and factors explaining the evolution of geographic structures in new industries. The empirical part (Section 3) begins with the illustration of the role of environmental movements in the evolution of schemes supporting renewable energy in Germany. Section 4 explains how these developments resulted in a window of locational opportunity for the PV industry in Eastern Germany, and describes the evolution of spatial patterns in this industry. Section 5 explores the factors promoting the spatial patterns of the PV industry, and Section 6 concludes with a discussion of the results.

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ENTREPRENEURIAL OPPORTUNITIES AND THE FORMATION OF CLUSTERS

When new industries emerge, initial locations are scattered spatially, but not all of these are able to attract or generate concentrations of economic activity that lead to potential industrial clusters in later stages of the industry growth cycle (Storper and Walker, 1989). Given this knowledge, theories have been put forward to explain how the spatial patterns of these new industries evolve, and which factors translate industry growth into geographical industrialization (ibid.; Krugman, 1991; Arthur, 1994; Brenner, 2004). These theories have in common that they cite ‘historical accidents’ or ‘chance events’ as main factors explaining the development of new industries in certain locations. When looked at more closely, it is evident that there are processes behind these ‘historical accidents’ and ‘chance events’ that explain why industries evolve in certain places. Therefore notions such as ‘chance events’ should not be taken as given (Menzel, 2008), and research should focus on these as a central theme when examining the emergence of the constituent components of new industrial clusters. Entrepreneurship and Entrepreneurial Opportunity There is a growing body of work highlighting entrepreneurship, entrepreneurial opportunity and spin-offs as constituent elements in the formation of spatial structures in new industries (Bathelt, 2001; Brenner, 2003; Dahl et al., 2003; Sternberg, 2003; Henn, 2008). Feldman and Francis (2001, p. 2) argue that ‘Entrepreneurs appear to be a critical element in the formation and vibrancy of clusters of technology intensive firms’. Entrepreneurship is defined as the discovery, evaluation and exploitation of future goods and services (Venkataraman, 1997), so regions must first offer opportunities to induce entrepreneurship (Shane and Venkataraman, 2000). Such opportunities are characterized as ‘situations in which new goods, services, raw materials, and organizing methods can be introduced and sold at greater than their production costs’ (ibid., p. 220). Literature presents three different ways of categorizing emerging entrepreneurial opportunities (Eckhardt and Shane, 2003): ● ● ●

by their locus of change; by the initiator of change; and by the source of opportunities.

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The locus of change suggests five different loci, following Schumpeterian types of innovation. These include opportunities emerging from the creation of new products or services, the discovery of new markets, entrepreneurial opportunities arising from innovations in new raw materials, new methods of production, or new ways of organizing (Schumpeter, 1934). The initiators of change can vary, as non-commercial entities such as governments or universities are as likely to generate opportunity-creating changes as are commercial entities such as existing companies, their suppliers or customers, independent entrepreneurs or diversifying entrants (Klevorick et al., 1995). Opportunities may also differ depending on their sources. Exogenous shifts in information in response to government actions, demographic changes or new knowledge influence the variety and number of entrepreneurial opportunities. Additionally, information asymmetries between different market participants, supply- or demand-side changes and rent-seeking behaviour may act as additional sources of entrepreneurial opportunities (Eckhardt and Shane, 2003). Social Movements, the Transformation of Regulatory Regimes and Entrepreneurial Opportunity in the Energy Sector As noted above, government action is one source of entrepreneurial opportunity. Recently, literature on the consequences of social movements has begun to stress the relationship between environmental movements, government action and the creation of entrepreneurial opportunities (Sine and David, 2003; Lee and Sine, 2007; Sine and Lee, 2009). Examples of the successful impact of social movements on entrepreneurial opportunity and sector emergence can be found in different fields such as green building, recycling, organic food supply or renewable energy. This body of work highlights that new firms, industries or technologies do not emerge in isolation (Lee and Sine, 2007). Social movements are able to ‘prompt search processes that erode the taken-for-granted nature of institutions, resulting in the re-evaluation of the costs and benefits of existing institutional structures and the creation of new entrepreneurial opportunities’ (Sine and David, 2003, p. 186). By contesting existing institutions, they are able to ‘construct the cognitive framework, values, norms and regulatory environments which shape the extent to which potential entrepreneurs view particular types of technologies and characteristics of the material-resource environment as valuable elements of an entrepreneurial opportunity’ (Sine and Lee, 2009, p. 123, emphasis added). We focus here on the ability of social movements to stimulate government action and influence the design of legal structures. If social movements result in legal amendments, ‘[The] Law can . . . function in such a manner that . . . the prevailing norms controlling the operation of the coercive apparatus have such a structure as to induce, in their turn, the emergence of certain economic relations’ (Weber, 1978, cited in Lee and Sine, 2007, p. 97). Thus law and legal structure can influence the creation and expansion of new markets and therefore encourage entrepreneurial opportunity (Lee and Sine, 2007). Furthermore, as the impact of laws and legal structure are spatially bounded, and regulations can differ by region, these variations can induce changes in opportunities for new industries to emerge in particular regions. This spatial dimension allows the bringing together of social movements, the idea of entrepreneurial opportunity and the WLO concept (Storper and Walker, 1989; Boschma, 1997; Boschma and van der Knaap,

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Source:

I Localization – a new industry arises at several points away from older industrial areas

II Clustering – one start-up area surges ahead while others decline or grow more slowly

III Dispersal – growth peripheries of the new industry arise away from the core territory of the new industry

IV Shifting Center – a new center of an industry rises up to challenge the old (peripheral dispersal may continue under the sting of new competition)

Storper and Walker (1989, p. 71).

Figure 5.1

The four basic patterns of geographical industrialization (schematic)

1999). By linking these two concepts we are able to explain how institutional change can influence the emergence of the spatial structures of new industries in certain regions. The WLO Concept The WLO concept was introduced by Scott and Storper (1987) and later applied to a phase model of geographical industrialization by Storper and Walker (1989) (see Figure 5.1). The starting points of the WLO concept are ‘historical accidents’ leading to the localization of fast-growing industries (ibid.). In the Storper and Walker model, these emerging industries present new opportunities for all regions, as they denote a fundamental break with the past, offering relative locational freedom. New industries can be distinguished from older ones by two facts: first, their high returns on investment tend to free them from locational constraints; and second, fast-growing industries possess a locational capability to meet their specific requirements (Boschma, 1997). In contrast to traditional location theory, Storper and Walker (1989, p. 71) suggest that, via above-normal profits, ‘industries are capable of generating their own conditions of growth in place by making factors of production come to them or causing factor supplies to come into being where they did not exist before’. As a result of the newness of the industry they cannot rely on favourable institutional conditions in the early stages and have to develop new institutional structures (Boschma, 2007). These conditions result in a lack of location-specific constraints (in relation to labour, institutions or inter-industrial linkages), leading to substantial freedom to develop the area where the industry originated (Storper and Walker, 1989).

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This situation opens a WLO in the early stages of development. Following this location phase, as the industry life cycle proceeds, the WLO begins to close as the industry reaches regional critical mass. Causes of this closure can be seen in the emergence of Marshallian agglomeration economies, supportive local environments and supporting institutions (Boschma and Ledder, 2010), which together lead to the clustering phase of the industry. Despite Storper and Walker presenting a coherent approach to explaining the evolution of patterns of geographical industrialization at the industry level, their model is not able to explain the processes behind the initial concentration and the structure of economic activity (Henn, 2008). Later adjustments of the WLO concept reject the assumption that space is not important (historical accidents) in the evolution of new industries. Boschma (1997) cites generic resources – ‘skills and knowledge that are not yet specific to support the new industry, but may still favour their development’ (Boschma and Ledder, 2010, p. 3) – as sources of regional advantage in attracting or generating production capacities of new industries. While they point out that generic resources may act as necessary conditions, the regional appearance of these is by no means a sufficient condition for the growth of a new industry (Boschma, 2007). A better regional endowment with these generic resources might only increase the probability of developing as a location for the new industry. Furthermore, Boschma and Frenken (2009, p. 155) argue that ‘apart from basic institutions, it is hard to think of territories that are well endowed with very favourable institutions before a new industry starts to develop, because existing institutions generally do not fit with the specific features of a new industry’. This argument may hold for traditional industries evolving in previous centuries, but it may not for institutional change and governments reacting to recent environmental movements within the power sector. However, we agree with Storper and Walker (1989), as they mention that there are possibly existing industry-specific conditions under which initial innovations arise, including cultural, technological and institutional conditions for entrepreneurship. This view is supported by entrepreneurial opportunity and technological systems literature, which claims that institutions and institutional change are important not only for adopting specific technological paths but also for the growth of new industrial clusters (Carlsson and Stankiewicz, 1991; Edquist and Johnson, 1997; Jacobsson and Bergek, 2004). Our chapter therefore argues that institutional change and government action can be seen as alternative sources of generic resources within the WLO concept. As institutional change is able to induce government action, this can result in the emergence of certain economic relations and entrepreneurial opportunities. Furthermore, within a spatial context, this institutional change can contribute to regional variations in the evolutionary processes of growth, reflected by entrepreneurial opportunities, spin-off dynamics and the build-up of agglomeration economies. Determinants of the Evolution of Geographical Structures in New Industries Having focused on the deeper understanding of institutions affecting entrepreneurial opportunity in the initial stages of the evolution of geographical structures of new industries, we now consider the factors leading to concentrations of economic activity in emerging industries (see Phase II in Figure 5.1). Recent literature has begun to link the WLO concept with industrial dynamics (Boschma and Ledder, 2010). As industry growth results

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in the selective process of clustering in the WLO concept, factors behind this process need to be examined more deeply. While Storper and Walker (1989) hold that different locational capabilities for generation agglomeration economies are responsible for differences in development, the literature on industrial dynamics supposes that spin-off dynamics act as transmission channels through which knowledge and routines are created and diffused among a growing number of firms within a region (Boschma and Ledder, 2010). Agglomeration economies in the Storper and Walker (1989) model result from the regional division of labour, a specializing labour market, reduced transaction costs through the positive effects of spatial proximity, and the development of local supportive institutions. The role of spin-offs1 was highlighted by Klepper (2007). As spin-offs are expected to locate close to the incumbent firms, they can act as important factors in the explanation of spatial clustering. The spin-off process can induce agglomerations around successful firms and can magnify an early cluster of leading firms into an extraordinary agglomeration. Nevertheless, there might be no clear distinction between agglomerations and the spinoff process being solely responsible for the process of spatial clustering of a new industry. Agglomeration economies and spin-offs may in fact act as complementary processes at different stages of the industry life cycle (Boschma and Wenting, 2007). In Section 5 we shall analyse the importance of the part played by agglomeration economies and spin-off dynamics in the emergence of the PV sector in Eastern Germany between 1991 and 2008.

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ENVIRONMENTAL MOVEMENTS AND THE EVOLUTION OF A LEGAL SUPPORTING SCHEME FOR THE PHOTOVOLTAIC INDUSTRY IN GERMANY

Fossil fuels constitute the major source of energy in the world. As these sources are associated with environmental and climate challenges, the shift towards a low-carbon economy is seen as a major response to climate change (Jacobsson and Bergek, 2004). In Germany, the share of renewable energy as a proportion of total electricity generation has increased from 1.07 per cent in 1998 to 15.68 per cent in 2007 (see ‘EEG Quota’ in Figure 5.2). While this is still far from being a sustainable electricity supply, no other country has seen a comparable growth of renewable energy production capacity (Wüstenhagen and Bilharz, 2006). A deeper look into the share of specific sources of renewable energy shows that the wind sector in particular contributes 59 per cent (2007) of the renewable electricity generation. But, when we look at annual growth rates since 2001, despite starting from a low absolute level, solar energy is the most dynamic driver of growing capacity in the renewable energy sector. These developments indicate significant changes in the energy sector in Germany. To understand the conditions behind this development, one needs to look at the historical background. The literature recognizes three phases of renewable energy emergence in Germany (Jacobsson and Lauber, 2006). 1974–88: Social Movements and the Formation of a Renewable Energy Framework The discussion about renewable energies contributing significantly to the German mix of energy consumption began in 1973. The first oil crisis demonstrated German dependence

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The formation of photovoltaic clusters in Eastern Germany Share of renewables on total electricity generation from 2000 to 2007 18% 16% 14% 12% 10% 8% 6% 4% EEG Quota (in %) 2% 0% 2000 2002 2004 2006

Average annual growth rate of renewable electricity generation in Germany from 2000 to 2007 85% 90% 80% 70% 60% 49% 50% 40% 25% 30% 20% 2% 6% 10% 0% Gas Biomass Wind Solar Water Power Energy

Share of renewables on total renewable electricity generation in 2000 0% 34%

58% 8%

Source:

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Water and Gas Biomass Wind Power Solar Energy

Share of renewables on total renewable electricity generation in 2007 5% 8% 4%

24% 59%

Water Gas Biomass Wind Power Solar Energy

Bundesverband der Energie- und Wasserwirtschaft (BDEW) (various years).

Figure 5.2

The development of renewable energy in Germany since 2000

on oil imports, and demands arose for different sources of energy (Wüstenhagen and Bilharz, 2006). The initial reaction was a shift in energy policy to the promotion of nuclear power and coal, but the government also began to promote research into renewable energy sources. Public demand for the transformation of the energy system increased after the mid-1970s, as the use of nuclear power became increasingly controversial. Civil society organizations began to campaign against the rapid expansion of nuclear power stations, leading to many violent confrontations until the end of the decade (Kitschelt, 1986; Jacobsson and Lauber, 2006). Out of this controversy there emerged a green or anti-nuclear movement, which saw neither nuclear power nor oil as suitable long-term energy sources. The movement promoted ideas of energy efficiency and renewable energy sourcing (Jacobsson et al., 2004). With no major political party adopting a clear antinuclear position during the debate, established channels of political articulation offered very few possibilities for organized protest. This resulted in more confrontation, and anti-nuclear movements began to push for institutional change and government action with the help of a new ecological party founded at the end of the 1970s (Kitschelt, 1986). Their views were supported by the first Enquete Commission of the German Parliament in 1980, which recommended the adoption of renewable energy and energy efficiency as the first priority, but also the maintenance of the nuclear option (Lauber and Mez, 2004). Largely related to the issue of government-funded research and development (R&D) programmes for renewable energy technologies, universities, institutes and firms began research in various directions (Jacobsson and Lauber, 2006), building a second strand of emerging PV interest. Despite the political–economic electricity supply structure being in favour of coal and nuclear power generation at this time, research funds were allocated across the entire field of solar-powered systems manufacture, developing a broad

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academic and industrial knowledge base. Related to institutional change and public pressure, this contributed to the opening of a space for renewable energies through R&D efforts. The supply of public R&D funds encouraged the growth of knowledge and guided the development efforts of the firms entering the PV market (Jacobsson et al., 2004). In addition, public debate on environmental protection promoted the initiation of a more stable market development policy. As a result, a set of demonstration programmes were integrated in German R&D policy (Staiß, 2000). Overall, the formative stage of the renewable energy framework can be characterized in terms of institutional change in the form of increased public support for renewable energy. This change created the first niche markets and encouraged the learning process, thus strengthening the marketability of solar power. Moreover, different forms of supportive actors for renewable energy in general, and PV technology in particular, developed from the environmental movement: new political parties, industry and environmental associations, specialized research institutes (in particular, the Institute of Ecology), and solar energy development associations (Wüstenhagen and Bilharz, 2006). The aim of these organizations was to promote solar energy diffusion via the generation of institutional change – by shaping government action in favour of solar energy (Jacobsson et al., 2004). 1988–98: The Struggling Performance of Solar Power The disastrous accident at Chernobyl nuclear power station in 1986 led to recurring attention being paid to the nuclear debate. Between 1976 and 1985, public opinion had been divided fairly equally on the question of nuclear energy, but within two years of the Chernobyl accident, opposition to nuclear power had risen to more than 70 per cent (Lauber and Mez, 2004). In this context, the strong pressure from public opinion led to the flow of considerable amounts into R&D budgets for renewable energy sources – not per capita but in absolute amounts (Jacobsson and Lauber, 2006). Accompanied by increasing concern about the ozone problem and climate change resulting from emissions of CO2, there was general agreement that changes in energy use were needed. With the help of the installation of an Enquete Commission on climate change, the discussion was introduced into the political–parliamentary space. This resulted in a series of actions and proposals for institutional change, including different support programmes for PV energy, reflecting the considerable public concern about this issue (Schafhausen, 1996). The first major government action of importance for the PV industry was the 1,000 roof programme (1991–95), the world’s largest demonstration and market formation programme for the PV industry at this time. Despite being successful, with the installation of more than 2,000 PV systems with a cumulative capacity of 4 MWp (megawatt peak), the termination of the programme was not followed by subsequent promotions, leading to market exits and migration of the biggest solar manufacturers in Germany (Bechberger and Reiche, 2004). As the solar industry did not profit from the Energy Feed-in Law (StrEG) of 1991, because compensations did not cover production costs, German solar cell production was almost non-existent by 1994 (ibid.). After production fell, the most important help towards mobilizing market development in PV technology came from a further important development: the amendment of the federal framework on electricity tariffs. The legal framework was modified in

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such a way that local utilities were able to sign cost-covering contracts with suppliers of renewable energy. With the help of this amendment, local support groups for renewable energy were able to request local governments to adopt these models of energy supply in their regions (Jacobsson and Lauber, 2006). With additional aid from the federal states, many of the dispersed federal, regional and local support programmes for PV energy were able to sustain the market after the end of the 1,000 roof programme (Wüstenhagen and Bilharz, 2006). The large number of cities adopting local feed-in laws and green pricing schemes revealed that demand for solar power still existed and was still growing. Accompanied by intensified lobbying efforts, solar industry and solar development associations began to demand support for a large home market to emerge (Jacobsson et al., 2004). In sum, the second period of PV energy emergence has come about through external events (mainly Chernobyl and the emerging climate change discussion). These events led to a shift in public awareness towards changes in the established energy systems, and articulated demands for changes in favour of renewable energies. The green movement in particular was able to contribute significantly to this discussion. Supported by growing industrial and scientific knowledge about the ability of solar energy to contribute to the German energy supply, a broad set of institutional actors developed, supporting solar energy. These led to government action in PV market development and the introduction of legal amendments supporting the diffusion of PV technology. However, the high cost of solar energy generation still limited market diffusion, and government action was not able to introduce stable market development prospects, which led to a lack of entrepreneurial opportunities. The majority of the firms involved in PV technology therefore decided to leave the market and only local solar initiatives were able to contribute to the maintenance of the market. Thus an increasing proportion of PV development was now in the hands of policy makers – backed by a strong majority of the population – taking the lead in the policy process (Wüstenhagen and Bilharz, 2006). 1998 Onwards: The Opening Window for Solar Power The change to a Social Democratic–Green federal government in 1998 encouraged renewable energy development. Within the coalition agreement, some arrangements were made that were dedicated to renewable energy. Building on proposals from different solar development associations, these included the origination of a 100,000 roof programme for solar market formation and a reform of the StrEG to promote the diffusion of solar energy (Staiß, 2000). Under the initial StrEG of 1991, compensation for renewable energy producers was linked to avoided costs. By taking the average utility revenues per kWh, the government attempted to introduce a fair value payment for renewable energy generation. In this type of system, feed-in tariffs vary according to general electricity tariffs, exposing the producer to changes in these tariffs (Mitchell et al., 2006). For wind energy in particular, this compensation was high enough to induce market growth. Considering PV energy, an income of 16.52 Pf/kWh (~8.5 ct/kWh) compared to costs of DM 1.50 (~76.7 ct/kWh) for 1 kWh generated was not sufficient to encourage market development (Bechberger and Reiche, 2004). When electricity prices began to decrease in 1999 as a result of power

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market deregulation in Germany, producers of renewable energy came under pressure. Fearing the loss of incentives for market diffusion of renewable energy, market liberalization created a window of opportunity in political space (Wüstenhagen and Bilharz, 2006). The temporary price reduction left some room for fixed payments for renewable energy. Inspired by local feed-in laws for solar power, the introduction of fixed tariffs in the Renewable Energy Law (EEG) in 2000 was largely a response to this (Mitchell et al., 2006). The key elements of the EEG were (Wüstenhagen and Bilharz, 2006): ● ● ●

a purchase obligation for the local grid obligator; guaranteed minimum prices for twenty years; and a nationwide cost settlement system to balance out regional disparities.

Accompanied by the launch of the 100,000 roof programme (subsidies in the form of low interest loans to investors) the improvements in incentives for solar energy production were dramatic. New compensation rates for solar energy increased to 50.6 ct/kWh for systems installed in 2000 and 2001, followed by an annual decline of the compensation rate of 5 per cent. This combined with the 100,000 roof programme led to a situation where solar energy became an interesting investment option for the first time (Jacobsson and Lauber, 2006). Development was encouraged further by an amendment to the Energy Feed-in Law in 2004. The initial Feed-in Law of 2000 included a cap, limiting PV system installations to 350MWp a year. By 2003, market volume had already reached this point. As investment decisions slowed down, a subsequent law passed through parliament removing this cap and enabling further market growth. While some firms had entered the PV market a few years earlier in response to the market formation initiatives at the local level, these new conditions of solar energy promotion attracted further entries, and the WLO opened up for PV companies. Summing up, the Social Democratic–Green federal government introduced key elements which influenced the diffusion of renewable energies in general, and solar power in particular. The 100,000 roof programme – in response to the earlier proposals of solar development agencies, and the Energy Feed-in Law of 2000 – inspired by several local feed-in laws in different German regions, provided strong incentives to invest in solar power. But they were also showing a clear feedback loop from early diffusion to the subsequent ability to influence public political processes by shaping the regulatory framework in favour of renewable energy (ibid). These government actions brought about very favourable conditions for an expansion in solar generation production capacity, thus increasing dramatically entrepreneurial opportunities in this field. The next section explains in more detail the impact of the Renewable Energy Law on entrepreneurial opportunities.

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ENTREPRENEURIAL OPPORTUNITIES AND INCENTIVES RESULTING FROM THE GERMAN FEED-IN LAW

In contrast to organic food or other ‘green’ products, consumers of ‘green power’ do not demand a physically differentiated product. Within a feed-in tariff system, the difference

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between energy sources lies in the monetary flows a generator achieves for renewable energy production (Wüstenhagen and Bilharz, 2006). With the introduction of a fixed feed-in tariff system in 2000 (and its further amendment in 2004) government action created a situation in which solar energy could be introduced and sold at a price greater than the production cost. This exogenous shift ensured that a solar energy producer received a fee above the market price, reflecting the fact that solar energy was not yet competitive. Furthermore, the design of the Renewable Energy Law supported entrepreneurial opportunities by reducing risks for renewable energy producers, making investments highly attractive and pushing demand. These risks can be divided into three sources (Mitchell et al., 2006): ● ● ●

price risks; volume risks; and balancing risks.

Looking at price risks, a feed-in tariff removes these, since the fee is not dependent on the market price. In addition, solar energy producers do not face any price volatility leading to a price reliability. Because the volume produced builds a second constraint on producers’ revenues, the purchase obligation for the local grid obligators mitigates the individual producers’ risk that their energy will not be purchased (ibid.). With regard to the balancing risk in a feed-in tariff system, generators can bypass the need to supply a certain load profile. As the production of energy from solar sources leads to an unreliable amount of power being generated, the purchase obligation does not punish time-varying load profiles. Overall, this situation has created a number of advantages for renewable forms of energy in general and solar energy in particular. The reduction of risk gives the renewable energy producers an increased ability to finance their projects with the help of the capital market, and this also enables smaller firms to undertake projects. This situation has had a strong impact on market growth, enabling firms to tackle the construction of large solar parks, which has led to major increases in the demand for PV systems. Government action has therefore influenced the number of entrepreneurial opportunities, and possibilities for new entrants have arisen through the creation of uncapped markets in the PV sector. They can sell their products, if they are able to produce at prices below those set by feed-in tariffs, up to their production capacity limit without major entrepreneurial risk. This situation has provided a WLO for the PV industry in Germany.

5

EVOLUTION OF THE SPATIAL STRUCTURE OF THE EASTERN GERMAN PV INDUSTRY

Data Description Information about firms in the PV industry was obtained from a unique database, collected within an ongoing research project, including the total number of firms (about 400) in the German PV manufacture and supply industry. The segment related to the trade in PV products, and the installation and operation of solar parks are not included

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in this database. The database focuses on information about the companies in the value-adding production chain in the PV industry: location, date established, market entry, products, employment and company turnover. The value-adding production chain includes silicon, ingot, wafer, cells and module manufacturers, thin-film companies and specialized suppliers that have at least one business division in PV technology. For a detailed description of the value-adding production chain, see Staiß et al. (2007). Regarding the entry of new firms, the study defines a market entry as follows. For firms in the value-added chain of the PV industry, the founding date of the enterprise corresponds to market entry. The market entry of the suppliers is defined as the point of firsttime production of specific PV products. The supplier industry comprises, among others, plant engineering and construction for the PV industry. The Localization Stage Regarding the emergence of entrepreneurial opportunities, these cannot be exploited by optimizing, because the set of alternatives is unknown when introducing new products (Baumol, 1993). Given this uncertainty, the resulting spatial structure is unlikely to be optimal in the initial stages of development, leading to the evolution of different physical locations in the early stages. As government action opened a WLO for the PV industry at the end of the 1990s, the first wave of market entry by PV producers in Germany can be observed. The majority of the new companies were founded in Eastern Germany – a result of different factors affecting the localization stage of the PV industry. Eastern Germany was less dominated by established industries than Western Germany, so openness to new industries was higher in these regions. The general policy of promoting economic development in Eastern Germany (in particular, extensive investment incentives) may also have had a stronger influence on the localization decisions in the (investment-intensive) PV industry than in other branches of industry. These conditions mainly favoured market entries in the eastern part of the country. We therefore focus our analysis of the evolution of the spatial structure of the PV industry on Eastern Germany (see Figure 5.3). The first entries in the localization stage (see Figure 5.4) focused on the federal states of Saxony (for example, Solarwatt in Dresden, SolarWorld in Freiberg), Thuringia (Ersol in Erfurt), and on Berlin (Solon, SolarWerk). While entrepreneurial opportunities were encouraged by government action, the choice of location was influenced by the above-mentioned generic resources, which played a decisive role in the regional allocation of production facilities. Freiberg, as the site of the former VEB Spurenmetalle (a former GDR state-owned company with experience in silicon production – the raw material for PV systems), and Dresden and Erfurt as centres of microelectronics, were well endowed with basically favourable conditions (for example, experience in dealing with silicon, available skilled labour in relation to PVs, specialized infrastructure) for the formation of new firms or the takeover of existing firms (for example, of the Freiberger Elektronikwerkstoffe GmbH by Bayer Solar) (Willecke and Räuber, 2003). However, companies were also formed that did not rely on existing generic factors in the region, in this case being the result of administrative intelligence on location policy in the respective regions (for example, Q-Cells in Bitterfeld-Wolfen). Consequently, the localization stage led to a dispersed location pattern of the PV industry in Eastern Germany (see Figure 5.4).

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Brachert and Hornych (2009).

Figure 5.3

Number of entries and spatial distribution of companies in the PV industry in Eastern Germany, 1992–2008

Production capacity of the plants at that time was characterized as being relatively low. The limited market volume and minor turnover of the whole PV industry restricted the formation of a specific supply industry. The first market entrants to this field emerged from cooperation projects around the year 2000 (see Figure 5.3). This development was pursued by existing engineering companies who diversified into the production of solar equipment, especially in Saxony. In particular, the existence of linked branches, such as the semi-conductor industry, favoured the formation of a supplier industry in this region. The Clustering Stage As a result of the strong market growth2 and the emergence of new technological solutions (in particular, thin-film technology), a second wave of market entries by new companies occurred after 2003 (see Figure 5.3). Caused by differing business strategies, there were specific developments at various industrial locations. Firms pursuing a strategy of vertical integration established spin-offs or joint ventures with existing PV companies, covering additional parts of the value chain (for example, SolarWorld in Freiberg). Such vertical integration offers the advantage of a comprehensive approach to cost reduction in PV systems and allows the internalization of profit margins throughout the value chain (Conkling and Rogol, 2007). Competing technology paths are the reason behind a second pattern of development in the clustering stage. The PV industry today is characterized by a wide variety of technological solutions, in the different stages of commercialization (Ruhl et al., 2008). It is not clear which technology in the respective market segments will be competitive in the future. A dominant design is still to come. As a result, some firms have chosen a strategy of technological diversification, leading to a second type of firm formation. These

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Brachert and Hornych (2009).

Figure 5.4

Locations of the PV industry, Eastern Germany, 1996–2008

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developments in firm strategy have been achieved mainly by successful incumbents in the PV sector, demonstrating their great importance for the development of regional industry concentrations, especially in Freiberg, Bitterfeld-Wolfen and Erfurt. As Klepper (2007) observed in studies on the emergence of the spatial structures of other industries, spin-offs or joint ventures seek to locate in geographical proximity to the incumbent firm. This is the same for the PV industry. Incumbent firms are important sources of competencies and entrepreneurial opportunities. The spatial proximity of spin-offs developing out of these allows increased interaction along the value chain (vertical integration) or exchange of production knowledge and experience between PV technologies, so that, from a theoretical perspective, increases in both productivity and innovation are expected (Feldman, 1999). The Role of Incumbent Firms: The Case of Bitterfeld-Wolfen Taking a closer look at the emergence of spatial structures in the PV industry in Bitterfeld-Wolfen, the firm Q-Cells demonstrates the role of leading incumbents in the evolution of the region’s concentrations of new industries. The case of this city illustrates how an early-entrant company can stimulate major agglomerations in new industries. Bitterfeld-Wolfen, a small town located in central Germany, 35km north-east of Leipzig, was one of the leading centres of the chemical industry in the time of the GDR. In the last decade of the GDR in particular, Bitterfeld-Wolfen had become a symbol of fatal pollution of the environment, through the use of obsolete production technologies and an absence of environmental regulations. After German reunification in 1990, the city faced far-reaching structural changes. Despite the shut-down of numerous plants and the loss of employment, Bitterfeld-Wolfen remained a location for the chemical industry. As the window of locational opportunity for the PV industry opened at the end of the 1990s, Bitterfeld-Wolfen was not seen initially as having favourable location conditions for the new industry. The city’s history as a location for the PV industry began in 1999, with the founding of the Q-Cells company. Despite the company preferring Berlin as a location, regional administrative intelligence was able to convince the founders of the benefits of Bitterfeld-Wolfen by offering rapid administrative procedures, available property and support from public venture capital companies. Entering the market in 1999, the firm can be characterized as an early entrant. The four founders of Q-Cells already had experience in the PV industry – they were formerly employed at Solon, a company producing solar modules, located in Berlin, which had been established in 1996. Moreover, the founder team also included an expert with broad management competencies (Kuehnle and von der Osten, 2008). Q-Cells started with a workforce of only 19 people. In 2001, the production of silicon-based solar cells began. After some years of high production and employment growth in a strongly expanding market, Q-Cells became in 2007 the single largest producer of solar cells worldwide. The development of the city of Bitterfeld-Wolfen as a location for the PV industry is strongly linked to the diversification strategy of Q-Cells. As well as being the leader in silicon-based technology, different approaches to generating solar power were also explored. To monitor advances in these fields, Q-Cells established a number of subsidiaries, each of them working with an alternative technology. Sovello was founded in 2004 under the

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Authors’ own illustration.

Figure 5.5

The emergence of the PV cluster in Bitterfeld-Wolfen

name EverQ, as a joint venture with two other firms in the PV industry. The aim of Sovello was to produce solar cells and modules using String Ribbon technology. CSG Solar, founded in 2004, applies a technology to crystalline silicon on glass. Q-Cells also pursued different approaches in thin-film technology. Calyxo (founded in 2005) specializes in cadmium-tellurid technology; Sunfilm (founded in 2006 as Sontor) in a technology using amorphous silicon; and Solibro (founded in 2006) in CIGS technology. Finally, in 2007, Q-Cells International was founded, an active project business developing solar parks. As all these companies are located in direct spatial proximity to the incumbent firm, Bitterfeld-Wolfen became one of the leading locations of the PV industry in Eastern Germany. As Klepper (2007) states, incumbent companies can be a source of agglomeration and cluster development. This observation is epitomized by Q-Cells in Bitterfeld-Wolfen. In fact, the spatial concentration of these firms led to decisions to establish additional firms in Bitterfeld-Wolfen. As well as the subsidiaries of Q-Cells, City Solar, an R&D service provider, has been located in the area since 2005. PV Crystalox, a producer of ingots and wafers, moved to Bitterfeld-Wolfen in 2009, and several firms from the supply industry are located in spatial proximity to the production firms. Thus the local firms profited from joint R&D projects leading to buyer/supplier relations (MABA, Resolut), while other firms located there because the demand for Q-Cells was combined with a demand for service locations in close proximity (IB Vogt, SSF). The growth of Q-Cells therefore led to the development of one of the leading sites of the PV industry in Eastern Germany. With approximately 3,500 employees, more than 25 per cent of the total employment of the Eastern German PV industry is located in the town (Brachert and Hornych, 2009). Figure 5.5 illustrates the evolution of the spatial structure of the PV industry in Bitterfeld-Wolfen. Returning to whole industry development, as well as the regional impact of incumbents, competing technologies were responsible for the creation of new PV companies. In particular, thin-film technology has seen 22 entrants since 2001, as well as enormous

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market and employment growth. Besides this concentration of the industry in SaxonyAnhalt, firms working with thin-film technology are also concentrated in the BerlinBrandenburg region. In addition, Eastern Germany has become attractive for foreign investors. Generally, the investors have set up their manufacturing facilities in geographical proximity to the already established centres of the industry (for example, Signet Solar in Mochau, or Masdar PV in Erfurt) or in regions with a high number of generic factors (for example, First Solar in Frankfurt (Oder)). As a consequence of increasing market volume, the clustering stages have led to the entry of numerous suppliers, strengthening the vertical dimension of emerging spatial structures (Bathelt et al., 2004). Since 2005 in particular, an increased number of entries to the supplier segment can be seen (see Figure 5.4 and Stryi-Hipp, 2005). As PV systems are increasingly standardized products, production efficiency gains result from the connection with different cross-sectional technologies such as optics, engineering, nanotechnology and so on. Therefore regions with concentrations in related industries – such as Saxony with its strong concentration in the semiconductor industry, for example – have been able to profit from entries in the supply field. This situation reflects the importance of knowledge shared among related industries that enables them to profit from new sector emergence. Alongside the activities of the expanding companies, agglomeration economies were appearing as a result of institutional arrangements accompanying the process of clustering. One element of the formation of clusters was the emergence of regional inter-firm networks. The intensity of collaboration within the industry has risen sharply (Richter et al., 2008). Examples of research cooperation are ‘SiThin Solar’ and the ‘INNOCIS’ network. Another aspect of the clustering process itself is the potential of the new industry to create supportive institutional structures. This is especially apparent in the establishment of training and education facilities to meet the growing regional demand for a qualified workforce. Almost all the regions in Eastern Germany are willing to build such capacity (Franz, 2008). There are, for example, PV courses of study planned at the TU Bergakademie Freiberg, the TU Ilmenau, the Technical University of Berlin, the University of Jena and the University of Applied Sciences Anhalt; the establishment of several endowed professorships – for example, at the MLU Halle-Wittenberg and the Technical University Ilmenau; various training programmes; and the establishment of specialized public research institutes (for example, the Fraunhofer Center for Silicon Photovoltaics CSP in Halle). As a consequence of the clustering stage, some leading centres of the PV industry have developed in Eastern Germany. Two-thirds of the approximately 14,000 employees working in the PV industry in 2008 are located in Bitterfeld-Wolfen, Freiberg, Dresden and Erfurt/Arnstadt. Regarding these concentrations, we agree with the observations made by Klepper (2007). As noted above, incumbents can be seen as one of the major structure-forming components in the regions. This not only holds for Bitterfeld-Wolfen, but also for locations such as Freiberg and Erfurt/Arnstadt. They are able to produce major agglomerations of the new PV industry with the help of spin-offs, and act as a source of knowledge for regional firms in related industries engaging in buyer/supplier relationships. Know-how from related industries leads to further entries to the PV market, influenced in particular by locations such as Saxony that have experience in supplying the semiconductor industry. These developments, accompanied by the emergence

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of agglomeration economies, have become an important location factor for the PV industry. These include, in particular, a strengthening of the institutional support for the PV industry through the establishment of specialized educational programmes (endowed professorships, degree courses in PV technology at universities, and vocational training schools). According to Storper and Walker (1989), these developments indicate the closing of the WLO. While in the localization phase, location was of minor importance for the company, but later the participation in agglomeration economies become an important location factor for the PV industry.

6

CONCLUSIONS

In the creation of the PV industry in Eastern Germany we can distinguish two different stages of development: the localization stage and the clustering stage. The evolution of spatial structures in the localization stage was influenced by entrepreneurial opportunities arising through government action, which in turn was stimulated by social movements making demands for institutional change in the energy systems. This pressure from social movements encouraged the government to introduce market development programmes. Despite it taking more than two decades for solar energy to become popular, it was the Renewable Energy Law that led to solar energy becoming established and sold at greater than its production costs. The design of the Renewable Energy Law also increased the number of entrepreneurial opportunities through uncapped markets with fixed prices and obligations to buy. Seen from an ex post perspective, this situation opened up a WLO for the spatial evolution of the PV industry in Eastern Germany. The emergence of new locations for the PV industry in the localization stage was influenced strongly by the generic factors of the regions. In particular, the old industrial areas with experience in microelectronics were able to profit from market entries. But there were also other locations, such as BitterfeldWolfen, which developed into leading sites for the new industries, despite offering no favourable conditions in terms of generic resources. Following the work of Storper and Walker, the current stage of development of the PV industry is characterized by the development of clusters at leading locations, while the secondary sites are losing relevance. This development pattern can currently be seen in Eastern Germany. In contrast to Storper and Walker, who suggest agglomeration economies as the sole factor explaining selective clustering, we have found that spin-offs of leading PV firms and the entry of firms with know-how in related industries are the main drivers in the process of cluster formation. These processes result from the strategy of vertical integration as well as from strategies of technological diversification. The results therefore agree with the observations made by Klepper (2007). Agglomeration economies may act as complementary effects, especially in the institutional support for the PV industry. The design of the Renewable Energy Law introduced further entrepreneurial opportunities for other regions to engage in PV production. In Germany, a strong domestic market is accompanied by a sizeable production capacity, indicating profits from the early establishment of lead markets. However, looked at from a global perspective, this link is not visible. For example, while Spain has been one of the biggest PV markets in

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recent years, its domestic industry has only a small production capacity (Salas and Olias, 2009), and China has become one of the leading producers of solar cells and modules despite an almost non-existent PV market (Meersohn and Hansen, ch. 6, this volume). China has also developed different spatial patterns in its PV industry, and has not shown concentrations of production comparable to those found in Eastern Germany. Against this background, the significance of proximity between producers and purchasers in the PV industry remains unclear. Further research is needed to examine the geography of upstream and downstream players in the PV industry.

NOTES 1. In this study we define spin-off as the splitting off of a part of a firm, which remains linked to or controlled by the incumbent firm (see also Kudla and McInish, 1988; Daley et al., 1997). 2. The emergence of spatially concentrated industry structures in the WLO model (clustering stage) is related to the strong market growth processes of the industry (Storper and Walker, 1989). This assumption holds in the case of the PV industry. The turnover of the industry increased from €201 million in the year 2000 to €5,741 billion in 2007 (Bundesverband Solarwirtschaft, 2008).

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The rise of Chinese challenger firms in the global solar industry Gabrielle Meersohn and Michael W. Hansen

1

INTRODUCTION

In a number of industries such as electronics, advanced services, building materials, financial services, farm equipment, steel production, hotels and hospitality, contract manufacturing and so on, we see the rise of firms from emerging markets moving into markets previously dominated by western multinational corporations (MNCs). Not least in the highly dynamic and rapidly growing industries for renewable energy such as wind power and solar energy, we have seen a surprisingly strong early performance of MNCs from emerging markets, especially from India and China. In the particular case of solar energy, we have seen Chinese solar panel producers rapidly gaining dominant market positions and challenging German, US and Japanese incumbents. The aim of this chapter is to understand the rise of Chinese solar producers. Implementing new technologies and developing new markets for solar energy have traditionally been the exclusive domain of western MNCs as this requires strong research and development (R&D) capabilities, economies of scale, financial strength, superior organizational capabilities and an extensive marketing and distribution system. And indeed, the solar industry has historically been dominated by players from Japan and Germany and to a lesser extent the US. However, more recently Chinese challenger firms are surprisingly rapidly gearing up to challenge the incumbent market leaders. Already, Chinese solar panels account for 27 percent of the world market and Chinese producers are rapidly upgrading to high-efficiency types of solar panels. In 2007, the Chinese module production increased by 60 percent, reaching 1,088 GW, thereby exceeding the production of the previous leaders Germany and Japan (REDP, 2008). The rapid rise of Chinese solar panel producers appears to challenge conventional theories of firm internationalization. According to conventional theories, emerging market firms are typically technologically, financially and organizationally backward. To the extent that they enter global industries at all, they will do it as low-cost suppliers and subcontractors to western MNCs or alternatively, produce technologically scaleddown products for less-advanced markets. Conversely, an emerging view – the so-called ‘latecomer theories’ – holds that factors associated with economic globalization have enabled the rise of a new breed of firms from emerging markets that, while coming from an initially disadvantaged position vis-à-vis western MNCs, may turn this latecomer status into an advantage. These firms exploit the fact that they are not inhibited by established paths and managerial conventions and that they have been forced to develop strong network capabilities to survive in their home market. Instead of moving into internationalization incrementally, they display ‘born global’ paths, where they rapidly move on to challenge western incumbents in their core markets. 104

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This chapter will describe the rise of the Chinese solar industry and discuss how we can explain this rise. The discussion will be structured around a contrasting of conventional theories of firm internationalization, that is, the ownership, location and internalization (OLI) paradigm (Dunning, 1988, 2000) and the Uppsala model of firm internationalization (Johanson and Vahlne, 1977) with theories of latecomer firms (Mathews, 2006; Buckley et al., 2007; Tolentino, 2008). The empirical aim of the chapter is to gain a better understanding of the internationalization of the Chinese solar panel producers; the theoretical aim is to critically assess the extant theory in light of the case studies. The chapter will be based on industry-wide data on the Chinese solar industry as well as three in-depth case studies of leading Chinese producers of solar panels conducted in 2008. The chapter is structured as follows. Sections 2 and 3 will describe the rise and internationalization of the Chinese solar industry and present three specific cases of Chinese solar producers that have seen rapid internationalization. Section 4 will present various theoretical frameworks that may shed light on the particular investment path of Chinese solar producers. Section 5 will discuss the strengths and weaknesses of the various theoretical frameworks with regard to explaining the rise of Chinese solar producers. Section 6 concludes.

2

THE SOLAR INDUSTRY

Rising environmental concerns have recently boosted demand for renewable energies and solar photovoltaic (PV) in particular, and the solar industry has become one of the fastest-growing industries in the world. Within renewable energy, the solar industry possesses one of the largest future growth potentials (see Figure 6.1). In 2008, the level of solar PV installation more than doubled compared to the level in 2007. According to preliminary estimates the capacity reached 9,533.3 MW compared to the 5,017.37 MW of 2007 only in Europe (Photovoltaic Barometer, March 2009). And according to a 2009 report from SRI Consulting (SRIC), the global solar energy market is projected to reach $70 billion by 2013, which is more than double the current situation. There are various technologies within solar PV and new technologies are continuously being developed. While there is intense debate as to the future importance of emerging solar technologies (see, for example, interviews with Mogstad and Langmoen, 2008 Biomass Large hydropower Small hydropower Solar hot water heating Solar PV, off-grid Geothermal heating Wind power Biodiesel Solar PV, grid connection 0

Source:

10

20

30

40

50

60

70

Renewables Global Status Report (2007).

Figure 6.1

Renewable energy: annual growth rate, 2002–2006

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Others 2.7% PV cells Amorphous Silicon 3.9% Cadium Telluride 2.7% Thin Film CIS/CIGSO 2% Dye-sentized 0.0% Note: Source:

Interface Optimization of Heterojunction Silicon (HIT). JP Morgan (2008).

Figure 6.2

Market shares of main photovoltaics technologies

and Jäger-Waldau, 2008), this chapter focuses on the silicon-based crystalline cells and panels as this technology currently represents the bulk of diffused technology within the industry as a whole (see Figure 6.2). Production has historically been concentrated in relatively few countries. Japan and Germany were the first to invest in solar PV, and historically these two nations, besides constituting the two main markets for solar PV power due to national government incentives, have been host to the largest producers of solar cells and modules. The Japanese electronics giant Sharp was for a long time industry leader, however according to an international industry ranking from 2007, the Norwegian Renewable Energy Corporation (REC) had become the market leader, followed by German Q-Cells, Japanese Sharp, German Solarworld and the Japanese-based Kyocera (Fawer, 2007). In particular three factors drive competition in the industry, namely subsidies from governments, cost orientation and innovation capability. A major obstacle to the adoption of PV for electricity generation is that it remains more expensive than electricity generated from more conventional energy sources and wind power. Therefore, demand for solar PV systems is strongly driven by the incentive schemes implemented in various western countries, such as Germany, France, Italy as well as Japan and more recently the US (Fawer, 2006; China REDP, 2008; interview with Wong, 2008). Due to the strong incentives in the home market, the German, Japanese and US producers have had a strong first-mover advantage and have built incumbent positions that are difficult for newcomers to challenge.

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Another factor impacting on the competitive landscape within the industry is technological innovation. First, innovation refers to the fact that the industry is continuously developing technologies and standards to improve features such as the conversion efficiency and power output of the modules. The current technology leader within the PV industry is Sunpower, a Silicon Valley based cell manufacturer, which has been able to develop a monocrystalline cell with an efficiency conversion of 22 percent as well as achieving a 20.1 percent conversion efficiency for its solar panels (see Table 6.4, below). Second, innovation refers to the introduction of substitute technologies. Here it appears that thin-film technology in the long run may challenge the dominant cell technology and some of the market leaders such as Sharp and First Solar are aggressively diversifying their production into thin-film technology. However, the competitiveness of this technology is being hampered by falling costs of mono- and multi-crystalline modules due to increasing efficiency levels and improved supplies of silicon. As the relatively mature cell technology still dominates the market, cost factors continue to play a key role in the industry. According to several of the industry experts interviewed for this chapter, the ability to supply a significant quantity of modules at a relatively low price constitutes the main source of competitive advantage in the industry. Thus, the ability to reduce costs and identify low-cost manufacturing locations is vital if firms are to be successful within the solar PV industry. Due to the financial crisis, module prices are falling and demand is declining. In this situation, low-cost orientation may become an even more important competitive parameter (interview with Combs, 2008).

3

THE CHINESE SOLAR INDUSTRY

The Rise of the Chinese Solar Industry The PV industry has recently experienced the arrival of new players from China. In 2007, module production increased by 60 percent, reaching 1,088 GW. Thereby, China became the world’s largest and third-largest supplier of PV modules and cells, respectively. The exceptional growth has taken place against the background of a virtually non-existent home market. Although the PRC recently passed a historic law, the Law on Renewable Energy Resources, which pledged to use renewable energy resources such as solar, wind and geothermal energy for 10 percent of the energy consumption by 2020, a key concern with solar energy is that it is too expensive to become a major solution to Chinese energy problems. Thus, currently, the cost of solar PV for power generation is 10 times that of coal (REDP, 2008, p. 20), and to the extent that the PRC focuses on renewables, it is on biofuel and wind power. While China has not promoted the industry, export-oriented solar manufacturers receive strong support from the home country, for example, in the form of access to relatively cheap land and labor, relatively low taxes, and rapid policy implementation compared to both Europe and the US (The Fletcher School, 2008; interview with Wong, 2008). For instance, for Chinese manufacturers [I]t may cost eight to ten million dollars to install and commission a 30MWp PV cell production line, but in some foreign companies it may cost 20 to 30 million dollars to commission a 30MWp production line. (interview with Macpherson, 2008)

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Table 6.1

Cost profiles Silicon Utilization Silicon cost (g/watt) cost ($/kg) ($/watt)

Suntech Sun Power First Solar Source:

200 100 n/a

9 7 n/a

1.80 0.70 n/a

Other Total Module Gross Total Wafer/ costs cost ASP margin wafer ingot ($/watt) cost cost ($/watt) ($/watt) 0.27 0.40 n/a

2.07 1.10 n/a

0.80 1.78 n/a

2.87 2.88 1.19

3.80 3.80 2.48

24.5% 24.1% 51.6%

Merrill Lynch (2008).

Incentives from local government in the form of low taxes also support the low-cost structure of the Chinese manufacturers (interview with Wong, 2008). Furthermore, as the cost of labor in China is so low, PV cell and module suppliers have been able to adopt a semi-automatic manufacturing process, meaning that they have relatively low capital expenditures compared to their European and US competitors (see Table 6.1). The Rise of Chinese Solar Panel Producers In the following we shall focus on three major players in the Chinese solar panel industry, namely Suntech, Trina Solar and Solarfun. According to Sarasin’s 2007 ranking of the largest players within the solar industry, Suntech Power Holdings is in 11th place and Trina Solar 20th, while Solarfun is not included in the ranking. Our case studies of these three companies are based on interviews with managers and industry analysts as well as on secondary material (see references for an overview of the sources for the case studies). An analysis of these companies will provide a good picture of the rising Chinese solar industry, as these companies are among the largest Chinese players. However, it is not our intention to use the case studies for empirical generalizations regarding the Chinese solar industry, but rather to make analytical generalizations, where our findings help us to challenge and amend theorizing in the field (Yin, 2003; Saunders et al., 2007). The three firms have seen impressive growth rates in recent years. Between end 2005 and end 2006, Suntech, Trina Solar and Solarfun have grown 165 percent, 320 percent and 285 percent, respectively (Chinavestor, 2007). Indeed, these players have demonstrated strong skills in simultaneously expanding production capacity and keeping prices low despite an unreliable silicon supply. Thus, lower labor and capital expenditures have contributed to the Chinese players’ ability to grow rapidly and to increase production capacity (interview with Macpherson, 2008). In spite of the rapid growth, only Suntech is mentioned as a potential industry leader by analysts (interview with Maycock, 2008 and Ghirardello, 2008), which is mainly due to its vast production capacity and low cost structure. However, the company has long faced an unreliable silicon supply. In addition, the company is still perceived as belonging to the lower end with regard to technology and quality. In general, there appears to be a lack of trust in the Chinese manufacturers, especially from the western European experts. However, when we interviewed experts in newcomer developed markets, such as

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The rise of Chinese challenger firms in the global solar industry Table 6.2

109

Manufacturing capacity

Suntech Gintech First Solar Q-Cells Sharp Ja Solar Trina Solar Yingli BP Solar Sunpower Mitsubishi Solarworld Solarfun

2007

2008

2009

480 210 210 389.2 2070 175 150 142.5 118 212 121 120 88

1100 580 693 700 n/a 425 350 400 360 414 300 338 250

1400 580 910 850 n/a 600 600 600 440 574 360 390 300

Note: All values are accumulated capacity expansion expressed in MW; First Solar is a thin-film manufacturer. Sources: http://static.seekingalpha.com/uploads/2008/1/3/pv_supply_demand_data.gif; http://www.eetimes. com/news/semi/showArticle.jhtml?articleID=201310878; JP Morgan (2008); China REDP (2008); Trina Solar (2007); Suntech (2007, 2008); Solarfun website; Sharp website.

Table 6.3

Profile of the three companies

Year of establishment Estimated production capacity by 2009 Percentage of export to main PV markets in 2008 Sources:

Suntech

Trina Solar

Solarfun

2001 1400 MW >98%

1997 700 MW >95%

2004 300 MW >95%

JP Morgan (2008); China REDP (2008); Trina Solar (2007); Suntech (2007, 2008); Solarfun (2008).

Italy and Spain, both Suntech and Trina Solar are mentioned as leading PV module and cell suppliers. Suntech Power, Trina Solar and Solarfun all share the same low-cost structure and enjoy the benefit from their semi-automatic production mode. Furthermore, like many other cell and module manufacturers, they have all experienced an impressive increase in capacity (Table 6.2). Despite recent problems of securing their silicon supply, Chinese producers have been able to maintain relatively lower prices than the industry average. Lower module prices appear to be a particular advantage when expanding into the more price-sensitive markets such as Italy and Spain. However, the three companies also differ from each other to a certain extent. (For company profiles, see Table 6.3.) Besides timing of entry into cell and module production and size, the three companies also appear to differ with regard to the level of intangible assets, technology, brand recognition and market share. Suntech is a Chinese

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Table 6.4

Conversion efficiency of solar cells(%)

Suntech Trina Solar Solarfun Sunpower (not Chinese) Industry average

Mono-crystalline

Poly-crystalline

16.5 16.8 17.2 22 16–20

15.5 15.1 16.2 – 15–18

Sources: Suntech Power Holdings (2007), Trina Solar (2007), Solarfun (2007), Sunpower (2007), and China REDP (2008).

‘first-mover’ compared to Trina Solar and Solarfun, which have expanded into PV cell and module manufacturing more recently. Trina Solar initially focused on downstream activities, such as system and installations, and targeted the Chinese market. However, by the end of 2007 the company had developed into a major PV cell and module manufacturer focusing on international markets. It appears that Suntech has adopted a different growth strategy compared to the other two. Trina Solar and Solarfun have chosen to leave activities such as cell manufacturing and distribution to Q-cells, and concentrate on labor-intensive module assembly. Conversely, Suntech keeps technology development and know-how in-house (interview with Zhang, 2008). This has allowed Suntech to move close to the technological frontier in the industry; the company claims that it has a new technology ready for production, which will raise their modules’ level of conversion efficiency to 19 percent from around 16 percent (Table 6.4). In addition, the company has also established a thin film plant which starts production in 2009 (Suntech, 2008). It thus appears that Suntech at least may have the capacity to move from being mostly an imitator and acquirer of existing technology to an innovator in the field. The three companies are all highly internationalized. They export over 95 percent of their production and over 80 percent of their revenues are generated from sales in Europe and the US. Furthermore, they all have subsidiaries in the main markets to support their market expansion and tap into resources in the various locations (see Table 6.5). Besides sales activities and international procurement, all upstream activities (for example, cell and module production) of the three companies are concentrated in the Jiangsu province of China. However, the intensity and depth of internationalization varies significantly among the companies: Trina Solar and Solarfun are still focusing on exports through distributors and project developers and have only recently engaged in own project development in the various markets. To the extent that they have foreign subsidiaries, they are mainly aimed at supporting and servicing exports. In contrast, Suntech displays a more complex pattern of internationalization: Suntech’s largest markets in order of importance are: Germany, Spain and the US. About 80 percent of the company’s products are sold in Europe, but the company anticipates a major expansion in the US market in the coming years (The Fletcher School, 2008, p. 37). In January 2007, the company announced the establishment of Suntech Europe to develop its customer base in Europe, the Middle East and Africa (Suntech Homepage, 2008). In 2008, Suntech established the investment fund Global

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The rise of Chinese challenger firms in the global solar industry Table 6.5

Subsidiaries

Subsidiaries Germany Spain Italy France Greece US China (Shanghai) Australia South Korea Sources:

111

Suntech Power

Trina Solar

Solarfun

X X X – – X X X X

X X X X X X X – X

X X – – – X X X X

See companies’ official webpages.

Solar Fund (GSF) in collaboration with other investors aimed at investing in private companies that own or develop projects in the US solar energy sector. Suntech invested a total of €258 million in return for 86 percent of the share equity in GSF. Suntech has also invested in an R&D center located in Australia at the University of New South Wales.

4

THEORIES OF FIRM INTERNATIONALIZATION

In the following, we shall review a number of theoretical explanations for firm internationalization that we shall later use to structure our discussion concerning the rise of Chinese solar panel producers. We shall focus on two bodies of theory, namely the ‘conventional internationalization theories’ and the challenger ‘latecomer theories’. The Conventional Theories of Firm Internationalization According to conventional theories of foreign direct investment (FDI), FDI (that is, investment made to gain a lasting control over an activity in a foreign country) is closely related to the ownership-specific/competitive advantages of the investing firms (Hymer, 1976; Dunning, 1981, 1988). Ownership-specific advantages play two roles in firm internationalization. First, they are the reason why firms invest abroad in the first place. Thus, firms must possess some unique advantages (technological, managerial, reputational and so on) that they can exploit in foreign locations. Second, the possession of ownership-specific advantages explains why MNCs are able to overcome the ‘disadvantages of foreignness’ vis-à-vis indigenous firms. These disadvantages are related to problems of obtaining market intelligence, access to authorities, and access to factor markets, as well as to the costs of managing across borders. The advantages that enable firms to overcome their initial disadvantages of foreignness frequently come out of a dominant and protected home market position (Hymer, 1976). Drawing on Hymer’s understanding of ownership-specific advantages and integrating this with transaction cost theory and location theory, John Dunning formulated the OLI framework (Dunning, 1988). This framework argues that FDI will take place if

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three conditions are met. First the firm must have some ownership-specific advantages (O-advantages) that can be exploited in foreign locations and that can help the firm overcome disadvantages of foreignness. Second, there have to be some advantages in foreign locations over home-country locations that make it desirable to internationalize (L-advantages). Third, it has to be profitable to internalize the transaction rather than using the market to service the foreign market (I-advantages). Generally, conventional theory would expect little FDI from developing countries as firms from such locations would lack the resources, experience, capital and technology that normally explain why and how MNCs embark on FDI. To the extent that conventional theory deals with FDI from developing countries, it would predict that MNCs from such locations would adapt western business models and technologies to developingcountry conditions and invest in even less-developed countries to exploit those converted technologies and business models (Wells, 1983; Lall, 1983). Alternatively, developingcountry firms would invest in other low-cost locations to maintain their cost advantages as these erode in the home country due to economic growth and development (Dunning and Narula, 1996). Thus, in the view of conventional theory, FDI from developing countries would be rare and when it does take place, it would mainly be into less-developed countries to protect competitive positions and to exploit ownership-specific advantages in scaled-down technology. Another dominant strand within conventional internationalization theory focuses on the sociology of firm internationalization and argues that firms appear to be internationalizing in steps, starting from a strong home-market position, investing first in nearby countries, then moving into increasingly distant locations and committing growing resources as they gain more and more internationalization experience (Johanson and Vahlne, 1977). Originally based on studies of Scandinavian firms, this so-called ‘Uppsala theory’ has recently been applied to developing-country firm internationalization (see, for example, Beausang, 2003 or Kuada, 2004). Here the argument is that developingcountry firms would initially invest in nearby developing markets and only with a low commitment. Only gradually would these firms develop the experience and resources needed to take on culturally and technologically ‘distant’ western markets. The Latecomer Literature A number of authors have in recent years argued that as the conventional theories of FDI (that is, the OLI framework and the Uppsala theory) have largely been developed based on experiences of OECD-based firms, they are less suited for analyzing MNCs from locations where O-advantages are weak and where there are widespread market and institutional failures. Moreover, the conventional theories were conceived before the economic globalization process took off in earnest in the 1990s. Thus, the changes in economic activity normally associated with economic globalization (for example, falling transport costs and tariffs, liberalization of trade and investment regimes, technological developments and so on), may have altered the strategic space for developing-country firms dramatically. Seeking to fill some of these lacunas in conventional FDI theory, a number of authors have recently proposed alternative frameworks for understanding FDI from developing countries (Buckley et al., 2007; Mathews, 2006; Ramamurti and Singh, 2008; Tolentino, 2008).

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The antecedents of the latecomer literature can be traced back to the early 1980s where a first wave of outward FDI (OFDI) from Latin America, and West and South East Asia took place. A number of theories and perspectives were elaborated in an attempt to explain this phenomenon. This was the so-called ‘Third World Multinational Corporation’ (TWMNC) literature. Wells’s adapted product life-cycle model (Wells, 1983) and Lall’s localized technological change model (Lall, 1983) are two examples that explain the development from a microeconomic perspective. As OFDI from developing countries declined again during the 1990s, the TWMNC literature fell into obscurity. However, by the 2000s, there was a new and much more profound surge in OFDI from developing countries. Thus, FDI from these countries grew from approximately 11 percent of global FDI in the 1990s to approximately 19 percent. of global FDI in the mid-2000s (UNCTAD, 2008). The emergence of this second wave of MNCs from developing countries – especially, in the Asia-Pacific region – and a dramatic increase in outward investment from emerging markets, led to a new wave of theorizing on MNCs, which is sometimes called the ‘latecomer literature’. The core proposition of the latecomer literature is that the complementarity between the characteristics of the emergent global economy and latecomer and newcomer strategic intent is what drives the remarkable internationalization success of many Asia-Pacific firms. These ‘Dragon Multinationals’ are able to internationalize successfully and in some cases become leading firms despite latecomers’ initial ownership disadvantages (Teece, 2000; Mathews, 2006). Latecomers are able to turn their initial disadvantages into a source of success by leapfrogging to advanced technologies through partnerships and joint ventures with incumbents, by innovating organizationally and strategically, and by focusing on global rather than local markets. All these propositions are condensed in Mathews’s ‘LLL’ theory. Mathews’s LLL Theory Mathews (2006) defines two main characteristics common to latecomer firms, namely their ability to embark on accelerated internationalization and their ability to innovate strategically and organizationally. In contrast to companies from the Triad countries, which are more likely to have a regional outlook in their internationalization process, the latecomers tend to adopt a global outlook from the start (Rugman, 2003). In a very rapid sequence after inception, they will move towards exports and international production, thus skipping the stages approach predicted by conventional internationalization theory. This argument draws in many respects on the born global theory (see, for example, Oviatt and McDougall, 1994 or Madsen and Servais, 1997). Thus, in line with the born global theory, the latecomer theory predicts that latecomer firms will move rapidly into international markets, possibly not even having initial sales in their home market (McKinsey & Co., 1993; Oviatt and McDougall, 1994; Knight and Cavusgil, 1996). According to Mathews, the accelerated internationalization is made possible by organizational and strategic innovation in the latecomer firms. Mathews calls these innovations for ‘linkage’, ‘leverage’ and ‘learning’, thus the LLL model. This model is explicitly formulated as an alternative to the OLI, stressing that initial strong O-advantages are not necessary to become a successful internationalizer. Thus, through linking, learning and

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leveraging, latecomer firms successfully circumvent their initial technological, financial and organizational disadvantages: through linkages, the latecomer firms access technology and know-how developed elsewhere (Li, 2007) and use these as ‘springboards’ for internationalization (Luo and Tung, 2007). Linkages to foreign firms can be formed in a number of ways, for example, as strategic alliances (for example, outsourcing collaborations, original equipment manufacturer (OEM) contracts, license agreements, franchising) or equity-based collaborations (for example, joint ventures). In addition to linkage abilities, Mathews argues that latecomer firms are particularly skilled at leveraging their resources; that is, diffusing acquired knowledge and technology internally. For instance, the assets acquired through linkages are combined with a firm’s existing assets to enhance productivity and develop new advantages. The final observation by Mathews is that latecomer firms presumably have a strong ability (and incentive) to build new advantage from experiences in previous linkage and leveraging processes. This type of organizational learning ability is akin to Teece et al.’s (1997) notion of ‘dynamic capabilities’.

5

EXPLAINING THE RISE OF CHINESE SOLAR PRODUCERS

In the previous section, we described how the Chinese solar industry has grown from almost nothing to become a world leader in just a few years, and present in most of the world’s major markets. This was achieved without any initial home market strength. Chinese producers have moved from positions as OEMs servicing western incumbents with standardized low-cost inputs, to become own-brand manufacturers. It even appears that some of the Chinese producers are bridging the technology gap to incumbents. To what extent can the received theory help us understand this remarkable internationalization? Applying the Latecomer Theory Conventional perspectives on developing-country-based MNEs fail to explain the pace and scope of the internationalization of the Chinese solar panel manufacturers. Indeed, the three case study companies have moved rapidly into international markets. In spite of being young companies (established in 1997, 2001 and 2004, respectively) more than 95 percent of their sales are abroad. They have opened numerous subsidiaries in main PV markets such as Germany and Spain, but also in emerging PV markets such as South Korea and Australia. The spectacular rise of the Chinese solar industry took place against the backdrop of an almost non-existent domestic market for solar PVs. Thus, the Chinese producers were essentially born globals in the sense both that from the start they had a global market in mind and that their activity was overwhelmingly export oriented. Furthermore, conventional theory would tend to predict that firms with little prior internationalization experience will initially internationalize into culturally and geographically nearby markets. However, in our three case studies, the internationalization has been upmarket, that is from the South to the North; 96.5 percent of Trina’s revenues in 2007 were generated by its European sales (Trina Solar, 2007), 96 percent of Solarfun’s revenues were generated from sales in Spain (46 percent), Germany (36 percent), France (8 percent) and Italy (6 percent), and 80 percent of Suntech’s products were sold in Europe (The Fletcher School, 2008, p. 37).

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According to the latecomer theory, the explanation of this rapid internationalization would be that these companies had a strong ability to acquire complementary resources and technologies through international linkages. Indeed, we found that both Trina Solar and Solarfun were able to leapfrog into newer technology by using the capital received by foreign investors to buy new technology. For example, Solarfun was supported by investment from the leading renewable energies investor Good Energies, which by 2007 held a stake in Solarfun of 34.5 percent of equity. In general, it appears that the three Chinese producers were very effective in acquiring new technology, knowledge and market know-how through the collaborations. Thus, they essentially used their OEM positions as springboards for internationalization, for example, by acquiring new technology and/or customers. The collaboration between Solarworld and Suntech Power, for instance, helped the latter to enter the German market and raise brand awareness as the German incumbent had to rely on its Chinese supplier in order to meet growing demand in its domestic market (interview with Macpherson, 2008). In line with the latecomer theory, it appears that the Chinese producers are not technological leaders. Indeed, the Chinese level of conversion efficiency is still in the lower end of the industry average (see Table 6.4). Thus, the Chinese manufacturers still appear to imitate and acquire existing technology rather than operating at the technological frontier. Nevertheless, Chinese manufacturers seem to have succeeded in catching up technologically. They started as low-cost, low-technology suppliers, but succeeded in moving on to becoming global consolidators of mature technologies. The source of this upgrading appears to a large extent to have been a strong ability to foster international linkages and alliances. For instance, Solarfun and Trina Solar have engaged in collaborations with the German technology leader Q-Cells, with the aim of improving the efficiency of the Chinese panels and reducing the incumbent’s cost structure. Furthermore, Suntech’s technological upgrading has, among other things, been based on collaboration with the University of New South Wales in Australia, which today constitutes the company’s R&D center (interview with Macpherson, 2008). A Critical Assessment of the Latecomer Theory Based on the above analysis, it appears that the Chinese solar panel manufacturers, in accordance with the predictions of the latecomer theory, have moved very rapidly into international markets, and that they are indeed challenging western incumbents in their home markets. It also appears that Chinese challenger firms, as predicted by the latecomer theory, have compensated for the lack of initial technological and market advantages by skillfully linking up to foreign firms, which have provided them with capital, technology and markets. In short, it appears that the Chinese solar producers have followed trajectories similar to those described by the latecomer theory. But on closer inspection, the paths followed by the producers may seem rather conventional. First, while the solar manufacturers have indeed displayed very rapid internationalization, this internationalization is not yet very deep. The internationalization is mainly based on exports and the FDI undertaken is mainly (but not exclusively) undertaken to support exports. Although there is evidence that the Chinese producers attempt to use international acquisitions and strategic alliances as springboards for technology upgrading and strategic positioning, more complex

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international value chain configurations are still at an early stage; essentially, the Chinese solar manufactures remain Chinese firms servicing the world market with low-cost, mature technology produced in China. Second, contrary to the description offered by latecomer theory, the Chinese producers actually had rather strong initial ownership-specific advantages on which they could base their internationalization. Solarfun, for instance, is a spin-off from a large stateowned conglomerate and has therefore had access to the capital and organizational and managerial capacity that is required for accelerated internationalization. Moreover, all three companies enjoyed privileged access to support from the Chinese government in terms of low taxes, cheap land, and cheap electricity. The most important ownership-specific advantage for Chinese producers is arguably their low cost base. Thus, it appears that the firms have been very effective in combining their low-cost base with increasingly sophisticated technological and organizational capabilities, thus offering products of improving quality at low cost. A related advantage for Chinese producers is that they have been able to supply quite large amounts of modules at short notice and at low cost, which is definitely a considerable competitive advantage compared with many European and US incumbents. Finally, we should point out that the apparent latecomer dynamics seen in the solar industry to a large extent may be industry specific and tied to a special historical situation. Thus, it appears that the rise of the Chinese solar panel producers was made possible because the industry on the one hand experienced rapidly growing markets and low levels of consolidation, and on the other, had a technology that was relatively mature and standardized. These two factors in combination may have allowed Chinese latecomers to carve out market shares at manageable entry costs. We conclude that although the Chinese solar manufacturers at first sight act in accordance with the latecomer theory, a closer inspection reveals that there are fairly conventional forces at play as well, for example, privileged access to resources from the Chinese government, cross-subsidization within industrial conglomerates, and embeddedness in a low-cost base that is second to none. What remains of the latecomer theory is, in our view, that it identifies and elaborates on a particular O-advantage – namely a dynamic capability related to linkage, leverage and learning abilities – that have allowed the Chinese producers to overcome their initial technological disadvantages. In doing that, the latecomer theory provides a valuable contribution to FDI theory, but to launch this insight as an alternative to the conventional FDI theory in general and the OLI framework in particular as Mathews does, is to overstate the case. After all, as pointed out by Dunning (2006) and Narula (2006), the proponents of the OLI framework have long accepted and integrated the insights of the dynamic capabilities perspective (see, for example, Teece, 2000) in the understanding of O-advantages, arguing that with globalization, firms’ abilities to build new advantages through internationalization become increasingly important (see, for example, Dunning, 2000).

6

CONCLUSION AND IMPLICATIONS

Chinese manufacturers were pulled into the global solar PV industry at an accelerated pace by the opportunities offered by the ‘feed-in tariffs’ and generous government

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incentives, combined with the strong locational advantages of China. Within a few years, the Chinese manufacturers moved from being OEMs offering low-cost supplies to western brand manufacturers, to become global consolidators of mature technology. This technological catch-up was largely based on a strong ability to learn from foreign firms and integrate existing technologies with a low-cost base. However, it appears that the Chinese solar manufacturers now find themselves at a technological watershed. Either they will seek to build internal technological capabilities to raise conversion efficiency and develop new technologies, thereby potentially becoming global first movers. This appears to be the strategy of Suntech. On the other hand, they may leave technological developments to strategic alliances with other firms and concentrate on their current core competency which is the ability to produce at low cost with a reasonable quality. This appears to be the strategy of Trina Solar and Solarfun. Indeed, the future configuration of the solar industry may depend on the technological strategies currently being contemplated by the Chinese players. Seen from the perspective of incumbents, the Chinese challenge will not become any less in the future. In fact, the financial crisis with its falling demand and oversupply of cells may imply that the competitive position of Chinese low-cost producers will be further improved. In this situation, incumbents can adopt various strategies in response to the Chinese challenge. One strategy is to lower costs by moving more value chain functions to low-cost locations; another is to bet on technological leapfrogs and hope that Chinese latecomers will be unable to follow suit in an intensified technological race. In the short term, a third strategy is more likely, namely a shelter strategy, whereby governments are persuaded to raise entry barriers against Chinese low-cost producers. The pressure by companies such as Conergy and Solarworld on national governments and the European Union to discourage renewable energy investors from buying Chinese panels and cells (Comfort and Weiss, 2008) suggest that protectionism is a very real danger in this industry. In terms of implications for theory, our study suggests that the latecomer theory indeed captures many aspects of the rise of Chinese solar panel manufacturers. Chinese manufacturers have embarked on accelerated internationalization into advanced countries. Furthermore, Chinese firms proved exceptionally apt at acquiring new competencies through linking, leveraging and learning from foreign firms. This has allowed these companies to embark on a path of continuous technological and organizational upgrading. We argued, however, that the latecomer theory, in making some relevant observations, may overstate its case. After all, the Chinese solar producers had some fairly conventional O-advantages, such as support from the Chinese state, ample opportunities for cross-subsidization within industrial conglomerates, and a second to none low-cost base. This, in combination with strong learning and upgrading capabilities, made the Chinese producers increasingly powerful competitors. Our conclusion is that while the latecomer theory may indeed identify and describe an important O-advantage related to linkage, leverage and learning in latecomer firms, this advantage is simply a dynamic capability which can be comfortably analyzed through the lens of conventional FDI theories. On a final note, we shall emphasize that trying to generalize about Chinese MNCs will become an increasingly perilous endeavor in the future as the Chinese economy grows to become the second largest in the world. Rather than viewing China as a monolithic economy, it will have to be analyzed as if it were many economies, where some are on a par with most western economies while others resemble those of developing countries.

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Applying a regional rather than national perspective on MNC evolution in China may thus be a highly appropriate avenue for future research.

REFERENCES Beausang, Francesca, (2003), Third World Multinationals: Engine of Competitiveness or New Form of Dependency?, London: Palgrave Macmillan. Buckley, P.J., Chengqi Wang and Jeremy Clegg (2007), ‘The impact of foreign ownership, local ownership and industry characteristics on spill-over benefits from foreign direct investment in China’, International Business Review, 16, (2), April, 142–58. China Renewable Energy Development Project (China REDP) (2008), ‘Report on the Development of the Photovoltaic Industry in China: 2006–2007’, Washington, DC: World Bank. Comfort, Nicholas and Richard Weiss (2008), ‘Conergy and Solarworld Seek Protection from Chinese Price Dumping’, Bloomberg, August 21, available at: http://www.bloomberg.com/apps/news?pid=20601100&sid =aCkmL3g0RBJQ. Dunning, John H. (1981), ‘Explaining outward direct investment of developing countries: in support of the eclectic theory of international production’, in Krishna Kumar and Maxwell G. McLeod (eds), Multinationals from Developing Countries, Lexington, MA: Lexington Books. Dunning, John H. (1988), ‘The eclectic paradigm of international production: a restatement and some possible extensions’, Journal of International Business Studies, 19 (1), 1–31. Dunning, John H. (2000), ‘Globalization and the theory of MNE activity’, in N. Hood and S. Young (eds), Globalization of Multinational Enterprise Activity and Economic Development, Basingstoke: Palgrave Macmillan, pp. 21–43. Dunning, John H. (2006), ‘Comment on dragon multinationals: new players in 21st century globalization’, Asia Pacific Journal of Management, 23 (2), 139–41. Dunning, John H. and Raineesh Narula (1996), ‘The investment development path revisited: some emerging issues’, in Dunning and Narula (eds), Foreign Direct Investment and Governments: Catalysts for Economic Restructuring, London: Routledge, pp. 1–38. Fawer, Matthias (2006), Sustainability Report: ‘Solar Energy 2006: Light and Shade in a Booming Industry’, Bank Sarasin, December. Fawer, Matthias (2007), Sustainability Report: ‘Solar Energy 2007: The Industry Continues to Boom’, Bank Sarasin, November. Hymer, Stephen (1976), The International Operations of National Firms: A Study of Direct Foreign Investment, Cambridge, MA: MIT Press; 1960 PhD thesis. Johanson, J. and J. Vahlne (1977), ‘The internationalization process of the firm: a model of knowledge development and increasing foreign market commitments’, Journal of International Business Studies, 8 (1), 23–32. JP Morgan (2008), ‘The Solar Cell Supply Chain’, Asia Pacific Equity Research report by G. Hariharan, S. Sato and C. Liu. Knight, G. and S. Tamer Cavusgil (1996), ‘The born global firm: a challenge to traditional internationalization theory’, in Cavusgill (ed.), Advances in International Marketing, Greenwich, CT: JAI Press, pp. 11–26. Kuada, John (2004), ‘Internationalization of firms from developing countries: towards an integrated conceptual framework’, paper presented to the ‘Globalization, Internationalization of Companies and Cross Cultural Management’ conference, Ålborg, October. Lall, Sanjaya (1983), The New Multinationals, Paris: IRM. Li, Peter P. (2007), ‘Toward an integrated theory of multinational evolution. The evidence of Chinese multinational enterprises as latecomers’, Journal of International Management, 13, September, 296–318. Luo, Yadong and Rosalie L. Tung (2007), ‘International expansion of emerging market enterprises: a springboard perspective’, Journal of International Business Studies, 38 (4), 481–98. Madsen, T.K. and P. Servais (1997), ‘The internationalization of born globals: an evolutionary process?’, International Business Review, 6 (6), 561–83. Mathews, John A. (2006), ‘Dragon multinationals: new players in the 21st century globalization’, Asia Pacific Journal of Management, 23, 5–27. McKinsey & Co. (1993), Emerging Exporters: Australia’s High Value-Added Manufacturing Exporters, Melbourne: McKinsey & Co., Australian Manufacturing Council. Merrill Lynch (2008), ‘The sun isn’t setting on solar yet’, Industry Overview by M. Heller, B. Hodess, L. Yeung, J. Jacobelli, M. Yates and F. Hill. Narula, Raineesh (2006), ‘Globalization, new technologies, new zoologies, and the purported death of the eclectic paradigm’, Asia Pacific Journal of Management, 23, 143–51.

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Oviatt, Benjamin M. and Patricia P. McDougall (1994), ‘Toward a theory of international new ventures’, Journal of International Business Studies, 25 (1), 45–64. Ramamurti, R. and J. Singh (2008), ‘Indian multinationals: generic internationalization strategies’, Ch. 6 in Ramamurti and Singh (eds), Emerging Multinationals from Emerging Markets, Cambridge and New York: Cambridge University Press. Renewables Global Status Report (RE 2007), ‘Renewable Energy Policy Network for the 21st Century’, available at: www.ren21.net. Rugman, A.M. (2003), ‘Regional strategy and the demise of globalization’, Journal of International Management, 9, 409–17. Saunders, Mark, Phillip Lewis and Adrian Thornill (2007), Research Methods for Business Students, 4th edn, Harlow, UK: Pearson Education Limited. Teece, David (2000), ‘Firm capabilities and economic development: implications for NIEs’, in L. Kim and R. Nelson (eds), Technology, Learning and Innovation, Cambridge: Cambridge University Press, pp. 105–28. Teece, D.J., G. Pisano and A. Shuen (1997), ‘Dynamic capabilities and strategic management’, Strategic Management Journal, 18 (7), 509–33. Tolentino, Paz Estrella (2008), ‘Explaining the competitiveness of multinational companies from developing economies: a critical review of the academic literature’, International Journal of Technology and Globalisation, 4, 23–38. United Nations Conference on Trade and Development (UNCTAD) (2008), World Investment Report Part One: Transnational Corporations and the Infrastructure Challenge, New York and Geneva: United Nations. Wells, Louis T. (1983), Third World Multinationals, Cambridge, MA: MIT Press. Yin, Robert K. (2003), Applications of Case Study Research, 2nd edn, New York: Sage.

Online Articles Chinavestor (2007), China Solar Energy Company Overview, available at: http://www.chinavestor.com/blog/ PermaLink,guid,c555120e-8e92-4425-a07e-7fa0efb58211.aspx. The Fletcher School (2008), ‘Scaling Alternative Energy: the Role of Emerging Markets. Dialogue Synthesis Report’, Joint Initiative by the Center for International Environment and Resources Policy and the Center for Emerging Markets Enterprises of the Fletcher School, Tuft University, available at: http://fletcher.tufts. edu/ScalingAlternativeEnergy/index.shtml.

Company Reports Solarfun (2008) and Schuco Enter Into 47MW Sales Contract, available at: http://investors.solarfun.com.cn/ releasedetail.cfm?ReleaseID=321743. Sunpower (2007), Reports Third Quarter 2007 Results, available at: http://investors.sunpowercorp.com/ releasedetail.cfm?ReleaseID=269912. Suntech (2008), Reports Second Quarter 2008 Financial Results, available at: http://www.prnewswire.com/ cgi-bin/stories.pl?ACCT=109&STORY=/www/story/08-20-2008/0004870396&EDATE=. Suntech Power Holdings (2006), Annual Report, available at: http://media.corporate-ir.net/media_files/ irol/19/192654/investorkit/Suntech2006AnnualReport.pdf. Suntech Power Holdings (2007), Annual Report, avaialble at: http://phx.corporate-ir.net/External.File?item= UGFyZW50SUQ9MzM2OTIxfENoaWxkSUQ9MzIxMzAyfFR5cGU9MQ==&t=1. Trina Solar (2007), available at: http://library.corporate-ir.net/library/20/206/206405/items/303030/ TrinaSolarLTD20F.pdf.

Official Websites Suntech, available at: http://www.suntech-power.com/ (accessed 21 November 2008). Sharp, available at: http://sharp-solar.com/ (accessed 21 November 2008). Solarfun, available at: http://www.solarfun-power.com/ (accessed 21 November 2008).

Interviews Chris Brown, China Solar Energy Director at Namkung Research; 15-minute telephone interview, June 26, 2008.

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Paul Combs, VP at Solarfun; interview conducted during a one-hour company visit at Solarfun’s international sales office at the BH tower in Shanghai, November 12, 2008. Marco Ghirardello (customer), Chief Operations Officer at Solar Advies – Solartechno NL; 30-minute interview, October 22, 2008. Harold Hoskens, CEO at Solarfun; 42-minute telephone interview, September 16, 2008. Arnold Jäger-Waldau, Institute for Environment and Sustainability; 45-minute telephone interview conducted in collaboration with DISTRES research assistants and co-workers Susanne Njekal and Pembe Bahadir, October 30, 2008. Rory Macpherson, Investor Relations at Suntech Power Holdings; 20-minute telephone interview, July 16, 2008. Paul Maycock, CEO at PV Energy Systems, senior continuing advisor to the PV industry; 30-minute telephone interview, March 25, 2008. Stig Are Mogstad and Lars Halvor Langmoen (European competitors), Vice President and Business Development Manager at NorSun Corporation; 20-minute telephone interview, April 16, 2008. Andre Nobre, Project and Logistic Manager at Solar-Fabrik in Singapore (European competitor); data collected through e-mail exchanges and a questionnaire. Gianni Operto, Investment Director at Good Energies – a leading global investor in energy and energy efficiency industries; an interview lasting approximately one hour, conducted in collaboration with DISTRES research assistants and co-workers Susanne Njekal and Pembe Bahadir, October 13, 2008. Jess Osborne, from Investing Company Thomas Weisel Partners; a 40-minute telephone interview, conducted in collaboration with DISTRES research assistants and co-workers Susanne Njekal and Pembe Bahadir, October 31, 2008. Roberto Parato (customer), Engineer at Enerray – an Italian PV installer – responsible for supervising logistics and commercial relationships with Asian suppliers; 20-minute interview, October 16, 2008. Rolf Wüstenhagen, Vice Director, Institute for Economy and the Environment at the University of St. Gallen; 30-minute interview, March 26, 2008. Yimei Wong, Global Procurement Manager at Trina Solar and organizer of JUCCCE; 42-minute skype conference, June 18, 2008. Boxun Zhang, CFO at Suntech Power Holdings; 30-minute interview conducted during an informal meeting at the JUCCCE conference, Yi yang Hotel, Beijing, November 11, 2008.

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International entrepreneurship in the offshore renewable energy industry Nicolai Løvdal and Arild Aspelund

1

INTRODUCTION: THE NEED FOR INTERNATIONAL DIFFUSION OF RENEWABLE ENERGY TECHNOLOGY

The world’s dependency on hydrocarbons as a dominating source of energy is about to become a global problem. Not only does it cause regional political instability, as the battle for control over new and increasingly scarce oil and gas reservoirs intensifies, but the emissions from the use of fossil fuels are also the dominating contributor to increased global greenhouse effects (IEA, 2008, p. 329). This chapter discusses how new innovative firms can play an important role in solving this problem through global dissemination of new renewable energy technology. Due to the political and environmental problems related to fossil fuels, intergovernmental institutions and national governments in most countries have developed plans to increase the share of renewable energy. Tangible examples are, for example, the Kyoto agreement and the EU’s Renewable Energy Directive (CEC, 2008). Many countries have implemented support schemes to facilitate the development of renewable energy in general and some have introduced tailormade schemes towards chosen natural resources, such as, for example, offshore renewable energy. Common to all these agreements and support schemes is that they require successful development and dissemination of new technology in order to meet their objectives. To ensure the former, successful development of new renewable energy technologies, many governments invest heavily in R&D and full-scale demonstration programs. In order to ensure the latter, rapid and extensive dissemination of viable new energy technologies, we must rely on motivated market actors that can carry new innovations rapidly and extensively into international markets. This can be done effectively by motivating existing multinational organizations, such as energy companies or technology providers that already have experience in industrialization of new technologies worldwide. Alternatively it can be achieved by internationalization of newly established firms as discussed in this chapter. Intuitively, the solution including the multinational corporations (MNCs) might seem the most effective; however, both previous experience and the data we shall provide in this chapter show that new firms might be even more effective carriers of new energy solutions than established actors. The reason for this is that new firms have fewer incentives for preserving current energy regimes and they also show a remarkable innovativeness in terms of coming up with radical new solutions. As a case industry we shall use the emerging offshore renewable energy industry. According to the International Energy Agency (IEA) the theoretical potential of wave and tidal energy sums up to more than 80,000 TWh/year (IEA, 2007). The potential for 121

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offshore wind is also tremendous. In the European Wind Energy Association’s scenarios, their reference case suggests 35,000 MW cumulative installed offshore wind capacity in Europe within 2020 (EWEA, 2008). Hence, there is a vast and global energy and industry potential for these technologies. This chapter contributes to the new energy debate by presenting and discussing the internationalization of new firms as a viable strategy for rapid and extensive dissemination of new energy solutions. We do this by departing from the literature on international new ventures (INVs) and employ a triangulation method based on quantitative and qualitative data from the offshore renewable energy sector in order to provide managerial and policy lessons on how new energy solutions can rapidly and extensively be deployed globally.

2

THEORETICAL BACKGROUND: INTERNATIONAL START-UPS

Traditionally, international business has been viewed as the arena of the large players, but in the past couple of decades small international firms have received more attention and recognition as viable international players (OECD, 2000). The newest trend is that even newly established firms play a significant part in international trade (Rialp et al., 2005; Aspelund et al., 2007). These newly established international firms have been given different names in the literature, but the most frequently used, ‘international new ventures’ (INVs), was coined by Oviatt and McDougall in a seminal article in the Journal of International Business Studies in 1994. They defined an INV as ‘a business organization that, from inception, seeks to derive significant competitive advantages from the use of resources and the sales of outputs in multiple countries’ (p. 49). This definition has been broadly accepted and widely used in the literature thereafter. One of the most interesting features of INVs, in addition to their rapid and extensive internationalization strategies, is that they are extremely good carriers of innovations. INVs are often formed in order to exploit business opportunities that arise from new technologies (Keeble et al., 1998; Crick and Jones, 2000; Aspelund and Moen, 2001; Stray et al., 2001) when industries goes through major shifts (Jolly et al., 1992). This makes INVs excellent carriers of new innovations on a global level as they effectively disseminate new technologies when the existing technological regimes become obsolete (Aspelund and Cabrol, 2009). In the following we shall use the literature on INVs to understand how such firms could facilitate rapid and extensive global dissemination of clean energy innovations by unveiling some of their characteristics and describe under which conditions they tend to emerge. Characteristics of Founders of International New Ventures There has been a good deal of research focusing on the role of the entrepreneurs in the internationalization process of new firms. One of the most frequently reported findings is that the entrepreneurs instill a strong international orientation in their

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organizations right from inception. International orientation is defined as ‘proactive and risk-seeking behavior that crosses borders and is intended to create value in organizations’ (McDougall and Oviatt, 2000, p. 903) and a key question to ask is where this international orientation stems from. One of the likely explanations was put forward in one of the earliest studies of INVs by McDougall et al. (1994). They found that entrepreneurs with extensive international business experience developed alertness to international business opportunities by their unique insight into business opportunities that arises with heterogeneity in factor costs and market demand across national borders. Hence, entrepreneurs with extensive international experience have a stronger tendency to establish international start-ups. This finding has found support in both qualitative (Jolly et al., 1992; Kuemmerle, 2002) and quantitative (Bloodgood et al., 1996) studies. However, as former business and educational experience is likely to affect the choice, it is also equally likely that current activities are influential. In particular, it is likely that INV entrepreneurs obtain a lot of business-related information through different communities of practice in which they participate. Research communities are good examples of such communities of practice. Research communities are normally highly international and participants often share large amounts of detailed information, not only on particularities of technological advances, but also on market development for potential applications, international research funding opportunities and governmental support schemes. It is likely that both the direction of internationalization and the extent of it might be based on information obtained through communities of practice. Hence, we propose: P1a: International entrepreneurs adopt an international orientation on their new ventures due to their extensive international experience and interaction with their international community of practice. The focus on international orientation deserves merit, because instilling an international orientation from the outset is possibly the most defining feature of INVs and a precondition for rapid expansion. One example of a study which found that the lack of international orientation inhibited the internationalization process is found in Crick and Jones’s (2000) study of UK high-tech firms. They found that technology entrepreneurs often had a tendency to develop ‘technological myopia’ and neglected the natural, and indeed necessary, internationalization of marketing activities. Moreover, McDougall et al. (1994) found that early international orientation is very favorable for the organization because the often far more painful change process associated with internationalization in later stages would then be avoided. This finding is consistent with a broad range of studies throughout the internationalization literature history showing that early strategic decisions regarding internationalization have a long-term effect on international performance (Simmonds and Smith, 1968; Bilkey and Tesar, 1978; Lee and Brasch, 1978; Cavusgil and Nevin, 1981; Moen and Servais, 2002). Hence, P1b: The new venture’s early international orientation is a necessary and facilitating factor for rapid and extensive internationalization.

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Characteristics of International New Ventures Even though some INVs might tell impressive stories of extreme growth and profitability, the general case is that newly established firms have severe resource constraints (Vesper, 1990; McDougall et al., 1994). International start-ups might be even more exposed to resource constraints than the average new firms as they need to establish international sales and marketing capabilities at the same time as they deal with all the other entrepreneurial challenges such as product development, finding investors and building an organization. A natural consequence of the resource limitations is that new firms find that ‘textbook solutions’ to strategic problems that they face might not be a viable option as they simply cannot afford them. This means that the strategic freedom of new firms is limited in comparison to established actors with a credit record, higher credibility in the market and more organizational resources at their disposal. We propose: P2a:

An INV’s strategic freedom is constrained by limited firm resources.

In order to solve the problem of resource constraints INVs often turn to hybrid structures to govern their international activities (McDougall et al., 1994; Gabrielsson and Kirpalani, 2004; Aspelund et al., 2009). They are frequently involved in partnership arrangements so that they can rely on the resources of a larger partner to perform necessary tasks that they cannot afford to do in-house (Acs and Terjesen, 2005). Most of the studies that have been done on the partnership arrangements of INVs focus on how they use partners to establish international sales and marketing capabilities, but there is no reason why the same thing should not apply to activities at the other end of the value chain. Hence, there is a strong tendency for INVs to actively seek a larger complementary business partner to perform resource-demanding tasks that the organization can ill afford to do in-house. P2b: New ventures often rely on hybrid structures and partner resources in their internationalization. The literature on INVs often gives the impression that extremely successful, growthoriented and profitable businesses are rare. However, the few quantitative studies with random sampling procedures that have been performed often show a very different picture. Studies from the Scandinavian countries and France show that early and rapid internationalization constitutes the rule rather than the exception among international firms (Madsen et al., 2000; Moen and Servais, 2002; Aspelund and Moen, 2005). Hence, they are very common. Moreover, the studies that have looked into motivation for international expansion specifically conclude that INVs primarily internationalize as a survival strategy rather than a strategy to increase profitability (Oesterle, 1997; Kuemmerle, 2002; Aspelund and Moen, 2005). However, the survival motivation appears to be a strong one as INVs reportedly operated on average in three times as many countries as firms with a slower and more restricted internationalization strategy (Aspelund and Moen, 2005). P2c:

Internationalization of new ventures is primarily a strategy to survive.

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The factors mentioned above might lead to the conclusion that due to limited strategic freedom, reliance on partners, weak governance structures and growth strategies based on need, INVs are unreliable carriers of new innovations into new markets. These shortcomings, however, might just be the factors that spur these firms into internationalization as they are strongly motivated by their need for expansion and actively search for appropriate complementary business partners that can help them launch their products and services on a global scale. Characteristics of the Context that Nurtures INVs Policy and institutions are well known to affect innovation and are regarded as central within the tradition of research on innovation systems (Bergek et al., 2008). The concept can, for example, be used to evaluate the conditions to develop new energy innovations in a certain nation (Foxon et al., 2005). Research on how contextual factors, like policy and institutions, lead to internationalization is not very well studied in relation to INVs (Zahra and George, 2002; Etemad, 2004; Autio, 2005; Rialp et al., 2005; Zahra, 2005). McDougall (1989) compared INVs with domestic firms and found that INVs perceived governmental policies more restrictive. However, the study did not address whether this was because INVs seek a more attractive policy context, or if it indicates that INVs are confronted with increased regulatory requirements when competing abroad. When the conditions to develop or commercialize an invention are radically better in a foreign country than in the home country of the start-up this will presumably motivate for internationalization. Different industries have different needs (Malerba, 2002) and research has shown that certain industry factors tend to favor the establishment of INVs (Aspelund et al., 2007). In cases where social added value constitutes a significant part of the value proposition, as with renewable energy, policy and institutions play a more important role. Hence we propose: P3a: Differences in national innovation systems facilitate internationalization of new ventures. As small companies with time and resource constraints, INVs benefit from markets with high levels of standardization. For example in the information and communication technology (ICT) and microelectronic industries we have seen examples that new firms have entered into original equipment manufacturer (OEM) contracts with global manufacturers that have given them high sales volumes in a very short time (Jolly et al., 1992; Gabrielsson and Kirpalani, 2004). The reason why this is possible in these industries is that all equipment operates on common technological platforms and the interfaces between components are standardized. In the general case this means that the entry barrier in the industry is lowered as new entrants do not have to overcome the cost related to adopting specialized interfaces or risk being kept out of the industry by incumbents with proprietary technological systems. P3b: Common technology platforms and international standards facilitate internationalization of new ventures.

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INVs are dependent on access to capital in the first crucial years of their existence. Obviously, they need financial capital in order to overcome the period of negative cash flow that most entrepreneurial firms experience. They also need access to a great deal of human capital in order to develop an efficient organization that can deliver world-class products and services. And most importantly, the creation of INVs requires motivated international entrepreneurs that are willing to forgo other safer career options to dedicate themselves to the life of an international entrepreneur. In other words, the establishment rate of INVs is dependent on the availability of relevant financial, human and entrepreneurial capital for an industry. If the environment is conductive to supporting the emergence of a new industry there are several ways in which capital can be stimulated. First, national and supranational governmental institutions can signal long-term commitment and industry-specific investments to initiate and develop an industry. Such signals and commitments can to a large extent reduce the perceived risk to investors and potential entrepreneurs of investing time, money and effort in a new industry. Moreover, the media and political attention given to specific industries can increase access to capital in an industry because business opportunities in the industry become well known to the public and because the general level of social status associated with the industry is increased. Hence, our last proposition: P3c:

3

Supranational agreements facilitate internationalization of new ventures.

METHODICAL ISSUES: TRIANGULATION OF DATA FROM THE OFFSHORE RENEWABLE ENERGY INDUSTRY

The present investigation is a case study with multiple case data and multiple units of analysis (Yin, 2003). The case is the offshore renewable energy industry and the units of analysis are the three levels in which entrepreneurs, their new ventures and the context are embedded. To ensure a rigorous industry case study and enhance validity we have triangulated qualitative and quantitative methods (Gibbert, 2008). The combination of methods increase accuracy ‘by collecting different kinds of data bearing on the same phenomenon’ (Jick, 1979, p. 602). This procedure is also suggested by Rialp et al. (2005) who argue that this approach is appropriate for studying complex and context-specific phenomena such as internationalization processes. Our first data point is a quantitative survey targeted at the commercial actors in the offshore renewable industry. The data were collected in 2007 through a web survey that was sent to all companies worldwide that are developing a technological concept to harness large-scale wave or tidal energy. The companies were identified by an assessment of the IEA (2006) list, through internet search and extensive use of personal networking. Only companies that aimed to commercialize their solution through a dedicated organization were included. That is, embryonic projects and pure university research projects were excluded. Through this process we also identified a number of companies that were not on the IEA’s list and included them in the study. The survey was sent to 90 companies worldwide. To ensure commitment and avoid getting answers from persons outside the target group, telephone contact was made on a managerial level before sending the web survey to personal e-mail addresses. Fifty companies

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answered the survey with sufficient quality, which gives a response rate of 56 percent. With this high number of targeted firms and high response rate we consider our sample to be representative of the worldwide population of companies within the offshore renewable energy sector. Our second data point is qualitative in-depth case studies of firms in the industry. These case studies were chosen using a convenience sample method (Eisenhardt, 1989). For this purpose data were collected from publicly available sources (web pages, conference papers, newspapers, magazines, annual reports and so on) and personal interviews with managers in the different companies. Our final data point is qualitative data from institutions supporting the industry. These data have been collected in the same manner as the in-depth company studies above. From an evolutionary life-cycle perspective (Rink and Swan, 1979), the offshore renewable energy industry must be defined as being in an introductory phase. This raises the challenge that official industry data are not easily accessible. However, we think that our methodology has been appropriate to overcome these challenges and at the same time has provided an excellent opportunity to study internationalization processes in the early phases of an industry. The triangulation strategy adds solidity to the study as it enables us to accumulate and ensure reliability and quality of case data from different information sources and also increases our ability to interpret results from different perspectives. One could argue that our focus on one industry reduces the direct transferability of the findings to other sectors, but on the other hand we reduce the risk of getting conflicting results (Rouse and Daellenbach, 1999; Fernhaber et al., 2007).

4

FINDINGS FROM THE OFFSHORE RENEWABLE ENERGY INDUSTRY

The majority of companies that are developing new concepts are start-ups. As Figure 7.1 shows, 74 percent of the respondents classify themselves as ‘new independent ventures’; Other; 6%

Spin-off from a university; 14% Spin-off from a firm; 6%

New independent venture; 74%

Figure 7.1

Type of company

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Mostly in foreign country

42%

58%

First sale of full-scale power park First demo project (1:1) First testing of prototype (1:2-10)

Figure 7.2

38%

62% 86%

14%

Historical or expected location of activities

14 percent are spin-offs from universities; and only 6 percent reported to be spin-offs from established firms. This strongly indicates that most of the new innovations within renewable energy originate from new venture rather than incumbents. The average age of the firms was six years (measured from the year the company was registered). Geographical distribution of the companies is as follows: 49 percent Europe, 35 percent North America, 12 percent Oceania, and 4 percent Asia. Obviously we do not expect all new ventures within offshore renewable energy to be INVs. However, when we consider the historical or expected future location for testing a prototype, carrying out a demonstration project and making a sale to the first full-scale power park, we can conclude that internationalization will be an important issue. As Figure 7.2 shows, 38 percent of the firms will carry out their demonstration projects in a foreign country and more than half of them expect the first sale to be abroad. In the following sections we shall present our findings on the three different levels through quantitative analysis of survey data and short qualitative case examples from offshore wind, wave and tidal. The Entrepreneur Level Survey data show that an increasing number of nationalities represented in the founder team correlate with the urge for rapid internationalization. Those with very strong international experience (32 percent) tend to agree on statements like ‘It is important for our company to internationalize rapidly’ and ‘10 years from now I believe my company will be one of the dominating companies worldwide’. They are also less concerned about theft of technology and cultural problems. Further, they are less reluctant to internationalize before the technology is proven. On the other hand, the survey reveals that respondents who agree to the statement ‘The domestic market still offers sufficient growth potential’ are significantly more likely to agree that ‘10 years from now our company will be a dominating national firm without international activities’. Hence, a domestic orientation correlates with a higher probability of becoming a non-internationalized company in the future. The historical development of the wave energy industry provides good examples on how research-driven communities have given new players an international view of the industry. What today looks like an international vibrant and emerging industry, with a good mixture of new ventures, established large companies and public initiatives, all started in the 1970s1 as national research projects. For many years the whole ‘industry’ was dominated by players from public research institutions. During the 1970s and

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129

Industrial organizations as of May 2009

Organization

Founded

IEA-OES1 OREG2 AWATEA3 OREC4 EU-OEA5

2001 2004 2006 2005 2007

Origin International Canada New Zealand USA Europe

Members

Countries represented

15 120 57 41 55

15 8 5 3 18 (incl. 3 outside EU)

Notes: 1. See www.iea-oceans.org. 2. See www.oreg.ca. 3. See www.awatea.org.nz. 4. See www.oceanrenewable.com. 5. See www.eu-oea.com.

1980s the projects could be characterized as ‘national projects’, but in 1979 the first international Symposium on Wave Energy Utilization was held in Sweden. Two international conferences were held during the 1980s despite it being a more difficult time to find funding to do research on wave energy, and in 1993 the first European Wave Energy Symposium was held with support from the European Commission to invite the international community to discuss results from various national research projects. This conference has now become the European Wave and Tidal Energy Conference and has since been held eight times in different countries. European Union (EU) funding has carried the phenomenon further by supporting international networks; the WaveNet (2000–03) was set up as a European Commission Thematic Network to share understanding and information on the development of ocean energy systems. Some 18 organizations from nine countries took part in the network. The network members addressed such issues as generic technology challenges and produced drafts regarding the development of standards. The work from WaveNet was continued in Coordinated Action on Ocean Energy (2004–07), established through the EU’s 6th framework program with the main objectives to ‘develop a common knowledge base necessary for coherent development of R&D Policies in Europe, the dissemination of this knowledge base and promotion of ocean energy technologies’. The network had 77 partners from 23 countries. Some 84 percent of respondents report that they have participated in international conferences or similar. Starting from the international culture and network that developed between the researchers, a community evolved where new industrial players could interact through international conferences, research projects and public funded networks. In this sense the international industrial network was, and still is, shaped through the relations and culture that already existed in the research communities. Recently, several industry-driven organizations have been established to better serve the industrial needs (Table 7.1) and these all have representation from many nations among their members. Survey data show that 52 percent of the respondents are members of an international industry organization. Companies with membership are more oriented towards rapid internationalization and even show a greater willingness to move their main office to a foreign country (if needed).

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Handbook of research on energy entrepreneurship More than €10 million €3–10 million €1–3 million €500 000–1 million €100 000–500 000 €0–100 000 0%

Figure 7.3

5%

10%

15%

20%

25%

R&D investment distribution

The Venture Level The development of offshore renewable energy concepts is capital intensive, especially when it is deployed into real sea conditions. The Marine Institute of Ireland has established a Development and Evaluation Protocol (Holmes et al., 2007) for wave energy concepts which includes a rough budget. The estimated cost of tests from concept verification to full-scale demonstration project is between €9 and €21 million. Clearly it is a challenge for new ventures to raise these levels of funds and sometimes internationalization is an outcome. Figure 7.3 gives a picture of how much each company has raised and spent so far on R&D. The Dutch company Teamwork Technology is a very good case to illustrate how INVs use international resources to reach their goal to commercialize their innovative idea, and how they manage to reuse the network and knowledge that they acquire from this process. The company was established in 1995 in the Netherlands. Portugal was selected as the country to deploy their prototype, because of Portugal’s attractive feed-in tariff and apparent hassle-free procedure for obtaining a permit to deploy the device. A scaled test of the device was carried out in Ireland, where they had suitable test facilities along with the needed experience. The hull was produced in Romania because of that country’s internationally competitive shipyards. Generator parts came from France and China and the converter from Germany. After a fairly successful deployment of the prototype, the company needed substantial new funding to further develop the business. A subsidiary in Scotland was set up because it was felt that the investment climate in Scotland was better than that in the Netherlands. They found local investors and with a new management team the company received substantial governmental funding from Scotland to develop a second-generation device to be tested in Scotland. This shows how a start-up has navigated internationally to develop the idea that they believed in. As a consequence of the new knowledge and network that Teamwork Technology acquired, they are now in the process of preparing a full-scale demonstration park of a new tidal energy innovation – in Scotland. An example from offshore wind is illustrative to demonstrate the difference between incumbents and new ventures. OWEC Tower is a Norwegian start-up which designed a jacket foundation for offshore wind turbines that allows wind turbines to be installed in deeper water than any traditional foundations allow. The company was established in 2004 by two engineers with experience from the oil and gas sector. The market for offshore wind in Norway is very limited compared to for example, the UK and Germany. Hence, the entrepreneurs decided from the beginning to aim for the international market to get

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Entrepreneurship in the offshore renewable energy industry Foreign opportunities attract us It allows for survival in a competitive market Setting the standard worldwide Desire to increase the speed of internationalization Achieve more at a lower cost Pre-empt competition worldwide Mitigation against limited resources (funding, knowledge, etc.) Avoid domestic market inertia Poor domestic conditions

Figure 7.4

131 80%

71% 69% 65% 63% 58% 49% 47% 40%

Factors explaining international activities

their product developed and commercialized. During the early years they earned money on consultancy work for foreign companies while they developed their own patented design. In 2005 they won a contract with regard to two towers in the €41 million EUsupported Beatrice demonstrator wind park in Scotland led by two big energy companies. The jacket foundations delivered by OWEC Tower were built by a Scottish shipyard. By 2009, OWEC Towers had customers in the US, Germany, the UK and South Korea. HyWind is an internal innovation project in the Norwegian state-owned energy company StatoilHydro. The concept involves a floating wind turbine for use in deep water. According to the company, the technology is especially well suited for energypoor countries with good offshore wind conditions, like the US and Japan. In contrast to OWEC Tower, StatoilHydro installed the first full-size demonstration project in Norway. This was done in 2009 with a project budget of approximately €47 million (NOK 400 million). As we can see, the start-up ventured abroad to find the opportunity to build its first demonstrator, while the incumbent company sought opportunities at home. Note that this example does not indicate the success rate of these innovations and we acknowledge the different complexity involved in the two innovations. Nevertheless, the example illustrates the classical rapid internationalization process of a start-up compared to large established companies. So, do international activities only stem from need and limited resources? The answer to this is no. INVs regard internationalization both as a need and as an opportunity. This is demonstrated in Figure 7.4, which shows a rated list of factors explaining internationalization. ‘Foreign opportunities attract us’ turns out to be the most important factor, but ‘survival in a competitive market’ is right behind, indicating that internationalization is an act of necessity. In the literature introduction we have proposed that INVs make use of hybrid structures to enable their rapid internationalization, and the industry is full of examples of internationalization through partnership. Table 7.2 gives some examples of agreements with different characteristics. To get a deeper understanding of which business activities trigger partnership, we asked the companies which business activities they plan to undertake themselves (inhouse) and which they plan to do through external firms. As Figure 7.5 clearly shows, the companies are planning for a hybrid structure and close cooperation with external partners in nearly all their activities. Only R&D and sales contain less than 10 percent external content.

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Table 7.2

Examples of internationalization through partnership

Company name

Country

Technology

Renewable Energy Holdings

Australia

Wave energy

Ocean Power Technology

USA

Wave energy

AW-Energy

Finland

Wave energy

Wave Dragon

Denmark

Wave energy

SWAY

Norway

Offshore wind

Type of agreements Agreed to give a European utility company exclusive rights to use their technology in the northern hemisphere Agreements with national energy company in France, a national utility company in Spain and construction/energy companies in Australia to establish wave energy projects in the respective countries Building a pilot power park in Portugal with a local construction company Joint venture (JV) with German and Portuguese investors to set up projects in Portugal and a JV with a Welsh company to carry out tests in West Wales (heavily subsidized by the Welsh European Funding Office) Deal to use a UK-based consultancy company as knowledge provider in their technical development

Selling electricity Owning power parks Decommissioning of power parks Maintenance/servicing of power parks Operating power parks Developing power park plans (concession/permits) Assembling the technology Manufacturing the tecnology Selling the technology R&D 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% In-house

Figure 7.5

External firms

Both

Planned business model

The use of a hybrid structure related to all phases of a typical power park should make new ventures compatible with incumbents who already have a strategic interest in this sector. Observations of utility companies in Europe reveal this to be the case. According to the biggest producer of renewable energy in Europe, Statkraft (2008), more than 50 percent of the top 20 European utilities have a stake in new wave and tidal technology through investments in start-ups. It is a similar situation with the more traditional energy companies, even if they are fewer in number. Very few of the companies will manufacture their technology in-house. In fact, more than 50 percent of the companies reported to have three or more foreign nationalities among their consultancies, suppliers and the research institutions with whom they cooperated.

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30%

First demo First international alliance

25% 20% 15% 10% 5%

Figure 7.6

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

0%

Time between first alliance and full-scale demo

As previously shown, a large share of the companies carry out their first full-scale demonstration in a foreign country, and if this is done using a hybrid structure it is likely to give rise to a need for foreign alliances in connection with the demo project. A good indication that this is a correct assumption is the correlation between experience or planned ‘first international alliance’ and ‘time for first full-scale demo’ as shown in Figure 7.6. The Context Level The most important barriers to development of the industry perceived by the companies are lack of long-term governmental support, license challenges and lack of public awareness. All these factors are affected by policy and institutions. Therefore it is not surprising that a proactive government is rated as the most important factor for the companies when they consider undertaking a demo or full-size park project abroad. Some countries have made far more effort to facilitate the development of offshore renewable energy than others.2 This could, for example, be in the form of direct financial mechanisms to aid technology development or market formation, more institutional efforts such as a transparent concession procedure or simply the existence of needed infrastructure, for example, subsea cables. The UK and Portugal are the countries that by far have introduced the most tangible initiatives to support the development of offshore renewable energy. As an example, the UK is the only country in the world to have officially announced a public international concession round for wave and tidal energy sites (700 MW3), and with regard to offshore wind they are in the third round of offshore wind concessions including as much as 25 GW4 in total capacity. In the UK,5 electricity from renewable energy sources is subsidized through renewable obligation certificates (Brock, 1971). Electricity from all the offshore renewable energy sources is given 1.5–5 times as many ROCs as, for example, onshore wind. In Scotland they have even put up a prize of £10 million to the first team that achieves a minimum electrical output of 100 GWh from marine energy.6 In Portugal,7 a ‘pilot zone’ of 320 km2 with simplified concession procedures dedicated to wave energy projects has been defined by the government. At the same time, Portugal has introduced Europe’s highest feed-in tariff (fixed price) on electricity (up to 0.26 €/ kWh) from wave energy demonstration projects. In the survey, Portugal and the UK are perceived as the two most attractive countries in which to build demonstration projects,

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and they are rated as the countries that will earn the highest value creation in the long term. To illustrate the effect of differences between innovation systems we shall use the case of Fobox, a Norwegian wave energy developer. Fobox is about to plan a full-scale demonstration project in Norway, for which they have been granted a license. At the same time they have been granted, after application, access to a public financed subsea cable in England. In Norway the government has recently rejected a proposition to fund subsea cables for this purpose. Both Norway and England have a feed-in tariff applicable to such projects which is in addition to the general market price of electricity. The basic price of electricity is lower in Norway than in England. The feed-in in Norway is 0.1 NOK per kWh (approximately €0.01). In England, where a tailormade feed-in for wave energy demonstration projects has been introduced,8 this tariff is potentially £0.1 per kWh (approximately €0.11), 10 times as much as in Norway. Fobox’s decision is still pending, but as this small example shows it is difficult not to opt for internationalization. A quote from the CEO of the US-based wave energy developer OPT, which went public on the London AIM stock exchange in the UK, underlines how context might affect the access to resources (Taylor, 2006, p. 67): OPT ‘test marketed’ its story in both New York and London, and found that the London capital markets were more knowledgeable about both the general renewable energy sector and about the wave energy arena. This was due in part to the UK having had several wave power companies gaining press coverage, and because the UK government had identified wave energy as an important, strategic source of electrical power. At that time the level of interest in renewables in the US, in particular wave power, was somewhat limited. Traditionally when companies listed they tended to do so in the countries where they were headquartered. But for an increasing number of renewable energy companies it makes perfect sense to look further afield where the political and investor audiences are potentially more receptive, while maintaining a broad international scope.

As the point above is to show how differences might lead to internationalization, equality might lead to the same – through standardization. The electricity sector is highly standardized regarding what is allowed to be fed into the grid and delivered to end customers. As described by Wüstenhagen and Teppo (2004, p. 11): ‘[the customer] cannot tell the difference in the final product that comes out of the wall socket’. This fact might make it more difficult to differentiate offshore renewable energy from other sources of energy, but it certainly makes it easier to sell the technology in several markets. There are various kinds of standardization, as certification makes technology compatible and make it possible, for example, to compare different concepts. Some 77 percent of the companies report that they are aiming for some kind of certification of their technology. The EU funded program EquiMar (2008–2011) is a good example of how barriers might be lowered through the development of international standards. The aim of EquiMar is to ‘deliver a suite of protocols for the equitable evaluation of marine energy converters’. This program involves a consortium from 11 countries representing universities, technology developers and certification agencies. International programs like EquiMar facilitate internationalization through common standards. Other intergovernmental institutions facilitate internationalization through a common understanding of a global challenge. Agreements such as Kyoto (1997) clearly

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200 Oil Crisis

150 100

Kyoto Protocol

250

50

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

0

Figure 7.7

Wave and tidal patents 1960–2008

stated global warming and the need for new renewable energy technology as a common challenge for every country in the world. This challenge demands cooperation between nations and several supranational activities have already taken place. Through the renewable directive (CEC, 2008), the EU have decided to implement at least a 20 percent share of renewable energy in their energy mix by 2020. The acceptance of global warming and scarcity of hydrocarbon resources combined with supranational agreements and plans lead to extensive media coverage of different technical solutions. This again affects the direction of search when entrepreneurs are seeking new business opportunities. The patent statistics9 in Figure 7.7 indicate that this is true. The number of issued patents per year increased after major events focusing on this issue. An assessment of media coverage of offshore renewable energy revealed the same, with a 36 percent growth since the year 2000.10 One company that has attracted a lot of media attention is the Scottish company Pelamis Wave, which installed the world’s first wave energy project under commercial terms in Portugal (due to the high feed-in tariff). This led to many requests from all over the world from people who considered such technology to be an option for their home country. As a consequence, Pelamis Wave designed a brochure tailormade to educate potential project developers to enable them to evaluate the business opportunity. Thus, Pelamis Wave can communicate with many potential customers worldwide without having to spend several hours with each interested party.

5

DISCUSSION

From analyzing the industry for offshore renewable from an INV perspective we conclude that newly established companies play a major role in the emergence and subsequent development of the industry. Start-ups act as international carriers of innovations. This might appear to be a trivial point, but when one analyzes the emergence of an industry from a historic perspective there is a tendency for the big actors taking commanding positions in the early days of the industry to be attributed with the industry’s success and the multiple entrepreneurial actors who have provided the enabling technologies to

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be neglected. An example of this is the familiar story of the auto industry where Ford’s mass production technology has been much lauded while the impact of the broad range of entrepreneurial auto-makers that emerged in the late 1890s are to a great extent neglected. Today, over 90 percent of the population of firms in the offshore renewable industry are university spin-offs or new independent start-ups. However, this situation is unlikely to continue as the industry matures. Many (maybe the majority) of these start-ups will cease to exist as they run out of resources in a competitive market, but a good number of them will survive under the wing of larger actors that will enter the industry as it grows and becomes commercially more interesting. And it is very likely that some of the solutions suggested by the firms in this study will in a more developed form represent the globally dominant industry design 20 years from now. However, this study has revealed another good reason why INVs are good carriers of innovation, and this is specifically related to the manner in which they grow and internationalize. INVs in the offshore renewable industry do not try to monopolize their technology. Rather, they actively seek communities and business partners that can help them advance their project. This is an open innovation practice that works in society’s interests with rapid and extensive dissemination of new energy technologies. Moreover, the open strategy seems to work very well in this industry as both actors are highly motivated to play the game. The new technology-providing firm is resource constrained and has few other strategic options than to partner up with a larger international industry actor in order to get access to funds for further research, building prototypes and subsequent full-scale implementation. The larger actor sees an emerging industry with very bright prospects for the future and strong governmental support on all levels and its inclination would be to take a bet on the best available technology regardless of whether it emerges from its own organization or externally. Together they have complementary resources that can spur the global dissemination of new renewable energy solution. Management Implications Now, what managerial lessons are there in this study for managers in new firms in the offshore renewable industry? Regarding the first level of analysis in this study we find that it is of vital importance that the entrepreneurial team consists of people with international experience so that they possess the capability to conduct international business. This is very important for new ventures in the renewable energy industry because, as this study shows, international alliances and transactions occur very early both upstream and downstream in the value chain. An industry in its infancy, such as the offshore renewable industry, has highly dynamic and competitive conditions, and governmental support regimes and technological paradigms change rapidly. In order to keep the firm up to date with these changes managers need to liaise closely with organizations and communities that supply relevant information. This study has suggested that research communities in the new energy sector might be one of the most important such arenas for the firms in our study. If there is a lack of any of these capabilities or relations in the entrepreneurial team, managers should take active steps to recruit suitably qualified and experienced personnel as soon as possible.

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That said, the ultimate survival path for most new energy INVs lies through partnerships with MNCs, either energy companies or technology providers, that have the financial and technical muscle to push a resource-demanding project all the way through to full-scale implementation. These are the actors that ultimately will decide the dominant design of the future industry. It is likely managers who realize that it is the MNCs, and not the grid, that constitute the primary market for their venture, and hold the best cards to win the ultimate game for long-term survival and the lion’s share of the industry’s vast potential future profit. Implications for Policy To get returns on the social value added is the most difficult part of the business model in renewable energy. Governmental incentives and support are required to reduce the risk for private start-ups and investors. Extensive internationalization among start-ups within renewable energy, combined with the perceived importance of proactive governments, clearly indicates an urge to reduce political risk and seek activities in those nations where they can get hold of required resources. Support schemes should be designed to include start-ups. By promoting an attractive national innovation system, countries are able to guide foreign INVs, in chosen industry sectors, in their direction and thus inject their innovation system with more innovative solutions. This has been a strategy to attract multinational HQs and R&D departments from multinationals, for example, but as far as we know, it has not been used to attract innovations in promising new industries. Local industry will be regarded as a potential partner and, even if there are some head-tohead competitions between national and foreign companies, the national industry as a whole will gain. As we see in the case of Scotland’s £10 million prize, it is even possible to attract attention without paying anything until successful innovations have been realized. Initiatives like these influence the direction of search through word of mouth in communities of practice, and through worldwide media attention. On the other side of the political landscape are those nations that find themselves having start-ups with inventions that may compete on an international level, but that clearly fall outside the national priority area (for example, as with solar energy in Norway). A wise policy in this case would be to facilitate rapid internationalization as the future market is abroad and other nations might offer better innovation systems. The start-up itself will establish foreign partners, have a better chance of success and learn more. Hence, the national resource base will grow as a result of the internationalization even though most of the activities will take place abroad. To be an attractive nation for INVs in the field of renewable energy it is not enough to establish financial incentives, as the perceived barriers are also related to more practical issues. Nations that are able to offer transparent concession procedures and good grid access will stand out as attractive. On a more international level we regard standardization as a facilitating tool to ease the flow of innovations between nations. However, it should be emphasized that standardization in the early stage of an industry should first and foremost be related to the ability to compare innovations and not to short cut the natural evolution of many different concepts.

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Future Research The INV literature track suffers from having too few applied studies (Aspelund et al., 2007). This chapter gives an example of how INV might be used to assess an industry and, by this, takes the INV literature one step further towards a more applied modus with implications for practitioners. We call for other researchers to follow our example. Several points for future research emerge from this study, of which the following seem to be the most promising. On an analytical level we have described the interaction between incumbents and INVs as a good fit and empirically we have shown several examples of partnerships. A detailed analysis would give insight into how these partnerships are perceived from the different sides and thereby provide a better opportunity to advise both INVs and incumbents. Further research on effects from (perceived) differences in innovation systems might give an insight into how policy should be made to reach national and international political targets.A study of the intersection between the phases of R&D and commercialization would probably give the most interesting results, while this is the area where the differences are biggest and the resource limitations of INVs most acute. INVs are important sources of innovation and seem to play an important role in the rapid international diffusion of new renewable energy technologies (and other needed technologies). Research should be done to investigate how national and intergovernmental policy could facilitate INVs. Finally, we would like to point to the fact that the offshore renewable energy industry is an industry in its infancy, although it is arguably already a global industry. The industry itself seems to be born global. To investigate the characteristics of a ‘born global industry’ would be a promising research focus.

6

CONCLUSIONS

This study has discussed how new innovative firms can play an important role in solving our global energy challenges. There are three main conclusions from this study. First, we can conclude that start-ups are an extremely important source of innovation within renewable energy. They are many and have strong motivation to succeed. This creates a foundation for a natural evolution towards more dominant technologies and a strong willingness to internationalize. Second, international start-ups are good carriers of innovative solutions across national borders and actively seek partners with complementary resources. From an incumbent’s view this makes INVs a source of business opportunities with built-in international orientation. For those nations with a strategy to build a competitive industry within this sector, foreign INVs are attractive energizers to their national innovation system. Finally, based on the two previous conclusions, we can clearly state that INVs are important actors in the global business eco-system which drives the diffusion of new renewable energy technology – increasing the global share of energy from renewable sources.

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NOTES 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Triggered by the oil crisis in 1973 when the members of Organization of Arab Petroleum Exporting Countries proclaimed an oil embargo in response to the US decision to re-supply the Israeli military during the Yom Kippur war. For a full overview of all countries see: http://www.iea.org/textbase/pm/?mode=re. See http://www.thecrownestate.co.uk/newscontent/92-pentland-firth-tidal-energy-project.htm. See http://www.thecrownestate.co.uk/round3_briefing_note.pdf. For England and Wales, see http://www.opsi.gov.uk/si/si2009/pdf/uksi_20090785_en.pdf. For Scotland, see http://195.99.1.70/legislation/scotland/ssi2009/pdf/ssi_20090276_en.pdf and http:// www.opsi.gov.uk/legislation/scotland/ssi2009/pdf/ssi_20090140_en.pdf. See http://www.scotland.gov.uk/Topics/Business-Industry/Energy/saltire-prize. See http://dre.pt/pdf1s/2007/05/10500/36303638.pdf. See http://www.berr.gov.uk/whatwedo/energy/environment/etf/marine/page19419.html. Number of patents in class F03B13 (Machines or engines for liquid) with keywords ‘wave’ or ‘tidal’ in title or abstract. Based on a search on the keywords ‘marine energy’, ‘ocean power’, ‘wave power’ and ‘tidal power’ in Factiva.

REFERENCES Acs, Z. and S. Terjesen (2005), ‘Born Global: Two Views of Internationalization’, paper presented at JIBS CIBER Conference. Rotterdam. Aspelund, A. and M. Cabrol (2009), ‘Internationalization as an act of entrepreneurship – economic effects and examples’, in M.V. Bradshaw and P.T. Carrington (eds), Entrepreneurship and Its Economic Significance, Behavior and Effects, Hauppauge, NY: Nova Publishers, pp. 179–92. Aspelund, A. and Ø. Moen (2001), ‘A generation perspective on small firm internationalization: from traditional exporters and flexible specialists to born globals’, Advances in International Marketing, 11, 195–223. Aspelund, A. and Ø. Moen (2005), ‘Small international firms: typology, performance and implications’, Management International Review, 45 (3), 37–57. Aspelund, A., T.K. Madsen and Ø. Moen (2007), ‘International new ventures: review of conceptualizations and findings’, European Journal of Marketing, 41 (11/12), 1423–74. Aspelund, A., R. Sørheim and M.S. Berg (2009), ‘International new ventures and the development of partnerships: a social capital approach’, in K. Ibeh and S. Davies (eds), Contemporary Challenges to International Business, Basingstoke, UK: Palgrave Macmillan, pp. 148–63. Autio, A. (2005), ‘Creative tension: the significance of Ben Oviatt and Patricia McDougall’s article “Toward a theory of international new ventures”’, Journal of International Business Studies, 36 (1), 9. Bergek, A., S. Jacobsson, B. Carlsson, S. Lindmark and A. Rickne (2008), ‘Analyzing the functional dynamics of technological innovation systems: a scheme of analysis’, Research Policy, 37 (3), 407–29. Bilkey, W.J. and G. Tesar (1978), ‘The export behavior of smaller sized Wisconsin manufacturing firms’, Journal of International Business Studies, 9, Spring/Summer, 93–8. Bloodgood, J.M., H.J. Sapienza and J.G. Almeida (1996), ‘The internationalization of new high-potential U.S. ventures: antecedents and outcomes’, Entrepreneurship Theory and Practice, Summer, 61–76. Brock, D.W. (1971), Symposium: John Rawls, A Theory of Justice. Cavusgil, S.T. and J.R. Nevin (1981), ‘Internal determinants of export marketing behavior: an empirical investigation’, Journal of Marketing Research, 18, February, 114–19. CEC (2008), ‘Directive of the European Parliament and of the Council on the promotion of the use of energy from renewable sources’, Brussels: Commission of the European Communities. Crick, D. and M. Jones (2000), ‘Small high-technology firms and international high-technology markets’, Journal of International Marketing, 8 (2), 63–85. Eisenhardt, K.M. (1989), ‘Building theories from case study research’, Academy of Management Review, 14 (4), 532–50. Etemad, H. (2004), ‘International entrepreneurship as a dynamic adaptive system: towards a grounded theory’, Journal of International Entrepreneurship, 2 (1–2), 5–59. EWEA (2008), ‘Wind Scenarios up to 2030’, European Wind Energy Association, Brussels. Fernhaber, S.A., P.P. McDougall and B.M. Oviatt (2007), ‘Exploring the role of industry structure in new venture internationalization’, Entrepreneurship Theory and Practice, 31 (4), 517–42.

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Foxon, T.J., R. Gross, A. Chase, J. Howes, A. Arnall and D. Anderson (2005), ‘UK innovation systems for new and renewable energy technologies: drivers, barriers and systems failures’, Energy Policy, 33, 2123– 37. Gabrielsson, M. and V.H.M. Kirpalani (2004), ‘Born globals: how to reach new business space rapidly’, International Business Review, 13, 555–71. Gibbert, M. (2008), ‘What passes as a rigorous case study?’, Strategic Management Journal (pre-1986), 29 (13), 1465–74. Holmes, B., K. Nielsen and S. Barrett (2007), ‘Wave energy development and evaluation protocol’, paper presented at the 7th European Wave and Tidal Energy Conference, Porto, Portugal, September 11–13. IEA (2006), ‘Review and Analysis of Ocean Energy Systems Development and Supporting Policies’, International Energy Agency, Paris. IEA (2007), ‘Ocean Energy Poster’, available at www.iea-oceans.org. IEA (2008), World Energy Outlook: 2008, Paris: OECD/IEA. Jick, T.D. (1979), ‘Mixing qualitative and quantitative methods: triangulation in action’, Administrative Science Quarterly, 24 (4), 602–11. Jolly, V.K., M. Alahutha and J.-P. Jeannet (1992), ‘Challenging the incumbents: how high technology start-ups compete globally’, Journal of Strategic Change, 1, 71–82. Keeble, D., C. Lawson, H.L. Smith, B. Moore and F. Wilkinson (1998), ‘Internationalisation processes, networking and local embeddedness in technology-intensive small firms’, Small Business Economics, 11, 327– 42. Kuemmerle, W. (2002), ‘Home base and knowledge management in international ventures’, Journal of Business Venturing, 17, 99–122. Lee, W.-Y. and J.J. Brasch (1978), ‘The adoption of export as an innovative strategy’, Journal of International Business Studies, Spring/Summer, 85–104. Madsen, T.K., E. Rasmussen and P. Servais (2000), ‘Differences and similarities between born globals and other types of exporters’, Advances in International Marketing, 10, 247–65. Malerba, F. (2002), ‘Sectoral systems of innovation and production’, Research Policy, 31 (2), 247–64. McDougall, P.P. (1989), ‘International versus domestic entrepreneurship: new venture strategic behavior and industry structure’, Journal of Business Venturing, 4 (6), 387–400. McDougall, P.P. and B.M. Oviatt (2000), ‘International entrepreneurship: the intersection of two research paths’, Academy of Management Journal, 43 (5), 902–6. McDougall, P.P., S. Shane and B.M. Oviatt (1994), ‘Explaining the formation of international new ventures: the limits of theories from international business research’, Journal of Business Venturing, 9, 469–87. Moen, Ø. and P. Servais (2002), ‘Born global or gradual global? Examining the export behavior of small and medium-sized enterprises’, Journal of International Marketing, 10 (3), 49–72. Oesterle, M.-J. (1997), ‘Time-span until internationalization: foreign market entry as a built-in-mechanism of innovation’, Management International Review, 37 (2), 125–49. Organisation for Economic Co-operation and Development (OECD) (2000), Small Businesses, Job Creation and Growth: Facts, Obstacles and Best Practices, Paris: OECD. Oviatt, B.M. and P.P. McDougall (1994), ‘Toward a theory of international new ventures’, Journal of International Business Studies, 25 (1), 45–64. Rialp, A., J. Rialp and G.A. Knight (2005), ‘The phenomenon of early internationalizing firms: what do we know after a decade (1993–2003) of scientific inquiry?’, International Business Review, 14 (2), 147–66. Rink, D.R. and J.E. Swan (1979), ‘Product life cycle research: a literature review’, Journal of Business Research, 7 (3), 219–42. Rouse, M.J. and U.S. Daellenbach (1999), ‘Rethinking research methods for the resource-based perspective: isolating sources of sustainable competitive advantage’, Strategic Management Journal, 20 (5), 487–94. Simmonds, K. and H. Smith (1968), ‘The first export order: a marketing innovation’, British Journal of Marketing, Summer, 93–100. Statkraft (2008), ‘Does the industry have enough knowledge and skills?’, paper presented at the International Conference on Ocean Energy, Brest, France, October 15–17. Stray, S., S. Bridgewater and G. Murray (2001), ‘The internationalisation process of small technology-based firms: market selection, mode choice and degree of internationalisation’, Journal of Global Marketing, 15 (1), 7–29. Taylor, G.W. (2006), ‘AIM admission opens doors to investment community’, Infrastructure Journal, Spring, 66–8. Vesper, K.H. (1990), New Venture Strategies, rev edn, Englewood Cliffs, NJ: Prentice-Hall. Wüstenhagen, R. and T. Teppo (2004), ‘What makes a good industry for venture capitalists? Risk, return and time as factors determining the emergence of the European energy VC market’, Institut für Wirtschaft und Ökologie (IWÖ) Discussion Paper 114, St. Gallen. Yin, R.K. (2003), Case Study Research: Design and Methods, Vol. 5, Newbury Park, CA: Sage.

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Zahra, S.A. (2005), ‘A theory of international new ventures: a decade of research’, Journal of International Business Studies, 36 (1), 20–28. Zahra, S.A. and G. George (2002), ‘International entrepreneurship: the current status of the field and future research agenda’, in M.A. Hitt, R.D. Ireland, D. Sexton and M. Camp (eds), Strategic Entrepreneurship: Creating a New Mindset, Oxford, UK: Blackwell, pp. 255–88.

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PART III ENERGY ENTREPRENEURSHIP AND LARGE INCUMBENT FIRMS

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Photovoltaic business models: threat or opportunity for utilities? Jean-Marc Schoettl and Laurence Lehmann-Ortega

1

INTRODUCTION

The forecast depletion of major fossil fuels, combined with a growing concern for environmental issues has triggered an exponential growth of renewable energy over the past decade: it represented about 14 per cent of total global primary energy supply in 2005.1 Although worldwide installed capacity increased from 1.4 gigawatts (GW) in 2000 to 9.1 GW in 2007, cumulative solar energy production currently accounts for less than 0.01 per cent of this total. Even moderate estimates predict a 30 per cent market growth rate increase in the next 10 years. These exponential growth rates are characteristics of a market in its infancy and thus facing challenges common to all emerging sectors: competing technologies, potential shortage of raw materials and a high proportion of new entrants, stimulating fierce competition in a turbulent market. Thus, as in all radical new markets, the photovoltaic (PV) sector presents both opportunities and uncertainties. Although utilities are among the main players in the overall energy market,2 it is worthwhile noting that they play only a limited part in this exponential growth. At today’s low levels of market penetration, distributed, grid-connected PV is not a central concern, or even of great interest to most utilities. However, as PV market penetration accelerates, utilities will become critical stakeholders, driven primarily by concerns about grid operation, safety, and revenue erosion. Until now, utilities have mainly responded to regulators, who asked nothing more of them than that they help customers who want to purchase or acquire PV systems. In the process, some utilities have removed key barriers to PV deployment to a limited extent, mainly adopting simplified, standardized interconnection standards and agreements. On the whole, however, the utilities’ role in the PV market has been passive. PV has been neither a core utility business endeavour nor a concern, the rationale being that the cost of PV still exceeds that of other energy delivery options. There is, however, another reason why utilities have not completely grasped this attractive market. The reason is that for conventional players PV appears to be disruptive, what Charitou and Markides (2003) define as ‘a way of playing the game that is both different from and in conflict with the traditional way’ (p. 56). Indeed, conventional energies rely on large, centralized units: utilities exploit economies of scale to achieve profitability. Utilities are traditionally large players that are integrated on the value chain, that is, they perform most of the steps in the chain. Hence, the distributed nature of solar power seems to clash with the utilities’ conventional centralized electricity generation: economies of scale are not the main driver. This market attracts many small, local new entrants that have the flexibility to adapt to an evolving environment by switching from one technology to another, performing a limited number of steps in the industry 145

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value chain. This deconstruction phenomenon leading to new, more fragmented competition has been the subject of experiment in other markets such as semiconductors and software and digital telecommunications technologies (Berkson et al., 1997; Bresser et al., 2000). Thus, utilities look for ways to address this attractive yet disruptive market. Some of them believe they will find their place in the long term, and that for the time being, they should not enter the market. Indeed, looking forward 10 to 20 years, there is a strong case to be made that PV in distributed applications will become an inevitable and significant component of the electricity sector, especially if forecast PV cost reductions materialize. In the long term, PV will pass a ‘tipping point’ beyond which it will be competitive with retail power supplied by the grid: customer-sited solar generation will reduce the utility’s revenue. At the same time, as the cost of PV comes down, producing solar energy in a central station will become competitive with conventional energy. Although not large scale, this type of production is much closer to the utility’s current model. Hence, PV represents both a threat and an opportunity to utilities that are aware of these long-time concerns. But shouldn’t they take part in the current attractive market to prepare for this long-term issue? In other words, if utilities recognize that PV will, in the long term, be an operational problem if it is not strategically managed, shouldn’t they consider entering the market today rather than wait for the market to be less turbulent? Wouldn’t it be too late to wait for the technology to set a standard? According to Robertson and Cliburn (2006), ‘Utility driven DPV (distributed photovoltaic) investments can be economically attractive, even at today’s PV prices. No technical or research breakthroughs are required. What is required is new thinking in both organizational capability and business model innovation in both the utility industry and the solar industry’ (p. 6). If technological research aims at finding cost reductions so as to produce more competitive PV energy, researchers in management can add their contribution to the debate by focusing on required organizational capability and business model innovation in the context of deconstruction of integrated value chains. The main issue that this raises is that research on business model innovation is an emerging phenomenon, linking theoretical concepts developed in strategic, innovation and entrepreneurship research. So, first we have to build a conceptual framework around business models in this type of context. The objective of this chapter is to identify which PV business models are best suited for utilities, so as to help them to turn the threat into an opportunity. To meet this objective, we need first to identify PV business models. To do so, we shall build a theoretical framework of business models based on industry deconstruction. This framework will enable us to identify potential generic business models in PV. These potential business models will then be screened and assessed with regard to the current core competencies of utilities, so as to determine which would best suit them.

2

THEORETICAL FRAMEWORK

Our objective is to build on the literature to determine a framework that will enable us to identify potential business models in a context of industry value chain deconstruction. First we give an operational definition of a business model, then we consider the consequences of a value chain deconstruction.

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Profit Equation • Sales revenues • Cost structure • Capital employed Figure 8.1

Business model components

The Business Model as an Operational Construct Although the term ‘business model’ is widely used by managers, there is limited academic literature on the subject. This term, first used by entrepreneurs who needed to explain to their investors the mechanism of value creation enabled by new technologies, has often been considered as a buzzword linked to the dot-com bubble, and has attracted much criticism. The best known is Porter’s: ‘A business model is a loose conception of how a company does business and generates revenue . . . it is murky at best’ (2001, p. 66). Nevertheless, an ever-increasing number of practitioners as well as academics recognize that the business models concept can be used in more general business settings and by established companies, and not only e-business or more generally speaking technology-based change in new ventures. The concept is frequently used in the context of radical change (Johnson et al., 2008), which is the case in the PV sector. However, there is still no consensus in the literature about the definition of a business model. A detailed analysis of the existing academic literature on business models shows that three major components can be identified. The first is the type of products/services offered to potential or existing customers. The second pertains to organizational characteristics enabling the firm to deliver these products/services to its customers. Finally, the third type of component, often called ‘revenue model’, deals with the ways value is generated, captured and transformed into profits. Some authors restrict the business model concept to this financial part (Rappa, 2000; Porter, 2001; Chesbrough and Rosenbloom, 2002). Amit and Zott (2001), however, clearly distinguish between revenue and business models, the latter describing how value is created whereas the former focuses on how the value is appropriated by the different participants in the transaction. Finally, for another group of authors, business models refer to the customers and the firm’s organization as well as to the revenue model (Johnson et al., 2008). We rely on this most recent definition and suggest that, as shown in Figure 8.1, a business model has two major components): ● ●

A value proposition, that is, the answer to the question: who are our customers and what do we offer them that they value? A value constellation,3 that is, the answer to the question: how do we deliver this offer to our customers? This involves the company’s own value chain but also the value network with suppliers and partners.

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Source:

Schweizer (2005).

Figure 8.2

Integrated model

These two components need to fit together as pieces of a puzzle to generate a positive profit equation, as shown by Zott and Amit (2008). This profit equation is the financial translation of the two preceding components: it describes the sales generated due to the value proposition and the cost structure and capital engaged resulting from the value constellation. Thus, a business model depicts the mechanisms that enable a firm to create value through the value proposition to its potential customers, its value constellation, and how it captures this value to transform it into profits. The business model offers a consistent and integrated picture of a business and the way it generates revenues and profit: if the value proposition and the value constellation are not well balanced, there will be no profit. The proposed components of business models are not new, and are well studied in existing literature, such as marketing, finance, strategic management and innovation. However, the business model concept, by bridging strategy, business processes and profitability, offers a comprehensive and easy-to-use framework. Hence, for Amit and Zott, the business model is a new unit of analysis integrating several paradigms that have so far only coexisted in strategy: Porterian analysis, the resource-based view, the transaction cost theory, and entrepreneurship. As such, the business model appears as a new and relevant construct. We believe this definition to be a simple yet useable concept. Thus, identifying business models for PV pertains to generating (new) sources of profit by finding a (novel) combination of value proposition and/or value constellation. As suggested by some researchers (Schweizer, 2005; Sabatier et al., 2010; Zott and Amit, 2008) and specifically by Wüstenhagen and Boehnke (2007) in the field of energy, the distinction between value proposition and value constellation generates a multitude of possibilities. Identifying the Value Constellation in a Context of Deconstruction Building on the resource-based view, Schweizer (2005) presents four main configurations for value constellations resulting from the deconstruction of an industry value chain: the integrated model, the orchestrator model, the layer player model and the market maker model, depending on which steps the companies perform on the industry value chain. Schweizer recalls that companies have historically applied the integrated model (see Figure 8.2). This model implies that the company covers the complete industry value chain, thus benefiting from all the complementary assets necessary to bring a product or service to the market. This leads to a high revenue potential, since it allows for costs and differentiation advantages.

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Source:

Schweizer (2005).

Figure 8.3

Source:

149

Orchestrator model

Schweizer (2005).

Figure 8.4

Layer player model

Over time, companies have recognized the advantages of outsourcing those steps in the value chain that are not core competencies of the company. This trend has led to the orchestrator model (see Figure 8.3) and what is called the ‘industry deconstruction’ process (Evans and Wurster, 1999). In this model, the player focuses on a few steps in the value chain. Their competitive advantage stems from superior coordinating capabilities, giving them access to the complementary resources they lack. Thus, the revenue potential remains high. In the layer player mode (Figure 8.4), a company focuses on one specific step of the value chain, such as for example manufacturing, or research and development. The benefits of this model are superior economies of scale. The player often expands the layer horizontally across several industries. Finally, the fourth generic model is the market maker model (see Figure 8.5), in which the player brings transparency to the market by providing relevant information to other players. The market power stems from the ability of this player to become the industry gateway. The deconstruction phenomenon leads to multiple possibilities in a firm’s value

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Market maker

150

Source:

Schweizer (2005).

Figure 8.5

Market maker model

constellation. Identifying business models requires the combining of potential value propositions and value constellations, as highlighted by Wüstenhagen and Boehnke (2008).

3

IDENTIFYING GENERIC BUSINESS MODELS IN PV

Our objective is to determine the type of business models that will be in use in the sector of PV energy in the years to come. First we present the methodology used to achieve this objective, and then we present the complete PV industry value chain and each specific step. This allows us to build a matrix leading to the identification of 14 so-called elementary business models, which are then grouped together according to the required core competencies: this process leads us to identify six so-called generic business models. Methodology Our objective was to identify the PV business models best suited for utilities. Research on business models is still nascent, as is research in renewable energy. Thus, following Edmondson and McManus (2007), who recommend quantitative data for mature theories and qualitative data for nascent theories, we have opted for the latter. So, the methodology used for this work is broadly qualitative, which is well suited to exploratory investigations where the objective is not to validate a research proposition but to explore and develop propositions (Eisenhardt, 1989; Miles and Huberman, 1994). The literature review on business models and industry value chain deconstruction led us to build a matrix of all potential business models, through a combination of both value constellation and value proposition (see Appendix 8A1). We then applied this theoretical output to existing business models. We have indeed collected extensive secondary data in business and energy-related publications and we have built upon studies of existing business models throughout Europe and the US, both in established and start-up firms, following Yin’s (1994) recommendations. Renewable energy business models are an emergent phenomenon so the analysis of existing business models was not sufficient to reach our objective, which is to identify

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Raw silicon material

Downstream

Cell manufacture

Module assembly

Project development

One shot

Source:

151

Construction Operations and and installation maintenance

Energy resale

Energy user or buyer

Ongoing process

Adapted from Frantzis et al. (2008).

Figure 8.6

PV industry value chain

the main business models. Thus, additional primary data were gathered from our experience as consultants in the field of energy as well as from 19 specific interviews with entrepreneurs, utilities and venture capitalists throughout the sector. We consider that these interviews made it possible to reach saturation as suggested by Yin, since every new interview did not bring new information to the proposition. Altogether, this reference back and forth between theory and reality allowed us to identify elementary and generic business models. This was then presented to practitioners, who broadly validated it. They also provided us with valuable examples as well as suggesting the main limitations of our research. The following subsections present the hypothesis underlying the matrix and the final results of the analysis. Presenting the PV Industry Value Chain Given the specificities of renewable energies (not storable and distributed generation), the PV industry value chain differs from conventional, centrally produced energy. First, the latter relies heavily on economies of scale, obtained from centralized energy generating plants. This characteristic has led to a concentrated market, involving a limited number of major players, largely adopting the integrated player model so as to benefit from all economies of scale. This does not mean that some steps in the value chain are not outsourced, but the companies remain involved in all major steps in the value chain. Second, the PV value chain can be split into two parts (see Figure 8.6), as can most industries that rely on installation or transformation at local sites (that is, for example, building materials): upstream (including raw material production, cell manufacturing and module assembly); and downstream (including project development, construction and installation, operations and maintenance and energy control). A manufacturer relies on technology and economies of scale, whereas downstream is made up of decentralized operations: these two parts of the industry value chain rely on different players, since the required competencies are radically different. So, only the downstream part will be of interest for us. Indeed, the upstream part is a manufacturing and global activity which is some way away from the utilities’ business. The main concern for utilities in that part of the chain is securing supply through long-term contracts or partnership with suppliers. So, as Michael Lewis, Managing Director Europe of E.ON climate and renewable states:

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Table 8.1

Required competencies for each step of the PV industry value chain Project development

Required competencies

Engineering, access to cash, lobbying and negotiation with local authorities = valueadded services

Construction and installation Bargaining power, local project management

Operations and maintenance (Not a standalone activity in PV)

Energy control Information systems, trading skills

I don’t see any inherent advantage for an operator owning a manufacturer . . . Having said that, as the industry consolidates and as a few major players emerge I think we will start to see longer-term strategic relationships with a smaller number of manufacturers, which will give us some certainty regarding when we can get turbines and the price at which we can get them.4

Thus, we shall focus here on the downstream portion of the value chain.5 The downstream part of the PV industry value chain can also be split into two subparts: the steps that are one shot (project development and construction and installation) and those that represent an ongoing process (operations and maintenance and energy control). Project development pertains to identifying the potential owner of the system (sales and marketing), engineering, and financing: this step provides a service. It includes applying for building permits from local authorities and incentives from state government. The construction and installation step includes the procurement of the PV system and its installation. It relies on merchants’ skills for the procurement side: companies involved in these steps buy products from manufacturers and resell them to final or intermediary customers. It also relies on managing local contractors to install the facilities. Both of these ‘one-shot’ steps have low capital employed thanks to low assets: they benefit from low margins but their profitability comes from high returns on capital employed. The operations and maintenance step refers to running and maintaining the facility. It includes the ownership of the facility as well as transferring the energy to the end user or selling it to a buyer (the utility or a wholesaler). As stated by Frantzis et al. (2008), this value-added activity can be ‘provided by multiple players in the value network, but may not be viable as stand-alone businesses due to the limited revenue potential. Unlike other power generation businesses, operations and maintenance of PV systems are not two very distinct activities’ (p. 4-2). The final step in this industry value chain is energy control: this step requires ‘smart metering’ technology and energy storage that is integrated within the PV system. If these technologies are not present, this step disappears in the value chain. To perform in energy control, a player needs both efficient information systems to manage local information and market knowledge, required to do the trading. These two steps (operations and maintenance on one side and energy control on the other) are said to be part of an ongoing process since they continue through the whole life cycle of the facility, which is usually around 15 to 20 years in PV. Table 8.1 synthesizes the competencies needed by a player to perform the different

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Required competencies for each type of application

Applications Project size Required competencies

Residential buildings 2.5 kWpdc Access to mass market

Commercial buildings 15 to 100 kWpdc Access to semi-mass market*

Ground mounted 5 MWpdc Ability to deal / invest in large projects

Note: * We use the term ‘semi-mass market’ to indicate that the commercial application is somewhat less fragmented than the residential application.

steps of the value chain. These steps are generic in the PV value chain. However, we see two main elements not included per se in the chain that will have an important impact on the costs and capital employed. First, the economics of these two substeps are radically different. Since operations and maintenance includes ownership, it requires the employment of high capital, whereas the first steps mainly involve working capital. This has a direct impact on the capital employed and thus on the source of profitability. Thus, a player that owns the facility has high levels of capital employed, since he/she invests in the project and supports all the costs. However, if the price of the produced energy is guaranteed through feed-in tariffs, he/she faces a lower risk. The return is low when the energy produced is subsidized but so is the risk. Access to cash is a required competency for the owner of the facility. On the other hand, if the player is not the owner of the facility, the capital employed will be low and the profitability mainly stems from economies of scale in accessing the market, in purchasing and installation. Second, although most renewable energies are distributed, that is, produced on a local scale as opposed to a centralized plant, three types of applications can be distinguished according to the sector and thus, the size of the project. The first sector is residential, where the PV facility is installed on individual homes: the project size is about 2.5 kWpdc.6 The second market is the commercial sector, where the PV facility is installed on a commercial facility or a farm, for example. Also included in this sector are bigger PV facilities installed on grouped residential roofs that are larger than individual houses.7 The project size is larger than the residential sector, ranging from 15 for small projects to 100 kWpdc for larger ones. Finally the third sector is ground-mounted PV systems installed specifically as a power production plant on the wholesale side of the distribution grid. These facilities usually represent about 5 MWpdc and are intended primarily for bulk power supply to the grid, using solar technologies suited for large-scale applications. Although this is still distributed energy, the volume of generated energy in one place is much larger than in the other two sectors. When looking for business models, it is important to take into account the type of application, since it has a major impact on the project development step. Indeed, market access to individual home owners willing to install a PV facility has a high cost compared to the size of the project. Thus, access to the mass market is key for the project to be economically viable. At the other end of the scale, ground-mounted facilities can more easily benefit from economies of scale in purchasing and installation. Table 8.2 summarizes the required core competencies. Thus, the industry value chain in renewable energy

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is deconstructed compared to the conventional energy one. This means that, in addition to the integrated model, many different models for the value constellation, leading to an even greater number of business models, can emerge in this industry. We then have to identify all possible business models along this industry value chain. Identifying Elementary Business Models To identify PV business models, we have built a matrix (see Appendix 8A1) combining the business model concepts and the specificities of value constellations in the context of deconstruction, as presented in our theoretical framework. More explicitly, the matrix combines the following elements: ●

●

Value constellation, that is, the steps performed in the value chain: has the player integrated all steps in the value chain, or is it an orchestrator, or a layer player, or a market maker? If it is not integrated, what are the steps performed in the industry value chain? (see rows 1 and 2 in Appendix 8A1). Value proposition: can be split into several parts: ● The application (type of end customers): is it aimed at residential or commercial buildings or is it ground mounted (see row 3 in Appendix 8A1); ● The ownership of the facility (see row 4 in Appendix 8A1): we consider that in the residential sector, there is no economic logic for a player to be the owner of a large number of very small facilities. Thus, this distinction can only be made in the commercial buildings and in ground-mounted project sectors.

For each possible combination, we consider what is offered (see row 5 in Appendix 8A1), who the customer might be (see row 6 in Appendix 8A1), and determine whether there is an economic rationale (see row 7 in Appendix 8A1), that is, a potential positive profit equation. If there is not, it is not a viable business model. Combining these elements leads us to a matrix that helps us identify 14 elementary, that is ‘pure’, business models for players wishing to be involved in the downstream PV market: Integrated players Two elementary business models are identified: ●

●

1.1 Build–own–operate rooftop PV model for commercial buildings offering a complementary revenue The integrated player performs all the steps in the industry value chain. The value proposition is twofold: it sells the produced energy to energy buyers, but it first has to convince large building owners to rent their roofs to set up PV facilities. In return, the building owner will benefit from complementary revenue, without having to worry about the PV facility, which they do not own: they basically rent out the roof. The economic rationale for the player is to own several local facilities so as to sell the produced energy to an energy buyer. 1.2 Utility scale builder and operator The integrated player performs all the steps in the industry value chain, and owns all the assets of the projects (both land and PV facility8). The sole customer is the energy buyer.

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Orchestrator Five elementary business models are identified: ●

●

●

●

●

2.3 Turnkey project provider for home owners also willing to own the facility In this case, the player does not own the facility, it only provides the home owners with the full service of project development and/or construction and installation. The offer is one shot, which means that when the facility is built, the player is no longer involved in the facility. As an orchestrator, it performs some of these steps and outsources others, for example local construction that can be done by plumbers. The home owner then uses the produced energy or resells it to energy buyers. 2.4 Turnkey project provider for commercial building owner also willing to own the facility This elementary business model is similar to the previous one; the only difference is the size of the project. 2.5 Builder, owner and operator of rooftop PV for commercial building owners providing a complementary revenue In this elementary business model, the offer is similar to 1.1, but the player outsources some steps in the value chain (excluding operations and maintenance). Most players providing this offer are likely to use this business model rather than 1.1, since it has become rare for a player to be completely integrated. 2.6 Service provider to the owner of a large PV facility This type of player provides a service to a large PV facility owner: it can either be project development or construction and installation or energy control, or a mix of these three steps. 2.7 Utility scale power builder orchestrator and producer In this business model, the player basically is an energy producer that builds part of the facility and outsources the rest.

Layer player Seven elementary business models are identified: ●

●

●

●

●

●

3.8. Small project development specialist This player is specialized in helping home owners willing to install a PV facility. It can provide help in finding finance and in the paperwork. 3.9. Small facility construction and installation specialist This player is specialized in constructing and installing small PV facilities. Plumbers are a good example of this type of player. 3.10. Medium-size project development specialist This business model is similar to 3.8 but deals with larger projects for commercial sectors. The customer is the commercial owner him/herself or an orchestrator. 3.11. Medium-size project facility construction and installation specialist This business model is similar to 3.9 but deals with larger projects for commercial sectors. The customer is the commercial owner him/herself or an orchestrator. 3.12. Large project development specialist This business model is similar to 3.8 and 3.10, but deals with larger projects for ground-mounted PV facilities. The customer is the large facility owner him/herself or an orchestrator. 3.13. Large project facility construction and installation specialist This business

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●

Handbook of research on energy entrepreneurship model is similar to 3.9 and 3.11, but deals with larger projects for groundmounted PV facilities. The customer is the large facility owner him/herself or an orchestrator. 3.14. Virtual operator and energy controller This player is specialized in energy control and is a virtual operator whose role is to control the distributed energy so as to flatten peaks. Such an operator becomes a market maker since it has access to information needed by all the other energy buyers in the market.

But these 14 elementary business models also present some similarities. Identifying Generic Business Models These 14 elementary business models are summarized in Appendix 8A2, which also presents the main key competencies required to perform these business models. If we group together those business models that present most similarities in terms of key competencies, six major strategic groups can be identified, which we shall call ‘generic business models’. To make an analogy with the well-studied airline industry, Ryan Air and Easy Jet have the same generic business model (low cost) but have two distinct company business models (different choices of airport, different targeted customers). ●

●

●

●

Turnkey project provider: business models 2.3 and 2.4, for residential and commercial In these business models, the player is not the owner of the facility. He/she only provides all the ‘one-shot’ steps to the individual or commercial customer. The main difference is the size of the project. This model provides a clear value to customers who do not want to become experts in PV and do not want to act as general contractors in selecting and installing components. According to Shaw (2000), customers purchasing micro-generation systems want three things: ‘A competitive price per kWh – some customers may even pay a small premium if the system is environmentally benign or green; high reliability and immunity from long stormrelated outages that are very painful, and seem to be happening more frequently; assurance of rapid-response service and competent maintenance support. In effect, they want an energy services solution: a plug-and-play, no hassle, don’t-botherme-with-the details solution’ (p. 1). The required core competencies are access to the market, which is not concentrated, and local project management. Build–own–operate rooftop PV: business models: 1.1 and 2.5 In these business models, the player is the owner of the facility: he/she is an energy producer. He/ she provides the commercial customer with complementary revenue, and performs all steps for the customer (him/herself or through outsourcing). The required core competencies are access to the market, which is not concentrated, as well as access to cash to finance the ownership. Value-added service provider: business models 2.69, 3.8, 3.10 and 3.12 The player offers a value-added service such as project development and consulting. He/she can be either specialized in one step in the value chain or act as an orchestrator, but he/she does not own the facility. Construction and installation service provider: business models 2.6, 3.9, 3.11 and 3.13 The player offers a service with less added value than the previous generic

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Residential

Commercial

Ground mounted

Build–own– operate rooftop PV

Utility-scale power producer

Ownership of the facility

Figure 8.7

●

●

Virtual power plant

Turnkey project provider

Value- Construction added & installation service service provider provider

Pure service

The six generic PV business models

business model. He/she offers the construction and installation service to final customers or to orchestrators. The main competency is local project management. Utility-scale power producer: business models 1.2 and 2.7 The player owns the large PV facility: he/she is an energy producer who has built the facility him/herself or acted as an orchestrator. Main competencies are ability to deal with large projects and to raise cash to finance them. Virtual power plant: business model 3.14 The player is a virtual operator who controls supply and demand so as to deal with peaks. The core competencies are information system management and trading skills.

Figure 8.7 presents these different generic business models. It is important to note that these six generic business models are not exclusive: the same company could use several of the models at the same time. Now that we have identified the six strategic groups, we can consider which of them would best suit utilities.

4

IDENTIFYING GENERIC PV BUSINESS MODELS BEST SUITED FOR UTILITIES

As stated in the introduction, PV is an opportunity that utilities need to seize. Indeed, as the cost of solar energy decreases, the growing number of companies that will probably enter the business of installing solar equipment could cut off some utilities from their customers. Furthermore, for many utilities, solar PV represents a distributed energy

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resource that can reduce the need to build large, costly, polluting and unpopular fossilfuel power plants and can ease congestion in regions where energy demands stress the grid. Last but not least, in sunny regions PV is very attractive, notably in peak load times (Robertson and Cliburn, 2006). However, as mentioned above, PV is also a threat for utilities since distributed generation appears to be disruptive to most utilities. To enter this market, utilities must carefully choose a relevant PV business model in line with their strategic assets and core competencies. As Luis Adao de Fonseca, chief business development officer of EDP Renovaveis, points out [A]s a utility, we are trying a way to become a leading solar player, but we and other utilities face major challenges. The first is cultural; it is very difficult for utilities to go into new businesses. The second challenge is to understand exactly where the utility should play in the value chain. It is not manufacturing; it is not even in installation. My view is that in the long run most of the value will be very close to the customer.10

So the key issue for utilities is not whether or not to enter the PV business but clearly to identify their core competencies and choose a business model which fits with them. To address this issue we shall first analyse the utilities’ core competencies and then identify which of the six previously described business models best suits them. Utilities’ Structure and Core Competencies The structure of many utilities is in transition. At one end of the spectrum are the vertically integrated utilities that own generation transmission and distribution assets. At the other end are the grid companies that act as common carriers, owning only distribution assets: they do not generate the electricity they sell or transmit to customers. In Europe, as a result of EU policy, utilities are unbundled, with separate companies, although in many cases the companies belong to the same group. In the US, some states have unbundled their electricity utilities and in that case each of the basic functions is performed by a separate company. The key element to consider is that restructuring has separated the basic functions of generation, distribution and retail power sales. In these cases the companies that own the cables no longer own generation and the retail sale of electricity is opened to competition. Unbundled power markets present some unique issues for distributed PV in particular, how different value streams might be captured when there are several different entities along the electricity value chain. Utilities possess a range of core competencies and attributes that they can leverage for new PV business models. While they can vary depending on the utility structure and unbundling scheme, they generally fall into three categories: asset management, customer service/commercial and system operation. The first is asset management, which pertains to the ability to manage large projects and intensive asset business management. Thus, utilities benefit from previous experience in large, long-term, intensive capital investments. They have proven to be creditworthy. In addition, some of them also own estates that might be used for PV. The second competency relates to customer service and commercial skills. Utilities have usually built strong customer relationships over time, have easy access to customers and benefit from a high brand image. They have demonstrated ability to set up marketing campaigns to raise customer awareness of new

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159

Link between the core competencies of utilities and those of generic business models Current utility core competencies Asset management

Customer service

System operations

   

x x

   

 

 

 

  x x

     

     

 

 

x

Access to mass market Access to semi-mass market Value-added services (engineering . . .) Local project management Ability to raise cash Ability to deal with large projects (lobbying . . .) Information systems + trading

offers. They also have know-how in bulk energy trading. Finally, the third type of competency deals with system operations. Their conventional business has enabled utilities to run operations and maintenance on widely dispersed assets, with high safety concern (for employees and customers). They have the best knowledge of the distribution grid (which means that they are in the best position to extract maximum value). They also rely on information systems, and have mastered the skills needed to do metering and billing for a large customer base. Table 8.3 shows the current core competencies of utilities and compares them with the core competencies identified for generic business models. Business Models for Utilities We shall now consider the six generic business models identified in Section 3 to determine which are best suited for utilities: 1.

Turnkey project model In this model, utilities operate as system integrators who design the system, select appropriate components, do the installation, monitor system performance, and provide seamless maintenance and emergency repair. The utility assumes multiple roles in the PV transaction (for example, one-stop shopping), thereby significantly simplifying the transaction for the customer (homeowner or builder). This single entity can attain both transaction and installation cost reductions by streamlining and aggregating processes (design, installation, obtaining permissions, incentives, lending) and these savings can be passed on to the customer. Endesa is one of the largest electrical companies in Spain and in the world, holding a strong position in the Latin American markets and in Mediterranean Europe, as well as in other energy sectors such as gas, cogeneration and renewable energies. In PV, Endesa has adopted the turnkey model in the French market. The company offers a complete solution: it designs, installs, and maintains PV power plants at

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2.

3.

Handbook of research on energy entrepreneurship the customers’ sites. In this model, utilities benefit from their customer relations and credibility. Installation is not a core competence for most utilities. Nevertheless some utilities, especially those already involved in installation and maintenance directly or through their network, can be successful in this model provided that they can create a win–win game with installation partners. In terms of profitability, they can reduce the cost of equipment through their bargaining power, and the commercial cost through easy access to customers. Build–own–operate rooftop PV Several utilities are developing customer-sited PV with utility ownership, whereby they capture some of the potential revenue from rooftop solar by owning the equipment, selling the power to the grid through feed-in tariffs or to the property owners (and sending the excess energy to the grid). Duke Energy Carolinas is proposing to invest $50 million over a two-year period in as many as 425 solar energy arrays on the rooftops of homes, schools, stores and factories to establish a solar-distributed generation programme. Under the arrangement, the utility company would install, own, operate and maintain all equipment related to the solar array. The company, rather than the home or property owner, would also use and own the electricity produced. The customer receives the rent paid for using the rooftop or land, and the compensation is based on the size of the installation. While this model represents a significant change in the way utilities operate, it provides an opportunity for them to maintain revenue levels and keep their existing relationship with customers, leveraging their existing billing, customer service, and other operations skills. Furthermore, as utilities gain experience in installing and maintaining PV, they could develop new services. Value-added service provider In this model, utilities provide value-added services along the value chain. Gdf Suez, a major European utility, offers household services under the umbrella of a strongly promoted brand: Dolce Vita. The aim is to develop energy-efficient renewable energy-based solutions for private individuals in collective and individual housing. This business unit is a growth driver for Gdf Suez since it is active in value-added services to private individuals, which generate revenues and margins. It was created with a dual objective in mind: to meet the ‘Grenelle’ French environment policy goals while creating value and synergies between its businesses. It comprises three divisions: ● ● ●

4.

CLIMASAVE, which markets energy-efficient solutions based on renewable energy for housing (consulting, installation, financing, maintenance, warranties); SAVELYS, which maintains energy systems for private individuals; SOLFEA Bank, which specializes in financing efficient home energy installations.

This model can fit a utility provided that it benefits from similar expertise in its core business. Construction and installation service provider Installers are focused on the installation of solar systems. Their primary skill set is to build and manage solar projects. They make money via construction margins from labour and materials. Their model seems too far away from utilities’ core competencies. Installers may be the outsourced service and maintenance team in the turnkey or in the complementary revenue provider model.

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6.

161

Utility-scale power producer Utility-scale solar energy facilities generate large amounts of electricity to be put directly into the electricity grid. Pacific Gas and Electric (PG&E) has announced two utility-scale PV solar power contracts. The two solar farms will generate 800 MW of renewable energy – OptiSolar’s Topaz Solar Farm at 550 MW and Sun Power’s California Valley Solar Ranch at 250 MW. The 550 MW Topaz Solar Farm project will use low-cost, thin-film PV panels designed and manufactured by OptiSolar in Hayward and Sacramento. Although the technology is well proven, the price of PV has remained an obstacle to utility-scale deployment. With technological advancements in thinfilm PV, as well as crystalline PV, the market may sustain multi-MW projects that can compete with conventional power. The project would deliver approximately 1,100,000 megawatt-hours of renewable electricity per year. The project is expected to begin power delivery in 2011 and be fully operational by 2013. This model fits very well with utilities’ core competencies of asset ownership and operation. From an implementation point of view, it seems the easiest business model for the utility that incorporates deployment of PV into its capital planning. Virtual power plant The utility acting as a virtual power plant or aggregator plays the role of intermediary and facilitator for small customers and small PV generators to allow them to participate in the market mechanisms. Aggregation of small generators and controllable loads may give an opportunity to small units to reach mandatory volumes and offer competitive and significant energy blocks. In fact size, intermittence and actual non-dispatchability limit small PV production units’ ability to become active players in an open electricity market. The aggregator uses flexible demand from medium-sized industrial and commercial customers to balance renewable energy sources and integrate both in electricity markets. It benefits from the possibility that customers can rapidly modify their load. The revenues generated are shared between the customers, generators and the aggregator. Gdf Suez, a major European utility, is testing the aggregator model in the United Kingdom with its subsidiary Gdf Suez ESS. The objective is to estimate the cost and value of small-scale (10 kW to 1 MW) load management aggregation. The service tested is a flexibility contract where the demand flexibility is managed by the electricity supplier, called the aggregator. These tests are characterized by the flexible units having two main characteristics: availability of energy resources (in this case it is wind energy not photovoltaic) and flexibility in load reduction (clients are able to adapt their electrical energy needs by interrupting or delaying industrial processes, air-conditioning control, heat requirements, and so on). The selected clients are exclusively industrial and commercial companies, with a range of flexible power from 10 kW to 1 MW. Utilities are in a good position to adopt the aggregator model. They benefit from their credibility among customers and their skills in adjusting supply and demand in the electricity market.

Figure 8.8 summarizes the potential for transferring core competencies from the utility to the different PV business models .The figure shows how each generic business model relies on the utilities’ current core competencies. Different PV business models have varying degrees of overlap with current utilities’

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Handbook of research on energy entrepreneurship Overlap with core competencies Competencies

Utilities’ core competencies

Turnkey project

Build–own– operate rooftop PV

None Value- Construction Utility-scale & power added service installation producer service provider provider

Full Virtual power plant

Asset management Customer service/ commerical System operations

Figure 8.8

Generic business models and utilities’ core competencies

core competencies. At one end of the spectrum we find the utility scale business model with energy generation which is very close to the traditional utility business. It operates on the integrated traditional way of doing business where the utility builds, owns and operates the PV system. At the other extreme we find the construction and installation service provider which is not suitable for a utility. In between, the utility can focus on a few steps of the value chain and subcontract the others or build partnerships in order to get the complementary competencies.

5

CONCLUSION

Through a qualitative and exploratory study based on the business model as an operational construct, six generic business models in PV have been identified. An analysis of the current and required key competencies leads us to conclude that five of them are best suited for utilities. If we classify them according to the distance from utilities’ current core competencies, an attempt to build a hierarchy would be: utility-scale power producer, virtual power plant, build–own–operate rooftop PV, turnkey model, value-added service provider. We consider the construction and installation service provider to be too far away from the utilities’ skills. Identifying the business models that would enable utilities to turn the threat of PV into an opportunity was the aim of this research, which incorporated both theoretical and practical contributions. Indeed, we have used an operational definition of the business model construct and shown how helpful this concept is in an industry deconstruction process and more generally speaking in a radically new business environment. In addition, the practitioners that we have interviewed stated that the identification of these generic business models was helpful to them. However, those practitioners also highlighted the limitations of the research. Leaving aside the issue of the questionable theoretical definition of the business model construct, which is still shaky in the literature, they mainly insisted on two questions. The first pertains to the level of analysis. Most of them argued that we did not take into account

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specificities such as the current structure of the utility, the risk level or the value for the customer. Furthermore, the analysis focuses on large utilities, it could be less relevant for small/local utilities which in many cases in Europe belong to municipalities. These utilities are diversified in various public services including transport, district heating, and so on, and implement a broad spectrum of competencies. However, what we have identified are generic business models, and not company specific business models. The generic business models are similar to strategic groups in a conventional strategic analysis, where there is a clear distinction between strategic groups and the strategy of a company (Porter, 1980). The second limitation deals with the impact of financial incentives (rebates, production incentives, feed-in tariffs, renewable energy credits, and so on) on the generic business models. Indeed, our analysis does not take into account their existence: the underlying hypothesis is grid parity. Obviously, grid parity is not yet a reality, but again, local differences have major impacts on specific business models, not generic business models. Finally, the third limitation refers to implementation. Even if the best generic business models for utilities have been identified, how should they be implemented, since they are disruptive? We believe that these limitations offer perspectives for future research. Indeed, focusing on specific business models rather than generic business models will offer new insight to academics and managers. This analysis could draw from our findings on generic business models as a basis, and determine specific business models according to the current business environment and characteristics of the utility. As far as implementation is concerned, Markides and Geroski’s (2004) analysis offers a stimulating perspective. They consider that established companies (which utilities are) should not try to enter new, disruptive markets too fast: it would be like teaching elephants how to dance. What established companies do best is to scale up a technology once the dominant design has emerged. But this implies knowing the market. This is why those authors encourage leading companies to explore new markets through experimentation and investing in start-ups that have the flexibility to adapt to unstable and rapidly changing environments. This is exactly what most utilities should do. We hope that generic business models in PV will help them learn how to dance gracefully!

NOTES 1. 2. 3. 4. 5. 6. 7. 8.

Source: IEA. In this chapter, we deal only with PV in developed countries. The issues of PV in developing countries is different, mainly because PV is used as a unique source of electrical energy not connected to the grid. This is a reference to Normann and Ramirez’s vocabulary (1993). Source: ‘Perspectives on electric power and natural gas’, McKinsey on Electric Power and Natural Gas, Winter 2008, no. 1: 46. This value chain is presented for PV but can be adapted to other types of renewable energies that are distributed (wind, solar, bio-mass). Wpdc is the amount of power a PV device will produce at noon on a clear day with sun approximately overhead when the cell is faced directly toward the sun. DC is direct current (Chaudhari et al., 2004). We could further distinguish between retrofit and new construction in the residential and commercial segments. However, our study aims to identify generic business models (see conclusion). Ownership can take very different legal forms; for simplification purposes, we consider here that the player is the full owner of both land and the facility.

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164 9. 10.

Handbook of research on energy entrepreneurship This elementary business model falls into two generic business models according to the type of service provided (project development or construction and installation). Source: ‘Perspectives on electric power and natural gas’, McKinsey on Electric Power and Natural Gas, Winter 2008, no. 1: 48.

REFERENCES Amit, R. and C. Zott (2001), ‘Value creation in e-business’, Strategic Management Journal, 22: 493–521. Berkson, B., C. Eugster and R. Patrick (1997), ‘The atomization of markets’, The McKinsey Quarterly, 17: 125–31. Bresser, R.K.F., D. Heuskel and R.D. Nixon (2000), ‘The deconstruction of integrated value chains. Practical and conceptual challenges’, in R.K.F. Bresser, M. Hitt, R.D. Nixon and D. Heuskel (eds), Winning Strategies in a Deconstructing World, Chichester: John Wiley: 1–21. Charitou, C.D. and C.C. Markides (2003), ‘Responses to disruptive strategic innovation’, MIT Sloan Management Review, 44 (2): 55–63. Chaudhari, M., L. Frantzis and T.E. Hoff (2004), ‘PV Grid Connected Market Potential under a Cost Breakthrough Scenario’, The Energy Foundation and Navigant Consulting, Burlington, MA. Chesbrough, H. and R.S. Rosenbloom (2002), ‘The role of the business model in capturing value from innovation: evidence from Xerox Corporation’s technology spin-off companies’, Industrial and Corporate Change, 11 (3): 529–55. Edmondson, A. and S.E. McManus (2007), ‘Methodological fit in organizational field research’, Academy of Management Review, 32 (4): 1155–79. Eisenhardt, K.M. (1989), ‘Building theories from case study research’, Academy of Management Review, 14 (4): 532–51. Evans, P. and T. Wurster (1999), Blown to Bits: How the New Economics of Information Transforms Strategy, Boston, MA: Harvard Business School Press. Frantzis, L., R. Graham, R. Katofsky and H. Sawyer (2008), Photovoltaics Business Models, Burlington, MA: National Renewable Energy Laboratory. Johnson, M.W., C.M. Christensen and H. Kagermann (2008), ‘Reinventing your business model’, (cover story), Harvard Business Review, 86 (12): 50–59. Markides, C. and P. Geroski (2004), Fast Second: How Smart Companies Bypass Radical Innovation to Enter and Dominate New Markets, San Francisco, CA: Jossey Bass. Miles, M.B. and M.A. Huberman (1994), Qualitative Data Analysis, Thousand Oaks, CA: Sage. Normann, R. and R. Ramirez (1993), ‘From value chain to value constellation: designing interactive strategy’, Harvard Business Review, 71 (4): 65–77. Porter, M.E. (1980), Competitive Strategy, New York: Free Press. Porter, M.E. (2001), ‘Strategy and the internet’, Harvard Business Review, 79: 62–78. Rappa, M. (2000), ‘Business models on the web: managing the digital enterprise’, North Carolina State University, Raleigh, NC, available at: digitalenterprise.org/models/models.html (accessed October 2010). Robertson, C. and J.K. Cliburn (2006), ‘Utility-driven solar energy as a least-cost strategy to meet RPS policy goals and open new markets’, paper presented at the ASES Solar Conference, Denver, CO, 9–13 July. Sabatier, V., V. Mangematin and T. Rousselle (2010), ‘From recipe to dinner: business model portfolio in the European biopharmaceutical industry’, Long Range Planning, 43 (2): 431–47. Schweizer, L. (2005), ‘Concept and evolution of business models’, Journal of General Management, 31 (2): 37–56. Shaw, R. (2000), ‘System integration: the missing link in distributed generation’, Utilities and Perspectives, 7 (1), January, 1–3. Wüstenhagen, R. and J. Boehnke (2008), ‘Business models for sustainable energy’, in A. Tukker, M. Charter, C. Vezzoli, E. Sto and M.M. Andersen (eds), System Innovation for Sustainability. Perspectives on Radical Changes to Sustainable Consumption and Production (SCP), Sheffield: Greenleaf Publishing, pp. 85–94. Yin, R.K. (1994), Case Study Research, Design and Methods, Newbury Park, CA: Sage. Zott, C. and R. Amit (2008), ‘The fit between product market strategy and business model: implications for firm performance’, Strategic Management Journal, 29 (1): 1–26.

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Value constellation

Operations and maintenance + one of the other steps Project development and /or construction & installation and/or energy control (mix of these steps, except operations & maintenance)

ConsProject truction devel& instal- opment lation

4. Market maker

ConsEnergy truction control & installation

The company performs one specific step in the industry value chain*** (often for several renewable energies)

3. Layer player

Opera- Project ConsProject tions devel- truction develand opment & instal- opment maintelation nance + one of the other steps

Project development and /or construction & installation

PerAll formed steps in the value chain Project development and /or construction & installation and/or energy control (mix of these steps, except operations & maintenance)

The company performs a limited number of steps in the value chain and outsources the others

2. Orchestrator

Descrip- The company performs all tion the steps in the value chain

1. Integrated

APPENDIX 8A1

166

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Value proposition

Residential

Is the NA* player the owner of the PV facility? Offered   products and/or services

Application

APPENDIX 8A1

yes**

The whole project is managed by the player and the customer produces its energy or resells it

no

Ground Resimounted dential

The Energy whole producproject is tion managed by the player and the building owner gets some form of revenue

yes**

Commercial

(continued)

The whole project is managed by the player and the customer gets the energy or resells it

no

The owner of the building gets some form of revenue for renting its roof

yes

Commercial

yes

The Energy whole project is managed by the player and the customer produces its energy or resells it

no

Ground mounted

Service of project development

no

Service of construction and installation

no

Residential

Service of project development

no

Service of construction and installation

no

Commercial

Service of project development

no

(Residential + commercial +) ground mounted no

Service Energy of construction and installation

no

Ground mounted

167

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Typical   customers

Economic rationale (profit equation)

Value proposition

The player uses the customer’s assets (ie., the roof of a supermarket)

Home owners willing to produce their own energy or to benefit from tax reduction and / or increase their revenue (like a financial product)

The Service player offer controls all assets of the projects (land and operations) and benefits from the rent

ComEnergy mercial buyers building owners willing to benefit from a revenue increase + energy buyers Commercial builing owners willing to produce their own energy for use or to benefit from tax reduction and / or increase their revenue (like a financial product) Service offer Home owner not willing to deal with finding finances and/or getting the needed authorizations + orchestrators model 2.3 Home owner not willing to install themselves + orchestrator’s model 2.3 commercial or orchestrator’s model 2.4 and 2.5 commercial or orchestrator’s model 2.4 and 2.5 Owner of large PV facilities or as outsources for orchestrators model 2.6 and 2.7

Wholesale

Owner of Energy large PV producer facilities or as outsources for orchestrators model 2.6 and 2.7

The Focus on on step = economies of scale and know-how company controls all assets of the projects (land and operations)

Owner Energy of the buyers PV facility not wishing to deal with the oneshot steps

The Low player capital benefits employed from the energy rent and gives some return to the owner of the roof (a lease)

Commercial builing owners willing to benefit from tax reduction and / or increase their revenue (like a financial product)

168

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1.1 Build– own– operate rooftop PV model for commercial buildings 1.2 Utilityscale builder and operator 2.3 Turnkey project provider for home owners

(continued) 2.4 Turnkey project provider for commercial building owner 2.5 Builder, owner and operator of rooftop PV for commercial building owner 2.6 Service provider to the owner of a large PV facility 2.7 Utilityscale power builder orchestrator and producer 3.8 Small project development specialist

Notes: * There is no economic rationale for an integrated player to own a large number of small facilities. ** Since it performs the operation and maintenance step, the player necessarily owns the PV facility. *** In PV, the operations and maintenance step cannot be stand alone (limited need for maintenance).

Business model

APPENDIX 8A1 3.9 Small facility construction and installation specialist 3.10 Mediumsize project development specialist (same as 3.8 but larger projects) 3.11 Mediumsize project facility construction and installation specialist (same as 3.9 but larger projects)

3.12 Large project development specialist (same as 3.8 & 3.10 but larger projects)

3.13 Large project facility construction and installation specialist (same as 3.9 & 3.11 but larger projects)

3.14 Virtual operator and energy controller

169

1.2 Utilityscale builder and operator

Capital High employed (ownership)

2.4 Turnkey project provider for commercial building owner 2.5 Builder, owner and operator of rooftop PV for commercial building owners

One-shot part of the value chain

One-shot part of the value chain

Resident- Commer- Commerial home cial cial owner building building owner owners + energy buyer Service Service Complementary revenue

2.3 Turnkey project provider for home owners

Operations and maintenance + one other step High Low Low High (owner- (working (working (ownership) capital capital ship) only) only)

All

Commer- Energy cial buyer building owners + energy buyer Complementary revenue

Offer (if other customer than energy buyer) Steps All performed in the value chain

Customers

1.1 Build– own– operate rooftop PV model for commercial buildings

APPENDIX 8A2

Business model

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Energy buyer

2.7 Utilityscale power builder orchestrator and producer

Operations and maintenance + one other step Low High (working (ownercapital ship) only)

One-shot part of the value chain

Service

PV facility owner

2.6 Service provider to the owner of a large PV facility

Low

Project development

Service

Residential home owner or orchestrator

3.8 Small project development specialist

Commercial building owner or orchestrator Service

3.10 Mediumsize project development specialist (same as 3.8 but larger projects)

Low (working capital only)

Low

Construct- Project ion & developinstallament tion

Service

Residential home owner or orchestrator

3.9 Small facility construction and installation specialist

Service

Large facility owner or orchestrator

3.12 Large project development specialist (same as 3.8 & 3.10 but larger projects)

Low (working capital only)

Low

Construc- Project tion & developinstallat- ment ion

Commercial building owner or orchestrator Service

3.11 Mediumsize project facility construction and installation specialist (same as 3.9 but larger projects)

3.14 Virtual operator and energy controller

Low (working capital only)

?

Manages peaks through control of supply and demand Construc- Energy tion & control installation

Service

Large Energy facility buyer owner or orchestrator

3.13 Large project facility construction and installation specialist (same as 3.9. & 3.11. but larger projects)

170

Access to mass market Access to semi-mass market Value-added services (engineering . . .) Local project management Ability to raise cash

x

x

x

x

x

x

x

x

2.4 Turnkey project provider for commercial building owner

x

x

x

2.3 Turnkey project provider for home owners

x

1.2 Utilityscale builder and operator

(continued)

x

1.1 Build– own– operate rooftop PV model for commercial buildings

APPENDIX 8A2

Required key competencies

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x

x

x

x

2.5 Builder, owner and operator of rooftop PV for commercial building owners

or x

x

2.6 Service provider to the owner of a large PV facility

x

x

x

2.7 Utilityscale power builder orchestrator and producer

x

x

3.8 Small project development specialist

x

x

3.9 Small facility construction and installation specialist

 

x

x

3.10 Mediumsize project development specialist (same as 3.8 but larger projects)

x

x

3.11 Mediumsize project facility construction and installation specialist (same as 3.9 but larger projects)

x

3.12 Large project development specialist (same as 3.8 & 3.10 but larger projects)

x

3.13 Large project facility construction and installation specialist (same as 3.9. & 3.11. but larger projects)

3.14 Virtual operator and energy controller

171

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Required key competencies

Ability to deal with large projects (lobbying . . .) Information systems + trading

x

x

x

x

x

9

Why corporate venture capital funds fail: evidence from the European energy industry Tarja Teppo and Rolf Wüstenhagen*

The first thing to ask is: Which CVC funds have been able to stay in existence for 10 years or longer? There are not that many that have been around for very long. This tends to be a very cyclical kind of a mechanism. Many, many companies started programs and then got rid of them. Professor Henry Chesbrough, UC Berkeley1

1

INTRODUCTION

Corporate venture capital (CVC) funds are an important means for large firms to engage in innovation. However, academic literature as well as practical experience has provided ample evidence of the challenging nature of operating a CVC fund within a large incumbent organization. Venture capital researchers have demonstrated that CVC funds are volatile (Gompers and Lerner, 2001) and varying in success (Sykes, 1986; Siegel et al., 1988; Gompers and Lerner, 1998; Chesbrough, 2000). We argue that the understanding of CVC can be enhanced by answering the following research question: how does parent firm organizational culture affect the survival of a CVC fund? We investigate this research question in the context of an industry in which large, incumbent organizations are particularly relevant, and in which the need for innovation is increasingly acknowledged due to a variety of drivers in the energy industry. The energy industry is one of the largest sectors of the economy, and a number of environmental and geopolitical concerns, as well as new technological opportunities, have recently sparked interest in energy innovation. As a consequence, there is an increasing appetite in the venture capital community for investments in new, cleaner energy technologies. This has been mirrored by several large energy companies initiating CVC activities in the early years of this decade. Our study on energy sector CVC funds is motivated by the fact that most of the previous studies on CVC have focused on industries that have experienced a ‘venture capital glut’ such as internet and communications technologies. Venturing in new energy technologies has received only scant attention from academic researchers. This is in stark contrast to the frequent coverage of venture capital investments in new energy and other clean technology firms in the business press (for example, Frankel, 2000; Gunderson and Woodward, 2003; Henig, 2003; Stone, 2003; Wilson, 2003; Abrams, 2004; Cauchi, 2004; Weeks, 2004; Harvey, 2005; Rivlin, 2005). Studying electric utilities in particular seems interesting because they have been described as having a strong organizational culture that is more conservative than in other industries and may stifle innovation (Hirsh, 1989). The chapter develops an organizational culture-based model that aims to explain how 172

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parent firm organizational culture affects the survival of a CVC fund. We utilize empirical data gathered from interviews with CVC and VC fund managers The model consists of the following components, each of which will be discussed in detail in Sections 5, 6, 7 and 8, respectively: (i) parent firm organizational culture, (ii) organizational decisionmaking practices, (iii) managing and measuring success and (iv) CVC fund survival. Propositions are developed that can be tested in future research.

2

LITERATURE REVIEW

Several authors have looked at CVC as one way of organizing innovation within large incumbent firms. Starting with the wider theme of innovation in incumbent firms, we review existing CVC literature with regard to factors that may explain success or failure, and finally review some of the literature on organizational culture with particular regard to innovation. Innovation and Incumbent Firms Levinthal (1997) studied the ability of existing organizations to respond to changing environments and concluded that incumbents in general may have difficulties in adapting to changing environments because the changes negate the value of some of the organization’s existing assets. According to Henderson and Clark (1990) incumbent firms often fail to recognize destruction brought about by ‘architectural innovations’ that change the architecture of the product without changing its components. Sharma (1999, p. 146) notes that it is not that incumbents lack creativity and ability to invent new things, but it is ‘the inertia of past actions, the stifling effects of bureaucracy, and the inflexibility of collective mind-sets that inhabit large firms’. Liabilities of bureaucracy, inertia that accompanies organizational size and ageing have contributed to a common perception that start-ups are more innovative than established large firms (Chandy and Tellis, 2000). In addition, radical changes in the business environment can render the skills of the incumbent firms obsolete (Tushman and Anderson, 1986). According to Day and Schoemaker (2000) there are four common pitfalls for incumbents in dealing with emerging technology: delayed participation, sticking with the familiar, reluctance to fully commit and lack of persistence. They emphasize the use of ‘early indicators’ in order to spot emerging technologies, and encourage firms to look past disappointing results and limited functionality. Similarly, Ahuja and Lampert (2001) identify three traps that inhibit breakthrough inventions in established firms: favouring the familiar (familiarity trap), favouring the mature (maturity trap) and favouring the search for solutions near to existing solutions (propinquity trap). Christensen and Bower (1996, p. 197) studied the disk driver industry and showed that established firms ‘led the industry in developing technologies of every sort whenever the technologies addressed existing customers’ needs’, but at the same time, ‘projects targeted at technologies for which no customers yet exist languish for lack of impetus and resources’. Christensen (1997) introduced a model of disruptive innovation which attempts to explain why current industry leaders do well with sustaining innovations but not with disruptive innovations. Disruptive innovations redefine the

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development trajectory by introducing less-advanced products that have other merits such as simplicity or lower costs, targeting new or less-demanding customers. The disruptive innovation gains foothold in the marketplace and starts a cycle of innovation improvement. Chesbrough (2001), based on a meta-analysis of 16 empirical studies on the impact of technological change upon incumbent firms, proposed a framework consisting of three dimensions that synthesize the findings of the literature: challenge of managing technical complexity, importance of external linkages and the institutional environment. In his 2003 concept of ‘open innovation’, Chesbrough states that ‘in a world of widely distributed knowledge, a company must access external technologies for use in its business and allow its technologies to be accessed by other firms’ businesses’ (see also Chesbrough and Teece, 1996). One way of institutionalizing this link between the company and its external innovation environment is to implement a CVC fund. Corporate Venture Capital CVC is one specific form of corporate venturing (von Hippel, 1977; Burgelman, 1985; Block and MacMillan, 1983) or corporate entrepreneurship (Stopford and Baden-Fuller, 1994; Ahuja and Lampert, 2001; Dess et al., 2003) that involves investment intermediation by a dedicated fund (Miles and Covin, 2002). CVC can be described as equity investment into entrepreneurial ventures by established, non-financial corporations. The investment into start-up companies by incumbents ‘serves as a bridge that connects incumbents to start-ups that are exploring diverse and often competing new technologies that could evolve into technological discontinuities’ (Maula et al., 2003). Most firms create CVC funds with a dual mission in mind, as their goal is to reach both financial (Siegel et al., 1988; Block and MacMillan, 1993; Chesbrough, 2002) and strategic (Rind, 1981; Siegel et al., 1988; Sykes, 1990; Block and MacMillan, 1993; Chesbrough, 2000, 2002; Maula, 2001) objectives. The financial objective is to reach rates of return similar to independent VC funds. However, for many firms gaining strategic benefits is more important (Rind, 1981; Sykes, 1986; Block and MacMillan, 1993). Examples of strategic benefits are identifying future products or technologies, understanding management strengths or weaknesses in acquisitions, designing products faster and at lower cost, gaining a window on technology and offering a way of studying new markets (Rind, 1981). Dushnitsky and Lenox (2005) argue that corporations can learn from CVC investments in entrepreneurial ventures in three ways: first, prior to committing capital, the parent firm can learn through the due-diligence process; second, an investor may learn about new technologies post-investment by maintaining board seats as well as utilizing dedicated liaisons; and third, even a failing venture may constitute a learning experience to the extent that it points to remaining technological challenges or market unattractiveness. Maula et al. (2003) argue that incumbents’ CVC investments should be used to complement their internal R&D spending that enhances organizational learning and keeps incumbents’ knowledge current. If properly implemented, CVC allows incumbents to develop deep relationships with multiple start-ups, making it possible for them to observe their technological skills and understand their goals, resources and business models.

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CVC Success Factors and Challenges The financial outcome of CVC funds has been found to vary greatly (Sykes, 1986; Siegel et al., 1988; Gompers and Lerner, 1998; Chesbrough, 2000). On the positive end, Gompers (2002) showed that CVC investments have been at least as successful as independent VC investments in financial terms and the probability of success is substantially higher for funds operating in industries related to the parent company business. According to Siegel et al. (1988), CVC funds that enjoyed greater autonomy in investment decision making and longer-term financial commitment to the venturing activity reached higher financial return on investment and at least as good strategic benefits as the funds with less autonomy and corporate commitment. Gompers and Lerner (1999) reported similar findings on the importance of a high degree of autonomy. They concluded that greater autonomy combined with long-term commitment prevents the current corporate management from viewing the CVC fund as the pet project of the predecessors. More room to manoeuvre in investment decision making may also enable the fund to pursue alternative business models in its portfolio, which is one of the advantages of independent over corporate venture capitalists (Chesbrough, 2000). On the downside, several studies have reported high failure rates of CVC funds. Challenges faced by the funds may be one reason for the cyclical nature of CVC activities. In general, CVC funds have been found to be more volatile than independent VC funds (Gompers and Lerner, 1998). According to Chesbrough (2000, p. 31) ‘the general pattern is a cycle that starts with enthusiasm, continues into implementation, then encounters significant difficulties, and ends with eventual termination of the initiative’. Sykes and Dunham (1995) argued that the root of the CVC management problem in corporations is a preconceived mental model about how new ventures should be managed and how performance should be measured. Examples of challenges are problems with venture manager incentives (Block and Ornati, 1987; Chesbrough, 2000), internal politics (Sykes, 1986), or inadequate financial commitment (Siegel et al., 1988). Again, a lack of autonomy might be the root for several of the listed challenges (ibid.). Comparing corporate and independent venture capitalists, Maula (2001) found that ventures backed by the former fared better in initial public offerings than those backed by the latter. Gompers and Lerner (1998) have reported that ventures backed by corporate venture capitalists were as successful as those backed by independent venture capitalists when the lines of business of the venture and the investing corporation were similar. This indicates that some firms have been able to use their complementary capabilities to advance the ventures in the CVC fund portfolio (ibid.) and thus gain a competitive edge over independent venture capitalists. Organizational Culture and Innovation Many of the obstacles faced by the CVC funds discussed in the previous subsection have their source in the interaction between the parent firm and the CVC fund. Thus, the findings of previous research on CVC indicate that studying the organizational culture of the parent firm, that is defined as being ‘based upon internally oriented beliefs regarding how to manage, and externally oriented beliefs regarding how to compete’ (Davis,

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1984), could be helpful in understanding, and possibly even predetermining, the performance of a CVC activity. In his seminal work, Schein (1985) described organizational culture as the historic result of human actions and decisions, consisting of artefacts, values and basic assumptions. According to Schein, organizations typically share basic assumptions on five dimensions: relation between the organization and its environment; nature of reality and truth; nature of human beings; nature of human activities; and nature of human interactions. Several authors have discussed the relationship between organizational culture and innovation or corporate entrepreneurship. For example, von Rosenstiel (1999) recommends promoting risk-taking, employee initiative, a positive attitude towards innovation and cooperation as cultural aspects of enhancing corporate entrepreneurship. Similar dimensions have been identified by Jaritz (1999). With particular regard to innovation for sustainability, which may be relevant in the context of CVC in the energy sector, Seidl (1993) has taken Schein’s five basic assumptions as a starting point to define for each of them an economic, environmental and social dimension, leading to a rather comprehensive survey instrument addressing 45 aspects of organizational culture. Pichel (2003), in her analysis of corporate ecopreneurship, identified four key dimensions of organizational culture, namely the relevance of environmental aspects among the current corporate priorities; the role of the corporate environmental manager as a promoter for innovation; appreciation of individual performance; and openness to change. Our short review of literature related to organizational culture and innovation highlights that while there is widespread agreement on the importance of cultural factors for explaining organizational behaviour and performance, the wider concept of organizational culture needs to be carefully operationalized in order to be useful in any given context. None of the previous research has had a specific focus on the relation between organizational culture and corporate venture capital. Therefore, we shall use the broad definition by Davis (1984) rather than apply any of the specific operationalizations discussed above. It is worth noting that there is an industry-specific aspect of organizational culture. Gordon (1991, p. 399) presented a model on industry determinants of organizational culture that was described as follows: Organizations are founded on industry-based assumptions about customers, competitors, and society, which form the basis of the company culture. From these assumptions, certain values develop concerning ‘the right thing to do’, and consistent with these values, management develops strategies, structures, and processes necessary for a company to develop its business.

Thus certain cultural characteristics will be widespread among organizations in the same industry, and these are most likely different from characteristics found in other industries. This is consistent with the findings of Chatman and Jehn (1994) who investigated similarities in the culture of firms in the same industry. They found that stable organizational culture dimensions existed and varied more across industries than within groups of firms in a particular industry. Because of this industry-specific aspect to organizational culture, the potential for change may often be limited to actions that are neutral to, or directionally consistent with, industry demands.

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177

METHODOLOGY AND RESEARCH SETTING

The study employed a grounded theory approach and used interviews with CVC and VC fund managers as the empirical data source. Interviewees were granted anonymity, therefore individual names of respondents are not disclosed. Our interview partners were principals, managing directors or senior investment managers of the fund, with one interviewee for each of the funds listed in Table 9.1. Where quotes from the interviews are used in this chapter, we use the labels [CVC] and [VC] to indicate the type of respondent. In total, 27 interviews were carried out among independent and corporate venture capitalists Table 9.1

List of CVC and VC interviews

Name of the fund

Type of fund

Norsk Hydro Technology Ventures RWE Dynamics MVV/Accera Eon Venture Partners Vattenfall Europe Venture Suez NovInvest Edf Business Innovation EdF Capital Investissement Schneider Electric Ventures BASF Venture Capital GmbH Easenergy Nth Power SAM Group MSBI Capital Innofinance Glastad Invest PEM-fund Proventia Group Capman Apax Nordstjernan Ventures Draper Fisher Jurvetson Rustic Canyon Partners Good Energies Inc Pacific Corporate Group California Clean Energy Fund Chrysalix

Corporate VC

Norway

6.11.2003

Face to face (taped)

Corporate VC Corporate VC Corporate VC Corporate VC

Germany Germany Germany Germany

17.2.2004 18.2.2004 19.2.2004 5.2.2004

Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped)

Corporate VC Corporate VC Corporate VC

France France France

24.3.2004 25.3.2004 24.3.2004

Face to face (taped) Face to face (taped) Face to face (taped)

Corporate VC

France

23.3.2004

Face to face (taped)

Corporate VC

Germany

18.2.2004

Face to face (taped)

Corporate VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC Independent VC

USA USA Switzerland Canada Finland Norway Finland Finland Denmark Germany Sweden USA USA USA USA USA

17.2.2005 9.10.2003 20.8.2003 20.10.2003 21.11.2003 5.11.2003 7.11.2003 20.10.2003 14.11.2003 11.3.2004 29.10.2003 1.2.2005 26.1.2005 26.1.2005 29.3.2005 21.3.2005

Face to face (notes) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped) Face to face (taped)

Independent VC

Canada

24.1.2005

Phone interview (notes)

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Fund location

Interview date

Interview type

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both in Europe and in North America during 2003–05. The funds were identified through energy sector VC conferences such as European Energy Venture Fair2 and Cleantech Venture Forum,3 and by cross-checking with the Venture Economics database4 and with interview partners from our sample. We achieved almost full coverage of the European VC and CVC funds that were actively investing in clean energy technology ventures in 2003– 04. In spring 2005 additional interviews were carried out among North American venture capitalists investing in the same sector in order to lessen possible geographical bias. All of the VC fund interviewees had made at least one investment into clean energy technologies. Most of them publicly promoted clean energy as one of the fund’s focus areas. Our focus on the clean energy technology sector was motivated by three factors. First, the energy industry, which is of huge economic importance, is currently under pressure to change. Second, the energy sector is attracting a growing amount of attention from venture capitalists. Third, since European CVC funds have been active investors in the clean energy market it was expected that interesting and rich research data would be available by focusing on clean energy. In this study, clean energy is defined as providing energy technologies and services that reduce environmental impacts, are socially acceptable and can be economically competitive (Moore and Wüstenhagen, 2004). Clean energy technologies and services can be divided into four main clusters: renewable energy, distributed energy systems, natural gas and demand-side energy efficiency (Pfeuti, et al., 2002).

4

CONCEPTUAL MODEL

In order to gain a better understanding of the factors that determine the survival of a CVC fund, we took a perspective that concentrated on the organizational culture of the parent firm. We argue that selecting organizational culture as the viewpoint of the analysis will provide fresh new perspectives on the survival challenges that CVC funds face. Without explicitly referring to the concept of organizational culture, some of the previous findings or CVC research discussed above hint to cultural aspects of the parent firm, such as venture manager incentives, internal politics or low level of fund autonomy. Another aspect that makes our perspective promising is the link between organizational culture of the parent firm and the surrounding industry context (Gordon, 1991). None of the previous CVC research has had an empirical focus on the energy sector. Instead, CVC researchers tended to rely on empirics from information technology, telecommunications or pharmaceutical industries. Our study is based on empirical data from the energy sector where the industry context differs from these sectors in many respects such as in market concentration, regulation and patenting activity. Analysing energy sector CVC fund investments into clean energy ventures may therefore bring out new perspectives that have gone unnoticed in previous research. The dependent variable of our research is survival of the CVC fund. While previous literature has discussed various indicators for measuring the achievement of financial and strategic objectives of a fund, we argue that in order to achieve financial and strategic objectives, survival of a CVC fund is a necessary prerequisite. As we shall find in our sample, even this basic prerequisite is not fulfilled in many cases, rendering a more detailed discussion of financial or strategic performance obsolete.

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CVC fund survival

Parent firm view of innovation Parent firm view of industry development Parent firm organizational mindset

Risk and organizational decision making Parent firm involvement in due diligence Parent firm involvement in investment decision

Parent firm skills in managing and measuring success

Figure 9.1

Conceptual model to explain CVC fund survival

The explanatory model shown in Figure 9.1 emerged as a result of the data analysis of interviews with CVC and VC fund managers, and previous research findings on organizational culture, industry context and decision-making behaviour. The model is based on the argument that the parent firm organizational culture affects CVC fund survival. The effect of the organisational culture is moderated by risk-taking practices in the parent firm decision-making process and the parent firm skills in managing and measuring fund success. Therefore, depending on the strength and nature of the two moderating factors, the parent firm organizational culture may have more or less effect on the CVC fund survival. The following sections discuss the elements of the model in more detail.

5

PARENT FIRM ORGANIZATIONAL CULTURE

CVC funds operate as separate entities within the parent company, some more autonomous than others. CVC managers interact with the parent company in investment decision making, due diligence and other services such as legal support. When we analysed the empirical data from our interviews, a large amount of the CVC fund challenges were linked to interaction with the parent company. When these challenges were analysed further, three main factors related to parent firm organizational culture were identified: parent firm view on innovation, parent firm view of industry development and parent firm organizational mindset. These three factors will be discussed in detail below. Parent Firm View of Innovation From the CVC and VC interviews two issues were identified regarding innovation in the energy sector. First, many electric utilities did not perceive innovation as a key competitive advantage, which in turn made it difficult for a CVC fund to identify new innovative

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business models promoted by start-up firms. Second, even in cases where the parent firm had realized that scouting for new innovative business approaches was important, the parent company saw no urgency to act. The lack of urgency was due to the fact that parent companies were used to reacting to external regulatory pressures, not to business threats imposed by new external ventures. In other words, the CVC activity was not perceived as a crucial activity, but rather as a convenient approach to keep track of the latest market developments. The term ‘innovation’ has become a buzzword in many industrial sectors such as biotech, pharmaceuticals and information and communications technology (ICT). The energy sector seems in have headed in the opposite direction in innovation when measured in terms of R&D spending both in the public and private sectors. Kammen and Nemet (2005) studied the US energy industry and found that both the federal government and private industry had cut investments in energy R&D ‘at a time when geopolitics, environmental concerns and economic competitiveness call instead for a major expansion in U.S. capacity to innovate in this sector’. Their analysis shows that investments into energy R&D by US companies fell by 50 per cent between 1991 and 2003. When energy sector R&D spending is compared with other sectors, such as biotech, the picture is even bleaker. Total private sector energy R&D is less than the R&D budgets of individual biotech companies such as Amgen or Genentech (Kammen and Nemet, 2005). An interviewed venture capitalist commented on the electric utilities as follows: [VC]: The way that the power industry has changed in the last three years has been one of reverting back to the kind of core business of serving customers, generating electrons and managing risks and things like that. Not really about innovation and not about innovating service. So, I think most of them have done away with innovation culture.

However, previous research has shown that in order for the CVC activity to be successful, the parent firm must make venturing a mainstream function of the business (Sykes and Block, 1989) or create an atmosphere and structure that supports the innovative activity (Quinn, 1985). In other words, the parent firm organizational culture must provide a supportive structure for innovation, which may consist, for example, of R&D or other corporate venturing activities within the parent firm (Dushnitsky and Lenox, 2005). Creating a culture that nurtures innovation may take a long time to develop. According to March (1988) preferences tend to adapt in response to experience. Therefore, firms that have not developed competencies for innovation and R&D operations, also tend to lack a taste for these activities, which in turn shows in the level of organizational support that a CVC fund enjoys. Currently the large electric utilities have a strong hold on their customers, but not on energy technologies. They are in the business of generating and supplying electricity, but they are not in charge of bringing new technological innovations to the energy sector. For many electric utilities, competitive advantage through innovation is not a familiar concept. Kammen and Margolis (1999) have argued that cutbacks in energy R&D during the past decades have reduced the capacity of the energy sector to innovate. In the words of one interviewed CVC fund manager: [CVC]: The message is that it is really difficult to make a CVC unit exist [in a large electric utility] when you are not convinced that innovation will be the key in competition. In the

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corporate level they don’t think that innovation will be the key in winning the competition. They think it is the price or classical services

The independent venture capitals that had observed the energy company CVC fund activities, were more optimistic about the chances of success of CVC funds backed by large energy technology companies than of the funds backed by electric utilities. [VC]: [Energy technology companies] are the ones that ultimately are much more focused on innovation [than electric utilities] because they know how to absorb it and turn it into a value proposition. There’s very little that an electricity company can innovate on, because again ultimately I think that they are just in the core business of selling you know electrons. And there are no big changes that have happened . . . since the beginning of the last century that have really changed the way that wholesale power has been delivered to customers.

Proposition 1: A parent firm, whose organizational culture does not view innovation as a key component in gaining competitive advantage, negatively affects the survival of a CVC fund. Parent Firm View of Industry Development From the CVC fund interviews, a theme was identified regarding the parent firm view of industry development. The theme is concerned with the parent firm not recognizing that the surrounding business environment is undergoing a change and acknowledging that some of the new entrants could potentially threaten the firm’s market position. According to Bettis and Hitt (1995) the twenty-first century faces new aspects of competition and strategy due to rapid technological change including the blurring of traditional industry boundaries as substitute products are developed in other industries. This phenomenon is currently starting to take hold in the energy sector. For example, several of the independent venture capitalists that have focused on the clean energy market have large non-energy corporations as investors. One example is the Canadian fuel cell VC fund Chrysalix, whose investors include companies such as Ballard, BASF, BOC, Boeing, and Mitsubishi. One interviewed CVC manager commented on the views of his parent company managers on the change that was taking place in the energy sector: [CVC]: This industry is moving slowly, the driver is not technology but market power. So we are not really in the battle, even if [the new market entrants] claim that we are in a battle. In the mind of a manager, we are not in a battle. So we are anticipating here and it is not easy to anticipate in big companies.

Regulatory authorities rather than market forces were seen as driving innovation in the energy sector, and where regulatory pressure was low, there seemed to be little incentive to innovate: [CVC]: I think the extent to which the established corporations like [our company] are ready to accept innovation and invest in new business models largely depends on the regulatory framework. Because it is relatively stable they do not have any urgency to change their business model. Just do nothing and do nothing new, is the best strategy. I’m definitely convinced that this is the best strategy.

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Many of the interviewed CVC fund managers indicated that the parent company views on the changes in the surrounding industry context and the introduction of new business models were conflicting with the views of the CVC fund, especially when it came to assessing the speed of change taking place. According to Aldrich and Fiol (1994), established industries may withhold recognition or acceptance of the new industry when they feel threatened. Sometimes they are even able to change the terms on which resources are available to emerging industries. This kind of blocking behaviour was not foreign to the CVC managers, who had involved parent firm managers in the CVC fund investment decision making: [CVC]: Then we have had deals that have been very convincing. And [corporate headquarters] say, ‘People are great, as a technology it seems to be very, very interesting’. Then came: ‘if these guys become a success, they will cannibalize our business. We cannot invest in a company that is cannibalizing our own business’.

Abernathy and Utterback (1978) and Utterback (1994) have investigated different phases of product and process innovation in an industry. They pointed out a general pattern of the emergence of new industries, where innovation initially takes place at a high rate and many new players enter the market, followed by a phase of consolidation. Making sense of the new developments in an emerging industry may be challenging. According to Sanders and Boivie (2004), during the emergence of new industries, investors and analysts lack a codified body of knowledge and industry-specific experience. Therefore, identifying the winning business models among the various unproven but interesting models explored by competing start-up firms is difficult even for an energycompany-backed CVC fund manager. The CVC fund managers were at times in a position where they saw potential threats to the status quo of the parent company, but no serious counteract on behalf of the parent company itself: [CVC]: I’d say it is not very easy to compete against [our parent company]. So perhaps we don’t see the sign [that we need to act], we see a lot of start-ups working on these systems to measure the consumption, to evaluate the right services to cut on consumption. But we don’t see a big movement of large energy companies heading to catch the value of these start-ups.

Proposition 2: A parent firm, whose organizational culture supports a perception of industry stability and belittles the speed of technological change, negatively affects the survival of a CVC fund. Parent Firm Organizational Mindset Two themes related to parent firm organizational mindset emerged from the interviews with CVC and VC fund managers. The first theme was differences in the organizational mindset of the fund and the parent company. Second, a lack of entrepreneurial thinking and mindset within the parent firm caused conflicts in the CVC fund–parent firm interaction. Levinthal and March (1993) argued that organizations find and construct their private comprehensible worlds. The parent firm worldview or organizational mindset may differ strongly from the one present in the CVC fund. The organizational culture mismatch

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may lead to a clash of management cultures if the parent firm does not provide adequate autonomy for the venturing activity to establish its own management processes. An interviewed CVC fund manager commented about a clash he had experienced with the parent company as follows: [CVC]: [Our company] of course tried to duplicate their controlling system here at [our CVC fund]. And I said, hey, I’m not willing to accept this. Otherwise you are calculating every project to death. You are not able to [apply the corporate] mindset [to a CVC fund]. We have a different mindset and culture.

Changing the prevailing mindset means adopting a different worldview. Electric utilities have in many countries until recently been part of a government-owned and -regulated entity. For these firms, switching to entrepreneurial mode of operation and thinking can be difficult. An interviewed CVC fund manager was frustrated and commented on the lack of entrepreneurial spirit in his parent company: [CVC]: You always have to ask why people are working with a big conglomerate or a big energy company and not working as an entrepreneur. They have a different spirit. And I asked a board member, . . . and he said: ‘Look at these people. They are not entrepreneurs. So you are trying to do something that is impossible, to move these people to your side’.

Another interviewed CVC fund manager described his parent company’s research centre activities as follows: [CVC]: It is always a question of people. And if you have a research centre with 100 people or 200 people, they can gather all the information available in the world about technologies and trends and so on. But they are not thinking in terms of business, they are just thinking in terms of a department that delivers information.

Foster (1986) has shown that the reason why incumbent firms fail in the face of technical change is due not to the character of the technology but to the cognitive errors the managers made in understanding the challenge of the emerging industry context. One interviewed independent VC fund manager, who had been following the CVC activities of energy companies, commented on the willingness of electric utilities to engage in business activities with small firms as follows: [VC]: The other characteristic of this industry might be that the utilities have a tendency to really only want to work with more mature companies and not with companies that they are concerned would disappear. Whereas you see in companies like Cisco or maybe even in the Biotech area partnerships between small lab companies and these big pharmaceutical companies. And, you know, lab companies don’t make the required discovery or something like that. They disappear or go away but this is probably their whole plan to work with this diversified portfolio of small companies. Utilities don’t seem to approach it that way. So you have to pass a certain level of maturity before the utilities really want to do business with you.

In a similar fashion, Henderson (1996) found that radical innovation could displace incumbent firms for organizational reasons due to cognitive limits and inertia, in addition to the more rational reasons such as unwillingness to render existing assets obsolete. One example of cognitive limits is the inability to adapt to a new way of serving the

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customers. An interviewed VC fund manager commented on the electric utilities and the way they conducted their business as follows: [VC]: So far they’ve always looked like ‘we are the utility and you are the subscribers’. And not like ‘you are the customer, how can I serve you and make a business’ . . . And that is an attitude that, you know, ‘it has worked so let’s not change it’.

Proposition 3: Lack of entrepreneurial spirit within the parent firm negatively affects CVC fund survival.

6

RISK AND ORGANIZATIONAL DECISION MAKING

In the CVC fund interviews two themes emerged regarding organizational decision making under risk, mainly concerned with due diligence and investment decisions. The first theme, gaining an outside view both in technical and market assessment through the parent company involvement in the preparation of CVC fund investment decisions, and thus balancing possible overconfidence of CVC fund managers, has a potentially positive effect on CVC fund survival. The second theme, involving parent firm managers with no venturing experience in the decision making, has a negative effect on fund survival. We argue that parent firm risk-taking practices in the organizational decision-making process moderate the effects of parent firm organizational culture on the survival of the CVC fund, as shown in Figure 9.1. The decision-making process regarding the fund investments often involves managers both from the parent firm and the CVC fund, making the decision-making behaviour and the biases each party brings to the table critical for the quality of decisions on venture investments and divestments, and the fund’s investment policy. The basic assumptions and values that are part of organizational culture also affect decision making in organizations. Kahneman and Lovallo (1993) studied cognitive perspectives of decision making and argued that decision makers in organizations are prone to two types of biases. First, their forecasts of future performances are often anchored on plans and scenarios of success rather than on past results, and are therefore overly optimistic. Second, their evaluation of single risky prospects neglects the possibilities of pooling risks and is therefore overly timid. Kahneman and Lovallo introduced a concept of an inside view and an outside view. The inside view is generated by focusing on the case at hand, by considering the plan and the obstacles to its completion, by constructing scenarios of future progress, and by extrapolating current trends. The outside view is a conservative approach that relies on statistics of similar cases to the present one. One example of the outside view upside effect is the help provided by a parent firm’s technical experts in the due diligence process. The interviewed CVC fund managers tended to appreciate the technical expertise that they received from within the parent company: [CVC]: If you are investing in start-up companies, [the knowledge needed] is definitely more on the technical side, definitely. The evaluation of the technology is really the core and very essential for calculating the risk and reward scheme.

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Parent firm managers can offer the ‘outside view’ to CVC managers in order to help balance the overly optimistic scenarios and thus avoid hype over a certain technological solution: [CVC]: For our investments, we have invested in very early stage companies. It was really technical due diligence and we were working closely together with [our parent company] engineering. And they do have four or five hundred specialists. Every specialist has really a specific area that he is concentrating on so you really get the best of technical experiences.

Involvement of parent company personnel may also shield the CVC fund managers from overconfidence. Managers may view risk as a challenge to be overcome and believe that risk can be modified by ‘managerial wisdom and skill’ (Donaldson and Lorsch, 1983, cited in Kahneman et al., 1991). Zacharakis and Shepherd (2001) showed that VCs are overconfident in their decision making and the same result can be assumed to apply also to CVC fund managers: [CVC]: In the beginning we were very broad. Everything was energy but we were able to invest in batteries for example which was really not core of the energy business. But we were able to do almost everything. And it was really essential to do so. But as soon as we got into discussions with the operating units, and we had to get into contact, whenever we make a project or an investment of course we have to involve them and to get some technical feedback.

One example of the outside view downside effect is the involvement of parent firm managers with no venturing experience in the investment decision making. Parent firm manager involvement in the venture investment decision-making process may lead to overly timid decisions, demonstrating loss aversion as losses and disadvantages are weighted more than gains and advantages, favouring inaction over action and the status quo over any alternatives (Kahneman and Lovallo, 1993): [CVC]: I had very deep discussion with all the board members, and also the ones that have been on my side. And I discovered one phenomenon. They feel definitely uncomfortable in making the decision if they were not able to understand the business. And you are not doing them a favour by giving them a proposal. The better way is to say, ‘Give me the money and let other people decide about this money’. So they can always say: ‘It was somebody else’s decision’.

The loss aversion problem becomes especially severe when the CVC fund has to involve parent firm managers in the investment decision making who have not enough market or technical knowledge to judge the investments accordingly. This involvement may lead to excessive loss aversion and inhibit the CVC fund manager from taking necessary risks. Kahneman and Lovallo proposed that one way to avoid excessive risk aversion is to analyse whether the organizational context in which the decisions are made is more likely to enhance or inhibit risk aversion. As the quotes below demonstrate, involvement of the parent firm inexperienced managers clearly enhanced the risk aversion in investment decision making: [CVC]: The problem was the corporate headquarters (HQ). The people who were deciding about the investments, they were corporate people from corporate HQ, they didn’t have any knowledge of the technical things and the market things. So they were very insecure.

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Fighting against loss aversion may require CVC managers to spend time on internal lobbying work, instead of focusing on the operation of the fund: [CVC]: So you have to convince people about the VC idea, who have not ever thought about VC. And maybe you get 50% of them if you are really convincing. So it was pretty much fighting against the organization.

Proposition 4A: Parent company involvement in technical and market due diligence positively affects the survival of the CVC fund. Proposition 4B: Parent company involvement in investment decision making negatively affects the survival of the CVC fund.

7

MEASURING AND MANAGING SUCCESS

An important theme that emerged from the interviews with CVC managers, parent firm skills in measuring and managing success, is argued to moderate the effects parent firm organizational culture has on the survival of the CVC fund, as shown in Figure 9.1. We use the term ‘measuring success’ to describe the methods parent firms use to quantify the strategic and financial benefits for the firm. The term is used to analyse the way firms reward the fund managers, the extent to which ‘out-of-the-box thinking’ is encouraged and the level of trust and patience the parent firm has on the fund managers. Managing success requires understanding what Levinthal and March (1993) have referred to as the political structure of an organization. Managers who have been successful in the past are launched into positions of power in the organization. These individuals tend to carry the recipe for past successes in their mind, which discourages out-of-the-box thinking. As Levinthal and March argued, ‘Organizations code outcomes into successes and failures and develop ideas and causes for them’ (p. 97). This easily leads to a situation where unconventional thinking within the CVC fund is not supported or rewarded from the parent firm side. Levinthal and March also noted that since return from any particular innovation or technology is partly a function of the organization’s experience of the new idea, even successful innovations tend to perform poorly at first until the organization has gathered experience. An interviewed CVC fund manager commented about his parent firms’ disability to support innovative approaches the fund was trying to promote as follows: [CVC]: The problem [with venturing] is that if you are really innovative you get in trouble with the traditional organization . . . And if [the ventures] are gaining market share, the headquarters or the operating unit are losing market share. And losing market share in the traditional sector or an operating unit is valued more than chances in the new growth area.

All of the CVC funds in our study were small compared to the annual turnover of the parent company. This may lead to a situation where only failures get punished but success goes without noticing. As an interviewed CVC fund manager comments: [CVC]: So we have only risk and even if you are very, very successful it’ll never be so successful that it will be reported in the quarterly report. So we as a supervising team can only lose. So if

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the money is away the shareholders are asking what happened to our money, is it really necessary to do these kinds of investments. And if you’re successful it is ‘so what’.

Not having a clear view of how strategic benefits were measured and compensated and what was regarded as a successful execution of strategic objectives was also found to be a constraining factor in the CVC fund manager interviews. Since finding the balance between strategic and financial objectives appears to be difficult, the fund managers may try to follow the traditional VC model and concentrate solely on the financial return: [CVC]: So basically it means we go after profits. If you don’t go after the profits, how do you know what you’re finding? Is it going to be the market leader in the future? So by definition if you can’t spot the best deals and get the best returns, you cannot spot what the market is doing.

Measuring the success of the CVC activity is challenging since the investment committee, consisting often of both parent firm managers and fund managers, needs to be able to quantify the strategic value of a venture investment in addition to the potential of future financial returns. Emerging industry operating procedures, competitive environment, firm size and market dominance strategies may differ from the current industry context, making the strategic value quantification difficult for managers tuned to the current industry context. An attempt to fulfil the strategic goals may require easing on the financial targets: [CVC]: I’m now concentrating on delivering strategic benefits and maybe I’m suffering on the return side, because I cannot invest so many resources in making financially really attractive deals.

The financial returns from small ventures may appear modest when benchmarked against the existing business units. Parent company managers may also see an investment into a venture as threatening and to contain a negative strategic value for the parent firm, especially if an investment is syndicated including CVCs of competing firms. As an interviewed CVC fund manager comments: [CVC]: It was odd to have so many other corporate [funds] investing there. It is very hard to argue for this investment from a strategic point of view. If you go to your investment committee they say, ‘Ok, it is an interesting case and you have these risks and opportunities’. But then they also notice that [our main competitor] is inside and then they say, ‘Hey what is here the competitive advantage. Maybe it is a disadvantage if they invest and we don’t’. But this is not so convincing. It is always more convincing when you say ‘We have this exclusive deal and if it is a big hit we have the advantage to acquire the rest of the shares and make a huge business out of it’. That is really convincing.

Proposition 5: Parent firms who have not been able to develop appropriate mechanisms to measure both strategic and financial success of the fund negatively affect the survival of the CVC fund.

8

CVC FUND SURVIVAL

We carried out the majority of our CVC fund interviews between autumn 2003 and spring 2004 (Table 9.2). Looking at the current status of CVC funds in the energy sector

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GE

Technology manufacturer Utility

Utility

Hydro Quebec Vattenfall Europe

Utility

Vattenfall Europe Venture (fka VEAG Betelligungsgesellschaft)

EDF

Utility

EDF Capital Investissement Hydro Quebec Capitech

Suez EDF

Utility Utility

Suez Nov Invest EDF Business Innovation

OPG

Utility

EnBW

OPG Ventures

Innotech GmbH

Endesa Enron

Utility Energy trading

Endesa Netfactory Enron Principal Investments (and related investment vehicles) GE Equity

E.On

Utility

E.On Venture Partners

Name of parent company

Type of parent company

Berlin, Germany

Montréal, Canada

Paris, France

Paris, France Paris, France

Starnford, CT, USA Karlsruhe, Germany Toronto, Canada

Düsseldorf, Germany Madrid, Spain Houston, TX, USA

Location (city, country)

Status of CVC funds in the energy sector as of January 2006

Name of the fund

Table 9.2

n/a

320

n/a

n/a n/a

62.7

62

>3000

400 >100

25

Fund size (€m)

32

13

10

>300

65

3

Number of investments made

1999

1998

1998

2000 Oct 2001

2001

1999

1995

May 2000 1997

2000

Fund initiated (date)

inactive / portfolio externally managed inactive no recent activity no recent activity no recent activity no recent activity

inactive

inactive

inactive inactive

inactive

2005

2005

2003

Jul 2005

Mar 2004

2002

2003 2001

2005

If not active, Fund status as date of last activity of or fund January termination 2006 (date)

189

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Source:

Technology manufacturer

Norsk Hydro AS Schneider Electric Royal Dutch/Shell Siemens

DTE Energy EDF

Houston, TX, USA et al. Munich, Germany et al.

Nanterre, France

San José, CA, USA Oslo, Norway

Ludwigshafen, Germany Houston, TX, USA et al. Detroit, MI, USA

Mannheim, Germany Munich, Germany

700

n/a

15

45

n/a

85

100

130

16

20

9

13

14

30

13

4

50 100

6

40

Own compilation based on company websites, press releases, interviews, and industry sources.

Siemens Venture Capital

Oil&Gas

Norsk Hydro Technology Ventures Schneider Electric Ventures Shell Technology Ventures

Technology manufacturer Oil&Gas

Utility

EasEnergy

BASF

BASF Venture Capital Chemical GmbH Chevron Technology Oil&Gas Ventures DTE Energy Ventures, Inc. Utility Chevron

MVV Energie AG RWE

MVV Innovationsportfolio Utility AG & Co. KGaA RWE Dynamics Utility

1999

1996

2000

Mar 2001

Jan 2000

1999

1999

2001

2001

2001

active

active

active

active

active

active

active

spun off / MBO spun off / MBO active

Jul 2005

2005

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in January 2006, it appears that eight of the 11 CVC funds in our study were either spun off, not actively investing or had been closed down altogether, indicating a significant failure rate. As for the specific industry background of the parent company, it is striking that electric utility-backed CVC funds appear to fail most often, whereas the survival rate has been a bit higher among oil company CVCs and power technology manufacturers. Relating this to the cultural differences, particularly between conservative utilities and the more innovation-driven power technology manufacturers, seems to support our argument about the importance of organizational culture. No clear trend seems to exist among different geographical regions, with North American CVC funds failing roughly as often as those in Europe. Fund size also did not seem to make a major difference, with both failing and surviving funds ranging from a few dozen million euros to several hundred million euros. Table 9.2 summarizes the status of CVC funds in the energy sector as of January 2006.

9

DISCUSSION AND CONCLUSION

Our discussion of organizational culture and CVC fund survival has shed new light on the important issue of how to successfully manage a CVC vehicle. It has demonstrated that incumbent firms face big challenges in renewing their business through CVC activities because of the constraints related to their organizational culture. By disentangling organizational culture into three subfactors, namely parent firm view of innovation, parent firm view of industry development, and parent firm organizational mindset, and supplementing it with two related factors, namely risk and organizational decision making and parent firm skills in managing and measuring success, we proposed a model that helps to explain why some CVC funds are more successful than others. Our empirical insights into the energy sector, and particularly among electric utilities operating CVC funds, illustrated the cultural mismatches between CVC units and their parent firms. Therefore, the empirical finding that a majority of energy CVC funds have been closed only a few years after they were launched, is well in line with our proposed model. On a more constructive note, we could also determine that some companies are more likely to succeed with CVC than others. This is underlined by the fact that many, but not all of the energy CVC funds in our study have failed. Of those that remain active, there seems to be an over-representation of firms that meet the necessary cultural requirements to interpret innovation as an essential element of their core business, and not as either a temporary management fad or even a threat to the basic assumptions of the organization. On average, electric utilities, whose organizational culture is built around notions of industry stability and risk aversion, seem to struggle more with CVC than, for example, energy technology manufacturers, for whom innovation is an essential element of competitive advantage. The study results bear implications for corporations that are planning to launch corporate venturing activities. The findings suggest that firms should closely analyse the parent firm organizational culture and the industry context where the firm operates. In this way the firm could identify the potential shortcomings in its organizational culture such as view of innovation and of industry development, as well as the organizational mindset prior to setting up the fund. A further study on decision-making processes and

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skills in managing and measuring success could be carried out in the firm to alleviate the negative effects, potentially leading to a better outcome of the corporate venturing activity. As this chapter was concerned with theory building rather than testing existing theory, a number of limitations to the results exist. Our findings are based on empirical qualitative data. The results have not been tested quantitatively. In addition, the theoretical scope is limited to corporate venture capital as one specific form of innovation in large incumbent firms. The empirical data of this chapter are drawn from venture capital firms and CVC funds in Europe and North America. The findings and limitations suggest several avenues for future research. First, the developed models and propositions should be quantitatively tested and further refined. It would also be interesting to use empirical data from another industry in the quantitative testing of the results of this study. Furthermore, the effect of parent firm organizational culture on the CVC fund survival warrants further investigation.

NOTES * 1. 2. 3. 4.

This chapter was first published in World Review of Entrepreneurship, Management and Sustainable Development (WREMSD), 5 (4), 2009, pp. 353–75. Copyright: Inderscience Enterprises Limited. Reproduced with kind permission of the publisher. Personal interview, Berkeley, 22 March 2005. See www.europeanenergyfair.com. See www.cleantechventure.com. See vx.thomsonib.com.

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Moore, B. and R. Wüstenhagen (2004), ‘Innovative and sustainable energy technologies: the role of venture capital’, Business Strategy and the Environment, 13, 235–45. Parker, N. (2005), ‘Cleantech’s players, performance and potential’, Environmental Finance, March, available at www.environmental-finance.com. Pfeuti, R., A. Flatz, M. Moor, R. Wüstenhagen and M. Zamboni (2002), Changing Climate in the Energy Sector – a New Wave of Sustainable Investment Opportunities Emerge, 2nd edn, Zurich: SAM Sustainable Asset Management. Pichel, K. (2003), ‘Innerbetriebliches Ecopreneurship durch Umweltmanagement-systeme? Eine empirische Analyse von Bedingungen umweltbewussten Arbeitsverhaltens’, doctoral thesis, TU Berlin. Quinn, J.B. (1985), ‘Managing innovation: controlled chaos’, Harvard Business Review, May–June, 73–84. Rind, K. (1981), ‘The role of venture capital in corporate development’, Strategic Management Journal, 2, 169–80. Rivlin, G. (2005), ‘Green tinge is attracting seed money to ventures’, New York Times, June 22. Sanders, W.M.G. and S. Boivie (2004), ‘Sorting things out: valuation of new firms in uncertain markets’, Strategic Management Journal, 25, 167–86. Schein, E.H. (1985), Organizational Culture and Leadership, San Francisco, CA: Jossey-Bass. Seidl, I. (1993), Ökologie und Innovationen. Die Rolle der Unternehmenskultur in der Agrarchemie, Bern: Haupt. Sharma, A. (1999), ‘Central dilemmas of managing innovation in large firms’, California Management Review, 41 (3), 146–64. Siegel, R., E. Siegel and I. MacMillan (1988), ‘Corporate venture capitalists: autonomy, obstacles, and performance’, Journal of Business Venturing, 3, 233–48. Stone, B. (2003), ‘Alternative energy. Venture capitalists are betting on fuel-cell and solar-cell technologies’, Newsweek, November 17. Stopford, J.M. and C.W.F. Baden-Fuller (1994), ‘Creating corporate entrepreneurship’, Strategic Management Journal, 15, 521–36. Sykes, H.B. (1986), ‘The anatomy of a corporate venturing program: factors influencing success’, Journal of Business Venturing, 1, 275–93. Sykes, H.B. (1990), ‘Corporate venture capital: strategies for success’, Journal of Business Venturing, 5, 37–47. Sykes, H.B. and Z. Block (1989), ‘Corporate venturing obstacles: sources and solutions’, Journal of Business Venturing, 4, 159–67. Sykes, H.B. and D. Dunham (1995), ‘Critical assumption planning: a practical tool for managing business development risk’, Journal of Business Venturing, 10, 413–24. Tushman, M.L. and P. Anderson (1986), ‘Technological discontinuities and organisational environments’, Administrative Science Quarterly, 31, 439–65. Utterback, J.M. (1994), Mastering the Dynamics of Innovation, Cambridge, MA: Harvard Business School Press. Von Hippel, E. (1977), ‘Successful and failing internal corporate ventures: an empirical analysis’, Industrial Marketing Management, 6, 163–74. Von Rosenstiel, L. (1999), ‘Mitunternehmertum – Unterstützung durch unternehmerische Kulturgestaltung’, in R. Wunderer (ed.), Mitarbeiter als Mitunternehmer, Neuwied: Luchterhand, pp. 107–21. Weeks, T. (2004), ‘Venture capital going green in 2004’, Tornado Insider, April 16. Wilson, L. (2003), ‘VCs getting ready to come clean: the next big thing could be a clean thing’, San Francisco Business Times, May 2. Zacharakis, A.L., and D. Shepherd (2001), ‘The nature of information and overconfidence on venture capitalists’ decision making’, Journal of Business Venturing, 16, 311–32.

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PART IV FINANCING ENERGY ENTREPRENEURSHIP

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10 Business angels and energy investing: insights from a German panel study Dietmar Grichnik and Christian Koropp*

1

INTRODUCTION

A sufficient and appropriate supply of financial resources is essential for fostering entrepreneurial activities in terms of successfully starting and growing new ventures. The lack of financial resources is a major impediment for innovative activities, particularly in small high-tech ventures (Canepa and Stoneman, 2008). Typically, start-up financing is limited to the private capital of the founder, family and friends, business angel capital, venture capital (VC) and public funds (Berger and Udell, 1998; Howorth, 2001; Grichnik, 2009). Entrepreneurial activities in the energy sector are mostly based on at least incremental technology innovation processes and thus carry high risks, especially in early development stages. In general, the amount of financing required by such technology-oriented start-ups and early-stage firms exceeds the available financial resources of founders, family and friends. Accordingly, there is the need to finance foundation and subsequent growth with outside equity. Despite the wide range of existing governmental grant schemes in Germany (for example, High-Tech Gründerfonds), the predominant financial source for early-stage ventures with its inherent uncertainty and high-risk nature seems to be business angel capital since venture capitalists’ investment focus has shifted to more mature ventures carrying less risk (Osnabrugge, 2000; Branscomb and Auerswald, 2002; Sohl, 2006; Dimov and Murray, 2008). In Germany, 80 percent of all high-tech start-ups obtaining outside equity received their funding from business angels (Fryges et al., 2007). Although substantial research on business angels began during the 1980s (Wetzel, 1981; Tymes and Krasner, 1983; Gaston and Bell, 1988), business angel activities date back at least to 1874 when the young Alexander Graham Bell received funding from two wealthy individuals for starting the world’s first telephone company (Sohl, 2003). Business angels are commonly defined as wealthy individuals who invest part of their private funds, time and expertise directly in unquoted companies to which they have no closer personal relation (Mason, 2007).1 Recent estimates on business angels’ prevalence suggest that there are about 5,000 actively investing business angels in Germany (Fryges et al., 2007). The activities of German business angels have been regularly surveyed by the quarterly VDI Business Angels Panel since the beginning of 2002. Panel results reveal an interesting phenomenon on business angels and energy investing: although German business angels perceive energy ventures to be favorable investment targets, they are somewhat hesitant with regard to energy investments. We thus extended the 2009 first quarter’s panel study in order to shed more light on the motivations and challenges of German business angels in energy investing. The remainder of the chapter proceeds as follows. Section 2 presents the value 197

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added of business angels’ investments for energy entrepreneurs and their effects on the newly founded ventures as discussed in recent research findings in the literature. In Section 3, we provide insights into the results of the VDI Business Angels Panel; that is, insights on business angels’ characteristics, their general investment approach, their perception of energy entrepreneurship, and their past as well as future investment behavior. In addition, we shed more light on the causes of business angels’ behavior. Finally, in Section 4, conclusions for energy entrepreneurs looking for business angel financing along with concrete recommendations are discussed based on the actual findings.

2

BUSINESS ANGELS’ VALUE ADDED FOR ENERGY ENTREPRENEURS

Unlike venture capitalists, business angels all over the world invest their capital more often in early-stage ventures carrying high risk. This is largely due to two reasons. First, business angels employ a different risk management approach. Whereas venture capitalists primarily try to cope with new venture risks ex ante by using formal agreements, business angels tend to handle those risks by monitoring, consulting and active management support (Osnabrugge, 2000; Bygrave and Hunt, 2007). Second, many business angels invest in new ventures not solely for financial return but also for non-monetary return, for example helping an entrepreneur to develop a fledgling business idea into a successful venture (Bygrave and Zacharakis, 2007). Consequently, a business angel’s investments feature two important resources for risky new ventures besides financing: human and social capital, both of which might provide a significant value added for energy entrepreneurs’ activities. Human Capital: Knowledge and Expertise Business angels are typically middle-aged, well-educated male individuals who have already founded at least one venture or have been in senior management positions in larger companies and thus gained substantial entrepreneurial as well as management experience (Brettel, 2003; Lindsay, 2004; De Clercq et al., 2006; Mason, 2007). The extensive entrepreneurial expertise enables business angels to quickly identify a broad variety of promising market opportunities for the energy entrepreneurs’ technologyoriented business ideas (Shane, 2000; Baron and Ensley, 2006; Ucbasaran et al., 2009). This may lead to significant time to market reductions which are fairly important for entrepreneurs in highly innovative sectors, for example, the energy industry, because it provides the entrepreneurial venture with the chance of being first mover and thus being able to realize monopoly rents. Furthermore, business angels typically possess profound management expertise, especially in marketing, finance and general corporate management (Mason and Harrison, 1996; Stedler and Peters, 2003; Madill et al., 2005) which is complementary to the technical knowledge of energy entrepreneurs. As business angels generally invest in industries and markets with which they are familiar (Lumme et al., 1998; Mason, 2007), they are also able to provide in-depth industry knowledge to the venture. From a resource-based

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view, the combination of technical and business know-how can be considered as a key strategic resource for the venture which is critical for creating sustainable competitive advantage (Prahalad and Hamel, 1990; Teece et al., 1997). The form of knowledge and expertise infusion into the entrepreneurial ventures ranges from informal coaching, mentoring, and hands-on advice to board participation. The most frequent value-adding role performed by business angels is acting as a ‘sounding board’ for the entrepreneurs (Politis, 2008; Wiltbank et al., 2009). In this role, business angels support business strategy formulation and business model development, reflect product ideas, give legal, accountancy and management advice, or assist in the manner and timing of value realization (Lumme et al., 1998; Brettel, 2003; Paul et al., 2003; Madill et al., 2005; Mason, 2007). Monitoring activities include providing moral support, raising the entrepreneurial spirit, providing a broader view and dealing with sensitive personal issues (Freear et al., 1995; Mason and Harrison, 1996; Brettel, 2003; Sætre, 2003). This role adds value to the venture as it supports the development of a stable, trustful and committed relationship between the business angel and the entrepreneur. This role is said to be very much facilitated by the angels’ own entrepreneurial experience and their self-perception of being entrepreneurs rather than financiers (Politis, 2008). Serving on boards of directors or as advisors is a common way of reducing information asymmetries and safeguarding the venture’s value – and thus the angel’s investment – from potential managerial misbehavior (Osnabrugge, 2000; Markman et al., 2001; Ardichvili et al., 2002). These monitoring activities are often accompanied but also partially substituted by instituting appropriate information systems (Ehrlich et al., 1994; Brettel, 2003; Sætre, 2003). Occasionally, business angels are involved so deeply and early in a new venture that they become virtually indistinguishable from the entrepreneurs, and furthermore are seen as part of the entrepreneurial team by the entrepreneurs (Sætre, 2003). The angel’s hands-on involvement per investment is usually handled on an occasional rather than a regular basis (Stedler and Peters, 2003), since business angels either have more than one investment or they invest as an extra activity in addition to their regular job as entrepreneur or senior manager. The nature and level of involvement is influenced by investment duration and geography. The time spent on supporting a venture decreases according to the duration of the investment (Brettel, 2003). In addition, the contact frequency is inversely related to the geographical distance between angels and investee (Landström, 1992). Social Capital: Business Network During their entrepreneurial or business career, business angels have usually established a broad network embracing contacts with professionals from different fields. Their networks include connections to related firms and industry contacts, relations to potential customers and suppliers, contacts with governments, working relationships with solicitors, tax consultants and accountants, and financial relationships. Business angels seem to be largely willing to contribute added value to their investment by acquiring necessary resources through their personal network (Mason and Harrison, 1996; Lumme et al., 1998; Paul et al., 2003; Madill et al., 2005; Sørheim, 2005). The lack of stable relationships with important key stakeholders is one of the major obstacles faced by small firms

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in early developmental stages (Aldrich and Zimmer, 1986); the business angels’ personal networks may help entrepreneurs to gain access to those critical relationships (Ardichvili et al., 2002) and to reduce related transaction costs. Empirical research found business angels to be a key factor for receiving VC financing in later stages (Shane and Cable, 2002). Financing On average, business angels invest between €10,000 and €500,000 per venture, which is rather modest compared to the financial investments in the later stages of business development (Grichnik, 2009). However, they have proven to be an important source of entrepreneurial finance because their investments are likely to close the existing ‘equity gap’ in the start-up and early stages of a venture’s life cycle (Harding, 2002). Besides the initial financial capital offered, investees may also benefit from using business angels as facilitators of additional finance: the presence of a business angel improves the chances of future debt and VC financing. To facilitate further finance, business angels might use their personal network contacts, personally assist the entrepreneurs during creditline negotiations and provide bank guarantees or even personal loans (Mason and Harrison, 2000; Madill et al., 2005; Sørheim, 2005). From a future financier’s perspective, active investors with a vested interest can be seen as a quality signal to the ‘outside world’, reducing the inherent information asymmetry by providing on-site monitoring (Osnabrugge and Robinson, 2000). Moreover, business angels’ non-financial contributions in terms of knowledge, expertise and network contacts increase the probability of commercial success of the entrepreneurs’ business ideas, which consequently raises the venture’s valuation and credibility.

3

BUSINESS ANGELS IN GERMANY: STYLIZED FACTS FROM THE VDI BUSINESS ANGELS PANEL

Since 2002, the market for business angel capital in Germany has been regularly surveyed by the quarterly VDI Business Angels Panel. The Business Angels Panel is the joint work of BAND – German Business Angel Network, VDInachrichten, WHU – Otto Beisheim School of Management and RWTH Aachen University. Around 30 German business angels are asked to take part in every panel survey. In general, the return rate ranges between 75 and 90 percent.2 The panel study surveys the status quo and future directions of the business angels’ investments. In addition, every survey includes special supplementary questions dealing with current topics. This section presents the empirical findings from the Business Angels Panel from 2007 up to the latest panel conducted in the first quarter of 2009. The findings are reported under four headings: ● ● ● ●

demographic characteristics; deal flow and general investment behavior; business angels’ attitudes towards energy investments; and business angels’ energy investment behavior.

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Management Engineering Engineering + Management Law Other N = 21

Figure 10.1

0%

10%

20%

30%

40%

50%

60%

70%

Educational background of business angels

Demographic Characteristics of Business Angels The characteristics of the business angels surveyed by the Business Angels Panel conform to the stereotypes reported in previous studies. German business angels are predominantly male individuals in the 39–69-year age group (mean: 55 years, median: 52 years). The vast majority of them have an entrepreneurial background: 75 percent have already started their own company; one-third of them are serial entrepreneurs (starting two or more ventures); the rest gained their business experience in senior positions in mediumsized and/or large corporations. These findings indicate that business angels hold sufficient above-average financial assets that are derived either from successfully harvesting one or more start-ups or from their high income as senior managers. Apart from business experience, economic success is based upon a high level of education. The angels of the VDI panel are experienced businessmen but also well educated. Most of them have a university degree (59 percent) or PhD (32 percent), whereas angels with a serial entrepreneur background generally hold a university degree (83 percent). This is in line with other research findings which suggest that the relationship between education and entrepreneurial behaviors follows an inverted U-curve (Reynolds, 1997). In addition, more than half had their educational focus on management and nearly 30 percent on engineering (see Figure 10.1). Despite their educational background, the majority of business angels have fundamental functional experience in corporate management and sales but less experience in technology-related R&D or production (see Figure 10.2). Accordingly, German business angels have the potential to add substantial complementary knowledge to the technical-oriented knowledge base of energy entrepreneurs. Deal Flow and General Investment Behavior During the first quarter of 2009, a business angel received on average about 10 investment propositions by means of submitted business plans. After a first glance, usually by reading the executive summary, nearly 60 percent of the investment opportunities were rejected by the angels. A deeper analysis of the business plans resulted in 2.7 investment negotiations and finally in 0.39 investments on average per business angel per

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Handbook of research on energy entrepreneurship Corporate Management Sales Finance Marketing Strategy HR/legal/admin R&D Production Other N = 24

Figure 10.2

0%

20%

40%

60%

80%

Functional experience of business angels 12

10

8

– 57.8%

6

– 74.3%

– 96.2%

4

2

0 N = 23

Figure 10.3

Business plans obtained

Business plans analyzed

Investment negotiations

Investments

Investment quota of German business angels

quarter. Accordingly, the average rejection rate is around 96 percent (see Figure 10.3). Investment inquiries have been made primarily by ventures being in the seed (30 percent) or start-up (47 percent) stage, which suggests that the capital-seeking entrepreneurs are well informed about the investment focus of business angels. Most of the contacts between capital seeking entrepreneurs and business angels materialized through private and professional networks, especially through business contacts, other business angels,

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15.30

16.00

11.66 8.39

8.75

1.83

1.92

0.32

0.33

11.37

12.17

12.36

12.04

10.30

8.00 4.00 2.00

1.93

1.59

1.78

2.08

2.30

2.39

2.65

1.00 0.50 0.25

0.35

0.18

0.19

Q3/07

Q4/07

0.17

0.20

0.39

0.18

0.13 Q1/07 N between 23 and 30

Figure 10.4

Q2/07

Business plans received

Q1/08

Q2/08

Q3/08

Investment negotiations

Q4/08

Q1/09

Investments

Average number of business plans received, investment negotiations, and investments from Q1/07 to Q1/09 per quarter (logarithmic scale)

or business angel networks and matching services. No more than 27 percent of investment propositions were made by entrepreneurs without any such relationships and only 8 percent of the investment contacts were the result of a personal search by the business angels. Accordingly, nearly two-thirds of all business angel investments were arranged by personal contacts, indicating that trust is an important issue for initiating the investment process. A closer look at the development of investment propositions, investment negotiations and investments over time reveals interesting insights with regard to financial crisis (see Figure 10.4). Since an interim peak in mid-2008, the average amount of received investment propositions per business angel are on the decline, approaching the low amounts at the beginning of 2007. At the same time, the average amount of investment negotiations is constantly rising and is about to reach an all-time maximum. In addition, business angels seem to be relatively untouched by the actual negative news on financial and economic markets as they invest as often as they did before the beginning of the financial crisis in mid-2007. These findings indicate that capital-seeking entrepreneurs possibly underestimate the angel’s investment propensity during a financial crisis and thus pass on capital inquiries. This holds especially true for entrepreneurs with business ideas of medium or lower quality: the overall perceived quality of business opportunity is constantly increasing as indicated by the rising ‘negotiation to business plans received’ and ‘investments to business plans received’ ratios. The business angels reported an average investment of €52,643 per venture for the first quarter of 2009 (investment range: €10,000 to €400,000; median: €25,000). The vast majority of them have been initial investments, with 21 percent being follow-up investments. The investment amount is considerably lower than the average amount of €79,585 invested per venture throughout 2008 (investment range: €6,500 to €700,000; median:

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Management advice

Active contribution

Contact mediation

Advisory board

Financial mediation

Other

N = 23

Figure 10.5

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

Business angels’ non-financial support (hours spent per venture per month)

€30,000). Neither of the surveyed business angels required a majority stake in return for the risk capital infusion. Two-thirds of the investments are realized in exchange for less than 10 percent of a venture’s shares. This is not surprising in the light of the business angels’ preference for early-stage investments and the relatively low investment amounts. In addition to the supply of financial capital, business angels are actively supporting the ventures in the early stages by a variety of ‘smart capital’ activities. They invested around 12 hours per month on average per venture (time range: 1.5 to 47 hours; median: 9.3 hours). Most of the time was spent in active hands-on participation in terms of management advice and collaboration (see Figure 10.5) – which is one of the main reasons why a business angel invests (Brettel, 2003). The reported figures suggest a more occasional involvement of business angels, whereby the total amount of time spent per venture depends on the number of an angel’s investments and the developmental stage that the venture has reached. Regardless of the non-pecuniary rewards that angels are hoping for with their investments, for example fun and self-satisfaction, they are also investing to gain a high return on their capital. The inherent risky nature of the early-stage investments means that there is a possibility of extremely high returns but also a considerable chance of complete loss. Therefore, a positive return on the invested capital is only recoverable by successfully harvesting at least a few investments. Successful harvesting of an investment usually requires a minimum holding period by the business angels. The promised holding period mainly depends on the developmental stage of the target venture and further economic conditions. Only very few business angels commit their capital either for a very short term (up to two years) or for a longer period of 7 or more years (see Figure 10.6). On average the surveyed angels exit an investment after a holding period of 4.9 years (range: 1 to 10 years; median: 5 years). Exits can be realized in five different ways (Cumming and Macintosh, 2003), of which

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70% 60% 50% 40% 30% 20% 10% 0% N = 17

Figure 10.6

up to 2 years

3 or 4 years

5 or 6 years

7 and more years

Holding period of business angel investments

the first two are most favored by business angels (Brettel, 2003): (i) an initial public offering of the venture’s shares at a stock market (IPO), (ii) selling the company’s shares to a strategic buyer (trade sale), (iii) a disposal of the venture’s shares to another financial investor (secondary purchase), (iv) selling the company’s shares to the entrepreneurial team (buy back) or finally, (v) a write-off due to the venture’s total loss. The year 2008 has been problematic for harvesting an investment due to the beginning financial market crisis. IPOs have not taken place; the majority of the reported exits have been conducted either as buy backs or trade sales (60 percent). Business Angels’ Attitude towards Energy Investments Research in social psychology has shown that the intention to perform a certain behavior and the subsequent behavior is highly dependent on an individual’s attitude (Ajzen, 2002). Accordingly, the more positive a business angel’s attitude towards a certain industry, the higher will be the possibility of an investment in ventures of this industry. An individual’s inherent attitudes towards an industry are reflected by an industry’s perceived attractiveness. Figure 10.7 shows the perceived attractiveness of selected industries being reported by business angels in the 18 months between Q4/07 and Q1/09.3 It is obvious that ventures in high-tech industries (for example, greentech or energy) are more attractive to business angels than ventures in low-tech industries (for example, financial services or chemicals). Beyond that, a further distinction between high-tech industries is observable. First, apart from the one of ventures from the greentech industry, an industry’s attractiveness seems to be ‘seasonal’ or inconstant over time. However, energy ventures are usually among the four most attractive industries. The attractiveness of energy entrepreneurs usually reaches its peak at the beginning of the year (Q1 or Q2), which is presumably due to the rising costs for conventional energy and the ‘energy debate’ throughout the winter period. In the first quarter of 2009, business angels rated

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6

5

4

3

2

1 Q1/08

Q4/07 IT (Hardware) Greentech

Figure 10.7

Q2/08

Internet Services Energy

Q3/08 Biotech Chemicals

Q4/08

Q1/09

Life Sciences Meditech Financial Services N between 23 and 30

Attractiveness of selected industries (1 = totally unattractive; 7 = highly attractive)

Market growth opportunities Manageable market risk Personal interest in market and/or technologies Expected above-average returns on investment Successful former investments Governmental support N = 23

Figure 10.8

0%

20%

40%

60%

80%

Reasons for perceived attractiveness of energy ventures

the attractiveness of the energy industry by an average of 5.3 (greentech: 5.35; meditech 5.2). The energy market is growing worldwide (Moore and Wüstenhagen, 2004), driven by three important conditions: (i) rising prices for conventional energy products due to their inherent finiteness, (ii) the increase in energy use caused by rapid economic development in emerging markets, and thus (iii) the existing necessity for renewable energies and related innovations. Business angels seem to be fairly aware of these trends, since they report the growth potential of the energy market to be the major reason for the steady positive attitude towards energy ventures (see Figure 10.8). The above reasoning also indicates a reduced market risk and, therefore, supposable above-average rates of return

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Life Sciences, Biotech, Meditech, Greentech: 16.8%

Other (e.g. Consulting, Services): 22.4%

Chemicals: 2.8% Energy: 0.9% Electrotech: 0.9%

Internet, IT (esp. Software): 23.4%

Media, Entertainment: 8.4%

N = 23

Figure 10.9

Mechanical Engineering: 6.5% Logistics: 1.9% Financial Services: 10.3%

Precision Engineering, New Materials: 5.6%

Business angels’ investment portfolio by industry

in the market. Besides these dominant economic-related rationales, the stated reasons for the attractiveness of the energy market reveal the non-monetary approach that is often prevalent in business angel investment decision making: more than one-third of the business angels reported a personal interest, for example contributing to a more worth living future, as a reason for their positive attitude towards energy ventures. Business Angels’ Energy Investment Behavior As stated above, business angels on average invest in one new venture per annum with a total investment of slightly more than €50,000. In total, the surveyed angels did not put all their eggs in one basket: each of them is currently holding around 4.65 investments (range: 0 to 17; median 4.0). However, they still have capital at hand waiting to be invested in promising high-tech business ideas. On average, business angels have invested barely more than half of their wealth that they have designated for angel investments (mean: 56.8 percent; median: 60 percent). Moreover, one out of five business angels has used a maximum of 25 percent of his investment potential so far. Business angels usually diversify their investment portfolio and spread the investments among different industries in order to reduce their risk. The industry-related dispersion of the total investment portfolio of all business angels who have participated in the recent VDI Business Angels Panel is shown in Figure 10.9.4 The vast majority of the investments held (in terms of amount of investments held) are ventures from the hightech sectors (IT and internet, life sciences, biotech, meditech and greentech), or from the service sectors (financial services, consulting and other services). However, just 0.9 percent of all business angels’ investments are made in ventures from the energy sector.

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Handbook of research on energy entrepreneurship Capital demand exceeds available investment capital Strict governmental regulations Lack of energy industry knowledge Lack of investment requests by energy entrepreneurs Capital-demanding energy ventures are hard to identify Energy ventures do not fit investment portfolio Low quality of energy entrepreneurs’ business ideas Lack of adequate exit options Generally no investments due to economic crisis Insufficient qualification of management team Other N = 23

Figure 10.10

0%

20%

40%

60%

80%

100%

Reasons for low energy investment of business angels

Accordingly, energy ventures are thus highly underrepresented compared to the other high-tech industries, indicating an upside potential for future energy investments. The rationale for this apparently uneven investment distribution is manifold (see Figure 10.10). As reported by the surveyed business angels, by far the most important reason for not investing in energy entrepreneurs is that the capital requirements of energy start-ups exceed the available investment funds of the average business angel. The energy industry is characterized by a comparatively high capital intensity, in particular R&D and manufacturing capacity frequently require multi-million-euro investments (Wüstenhagen and Boehnke, 2008). The second most significant reason is related to the identification of investment opportunities. Those problems are manifested first and foremost in a lack of investment requests but also on the side of business angels actively seeking energy investment opportunities. A further main reason reported by the business angels is the lack of industry knowledge. Although business angels do not invest solely in industries with which they are familiar (Stedler and Peters, 2003; Fryges et al., 2007), they invest only as long as sufficient and reasonable information is available. Sufficient information on the energy markets is difficult to obtain for industry outsiders since those markets are subject to a permanent technological and structural transition (Sonntag-O’Brien and Usher, 2004). Interestingly, venture-related aspects are seen to be only minor reasons for investment refusals. The surveyed business angels stated that

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Already negotiating energy investments: 8.7% Generally no interest in energy investments: 17.4%

Searching for energy investment opportunities: 4.3%

Energy investment imaginable under certain conditions: 26.1%

N = 23

Figure 10.11

No energy investments planned: 21.7%

Indecisive: 21.7%

Business angels’ future energy investment plans

a low-quality business idea and the qualifications of the energy entrepreneurs are a venture-specific reason for an investment denial. Despite the broad variety of rationales for not investing in energy entrepreneurs, only the minority of the surveyed business angels are generally not interested in energy investments or have not planned energy investments in the forthcoming 12 months (see Figure 10.11). Most business angels have not really thought about investing (22 percent) or will invest if conditions are acceptable (26 percent). Some business angels are even already negotiating an investment or are actively seeking investment opportunities in energy ventures.

4

SUMMARY AND IMPLICATIONS FOR ENERGY ENTREPRENEURS

Theoretical rationales and multiple empirical papers have indicated the key role of business angels in fostering entrepreneurial activities, especially in technology-oriented industries such as renewable energy, as they provide capital and knowledge to ventures in their seed and start-up phase. Angel investments increase the probability of a high-tech venture’s survival and success (Politis, 2008). But the presented findings for German business angels reveal a remarkable phenomenon with regard to investments in high-tech entrepreneurs being active in the energy industry: unlike in other high-tech industries, for example, biotech, greentech or meditech, the above-average positive attitude of angels towards energy entrepreneurs is so far not leading to an above-average investment behavior in energy start-ups. As indicated by the stylized findings of the VDI Business Angels Panel, the existing gap between the desire to invest

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and actual investments is mainly caused by inadequacies in information available to business angels. The desire to invest in energy entrepreneurs, especially in the renewable energy sector, presumably accrues largely from information on climate change, finite traditional energy resources or the like reported in ordinary business newspapers and magazines. But, investment decisions require in-depth information usually not obtainable from common sources. Since energy markets and in particular the renewable energy markets are subject to rapid technological and structural transitions, appropriate in-depth information on business processes, techniques and innovations are limited for industry outsiders. Furthermore, business angels usually have a lack of experience with the respective technologies since energy business models are largely based on technologies that are new and commercially unproven (Sonntag-O’Brien and Usher, 2004). Unlike VC funds that are usually managed by industry specialists, business angels are not highly specialized in their investments’ industries: most of the business angels have an industry background different from energy markets and a non-engineering educational background. Altogether, the peculiar information problems in the energy markets lead to rising information cost for business angels, reducing their desire to invest. Specifically, business angels fail to identify potential energy investments, cannot fully assess the business ideas of energy entrepreneurs and have severe problems in evaluating capital requirements. Nevertheless, the results of the conducted analysis reveal further important implications for energy entrepreneurs requiring equity capital or seeking angel investments. Besides the supply of capital, business angels potentially add significant value to their investment by contributing non-pecuniary support in terms of human and social capital. Indeed, most entrepreneurs regard the support as more valuable than the financial investment (Mason, 2007). Thus, it seems to be appropriate to regard business angels as co-entrepreneurs rather than as purely financiers of entrepreneurial ventures (Sætre, 2003; Lindsay, 2004). Due to their reported educational and professional background, the surveyed business angels have a large potential for significant value added regarding business- and management-related knowledge and networking contacts, both of which are usually missing in technology-oriented start-ups and small ventures. They invested a considerable amount of time per month in each of ‘their’ ventures, most of the time being spent on active hands-on participation. But energy entrepreneurs should be aware of the fact that business angels do not invest an equal amount of time in their ventures. Generally, they spent most time on their most recent venture and the total number of investments as well as the geographical distance to an investment have a negative effect on the time spent. Furthermore, not every angel is willing to invest both capital and knowledge. In addition, non-pecuniary support is sometimes only given following an actual request by the entrepreneurs (Fryges et al., 2007). A good way for capital-seeking energy entrepreneurs to prevent frustration with regard to the intangible investment of a business angel is a demand-driven due diligence by contacting the entrepreneurial teams of the business angel’s portfolio ventures. Business angels seem to be willing to invest in energy entrepreneurs and their investment ideas in the future, not least due to the favorable market characteristics (growth potential, risk and return ratio). Until now, capital requirements of energy entrepreneurs have been seen as the overriding impediment to angel investments. In most cases the investment amounts of the surveyed business angels range between €10,000 and

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€50,000 per venture, but there are some business angels who have invested €500,000 or even €700,000 in a single venture. Those amounts should be sufficient for service-related energy entrepreneurs, but R&D- and manufacturing-intensive energy entrepreneurs are showing higher capital requirements. However, because of the intangible value-adding potential of a business angel’s investment, energy entrepreneurs should actively strive for angel investments. A solution to the inherent disequilibrium of capital demand and capital supply might be syndication. Possible partners for syndication are other business angels, governmental grant schemes or even VC funds. In Germany, for example, the High-Tech Gründerfonds invests an additional amount of €500,000 in high-technology ventures if – beside other criteria to be fulfilled – a business angel has already agreed on an investment of €50,000. The energy entrepreneurs should include syndication as a viable option in their financial planning as well as their business plan before sending it to a business angel. The deliberate strategic selection of the right informal investor is thus vital to ensure the fit between the entrepreneurs and the business angel. Prior to this decision there is an identification problem which affects the entrepreneurs in particular, since angels rarely actively seek investment opportunities. Indeed, the vast majority of business angels strive to preserve their anonymity and are secretive about their investment activity, not least to avoid being inundated by entrepreneurs and other individuals seeking to persuade them to invest or provide financial support for other causes (Benjamin and Margulis, 1999). A valid way for energy entrepreneurs to overcome the existing opacity of the business angel market is to use the matching services of business angel networks such as BAND in Germany, where approximately one-fifth of all German business angels are registered to take part in nationwide business plan competitions or to get in contact with other high-tech entrepreneurs in order to gain information about their financial sources. In conclusion, energy entrepreneurs seeking angel capital should be aware of the fact that it generally takes more than one application to succeed in obtaining the required funding since only 5 percent of all investment inquiries are successful. Therefore, it is most important for entrepreneurs to take care in selecting the business angels to be addressed and to prepare their business plan and presentation rigorously, highlighting the potential financial and non-financial contributions of their business idea.

NOTES * 1. 2. 3. 4.

This chapter is based on the findings of the VDI Business Angels Panels from 2007 to 2009. We thank the VDInachrichten and in particular Stefan Asche for permission to use the data from the VDI Business Angels Panels. Active business angels are further separated according to their wealth and investment goals in ‘Entrepreneur Angels’, ‘Wealth Maximizing Angels’, ‘Income Seeking Angels’ and ‘Corporate Angels’ (Coveney and Moore, 1998). It is important to emphasize that the results of the VDI Business Angels Panel cannot claim to be representative of the total of business angels in Germany; a population that is by definition unknown to a large extent. Some industries are neglected (for example, electrotech, new materials, media, logistics) to ensure the readability of the figure. The deduced conclusions are in no way affected by this. Some industries are consolidated (for example, internet and IT) to ensure the readability of the figure. The deduced conclusions are in no way affected by this.

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Mason, C.M. (2007), ‘Informal sources of venture finance’, in S. Parker (ed.), The Life Cycle of Entrepreneurial Ventures, Berlin: Springer, pp. 259–99. Mason, C.M. and R.T. Harrison (1996), ‘Informal venture capital: a study of the investment process, the post-investment experience and investment performance’, Entrepreneurship and Regional Development, 8 (2), 105–26. Mason, C.M. and R.T. Harrison (2000), ‘Informal venture capital and the financing of emerging growth businesses’, in D.L. Sexton and H. Landström (eds), Handbook of Entrepreneurship, Oxford: Blackwell, pp. 221–39. Moore, B. and R. Wüstenhagen (2004), ‘Innovative and sustainable energy technologies: the role of venture capital’, Business Strategy and the Environment, 13 (4), 235–45. Osnabrugge, M.V. (2000), ‘A comparison of business angel and venture capitalist investment procedures: an agency theory-based analysis’, Venture Capital, 2 (2), 91–109. Osnabrugge, M.V. and R.J. Robinson (2000), Angel Investing: Matching Startup Funds with Startup Companies – The Guide for Entrepreneurs and Individual Investors, San Francisco, CA: Jossey-Bass. Paul, S., G. Whittam and J.B. Johnston (2003), ‘The operation of the informal venture capital market in Scotland’, Venture Capital, 5 (4), 313–35. Politis, D. (2008), ‘Business angels and value added: what do we know and where do we go?’, Venture Capital, 10 (2), 127–47. Prahalad, C.K. and G. Hamel (1990), ‘The core competence of the corporation’, Harvard Business Review, 68 (3), 79–91. Reynolds, P.D. (1997), ‘Who starts new firms? Preliminary explorations of firms-in-gestation’, Small Business Economics, 9 (5), 449–62. Sætre, A.S. (2003), ‘Entrepreneurial perspectives on informal venture capital’, Venture Capital, 5 (1), 71–94. Shane, S. (2000), ‘Prior knowledge and the discovery of entrepreneurial opportunities’, Organization Science, 11 (4), 448–69. Shane, S. and D. Cable (2002), ‘Network ties, reputation, and the financing of new ventures’, Management Science, 48 (3), 364–81. Sohl, J.E. (2003), ‘Angel investing: a market perspective’, in J. May and E. O’Haloran (eds), State of the Art: An Executive Briefing on Cutting Edge Practices in American Angel Investing, Charlottesville, VA: Darden Business Publishing, pp. 2–14. Sohl, J.E. (2006), Testimony in Support of the Access to Capital for Entrepreneurs Act of 2006 (HR 5198). Sonntag-O’Brien, V. and E. Usher (2004), ‘Mobilising finance for renewable energies’, Thematic background paper for the International Conference for Renewable Energies, Bonn, June. Sørheim, R. (2005), ‘Business angels as facilitators for further finance: an exploratory study’, Journal of Small Business and Enterprise Development, 12 (2), 178–91. Stedler, H.R. and H.H. Peters (2003), ‘Business angels in Germany: an empirical study’, Venture Capital, 5 (3), 269–76. Teece, D.J., G. Pisano and A. Shuen (1997), ‘Dynamic capabilities and strategic management’, Strategic Management Journal, 18 (7), 509–33. Tymes, E.R. and O.J. Krasner (1983), ‘Informal risk capital in California, in J.A. Hornaday, J.A. Timmons and K.H. Vesper (eds), Frontiers of Entrepreneurship Research, Wellesley, MA: Babson College, pp. 347–68. Ucbasaran, D., P. Westhead and M. Wright (2009), ‘The extent and nature of opportunity identification by experienced entrepreneurs’, Journal of Business Venturing, 24 (2), 99–115. Wetzel, W.E.J. (1981), ‘Informal risk capital in New England’, in K.H. Vesper (ed.), Frontiers of Entrepreneurship Research, Wellesley, MA: Babson College, pp. 217–45. Wiltbank, R., S. Read, N. Dew and S.D. Sarasvathy (2009), ‘Prediction and control under uncertainty: outcomes in angel investing’, Journal of Business Venturing, 24 (2), 116–33. Wüstenhagen, R. and J. Boehnke (2008), ‘Business models for sustainable energy’, in A. Tukker, M. Charter, C. Vezzoli, E. Stø and M.M. Andersen (eds), System Innovation for Sustainability 1: Perspectives on Radical Changes to Sustainable Consumption and Production, Sheffield: Greenleaf Publishing, pp. 85–94.

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11 Venture capital investment in the greentech industries: a provocative essay Martin Kenney*

1

INTRODUCTION

In the first decade of the twenty-first century there has been increasing awareness of environmental issues and recognition that these are now global in scope. This has occurred for many reasons and is perhaps best epitomized in the global warming discussion. The dramatic rise of China and India, in particular, reoriented the debate about the sustainability of the current trajectory of fossil-fuel usage and environmental degradation. Quite simply, if the economic growth of China, initially, and then India were to follow the historical trajectory of fossil-fuel energy usage and resource consumption that Japan, Taiwan, and Korea followed, the environmental impacts would be nothing short of monumental. This chapter does not propose to debate the need for ‘green technologies’ or the merits of particular technologies. It accepts that the current trajectory of the fossil-fuel-based energy system is not sustainable, environmentally or ethically. Evaluating the merits of particular energy generation or environmental technologies is beyond the scope of this chapter and, perhaps, at this early stage unknowable. Rather, the chapter addresses the question of whether venture capital (VC) in its current organizational form offers significant promise for funding the commercialization of what we shall term ‘greentech’. To presage the following discussion, this chapter is skeptical about the possibility that VC investment can become an important component of the financing of greentech. This is mainly because the investment criteria for successful venture investing are unlikely to be met by most green technologies. This is a contrarian perspective as the promise of VC financing for greentech and the potential of greentech as a new field of venture investing has already received an enormous amount of interest and hype in the global press and from elements of the venture community. In the academic literature, interest in VC investing in various green technologies has increased (O’ Rourke and Parker, 2006; Wüstenhagen and Teppo, 2006; Bürer and Wüstenhagen, 2009; Wüstenhagen et al., 2009). Despite these pioneering efforts, understanding of greentech VC investment is still limited. From a public policy perspective there are reasons to support private VC investment over other more direct corporate subsidy programs. Market-oriented economists would argue that private VC investment is desirable because it eliminates the need for public decision making on which technology or firms should receive funding. This limits the role of government in decision making and trying to ‘pick’ winners – a problem that has received significant attention in the energy and industrial policy literature (Pack and Westphal, 1986; Helm, 2002). This position is in particular strongly held in AngloSaxon market-centered nations such as the US and the UK. For the market-oriented 214

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economists, the market in the form of VC or other investors will discover, fund, monitor, and assist their greentech portfolio firms. Proponents of this model in general would confine governmental involvement to funding research and ensuring that markets operate transparently and in a non-discriminatory fashion. An entirely different group of observers argue that independent VC investing in greentech should be encouraged because it is not subject to the sunk costs, entrenched interests, and biases of established energy firms and government regulators (Hockerts and Wüstenhagen, 2009). For them, venture capitalists, with their willingness to support new technical solutions and/or business models, offer hope for change. These advocates observe that in their investment policies independent venture capitalists are not influenced by legacy costs and decisions and thus can finance firms whose success would portend the creative destruction of incumbents. Their goal is that VC-supported entrepreneurship should prove sufficiently disruptive so as to transform the economic environment. The analysis in this chapter focuses exclusively upon dedicated VC limited partnerships, the dominant form of formal venture investing globally. Excluded from direct examination are corporate VC operations1 and angel investors, both of which have different processes, logics, and goals from professional venture investors. Understanding the potential for building a successful VC practice in greentech investing begins with a description of the VC life cycle and the economics of the industries within which venture capitalists have typically invested (Section 2). Section 3 considers the question of whether greentech is a single industry or a variety of industries. This is important because successful VC investing (Section 4) is predicated upon developing deep knowledge of the evolutionary trajectories of technologies and markets. The decision to invest in new sectors is largely determined by the possibility that the investments will provide sufficiently large returns. A tentative answer to questions about returns can be given by examining previous returns (Section 5). Because the historical record may provide insight into the trajectory of this greentech investment boom, Section 6 briefly describes the VC response to the 1973–80 oil crisis period, during which there was a wave of VC investment in the greentech of that time, that is, alternative energy. The conclusion questions the possibility that greentech will prove to be a lasting investment interest for venture capitalists, and suggests that the current investment boom may be an unsustainable bubble.

2

THE VC LIFE CYCLE AND THE OPERATION OF THE TYPICAL VC FIRM

From 2006 through the first quarter of 2009, there has been a rush by US and European venture capitalists to raise greentech funds. Continuation, rather than episodic VC involvement in greentech investing, will require that the candidate greentech-recipient firms eventually, if not initially, develop the characteristics of successful VC portfolio firms in terms of rates of growth and desirability to post-VC investors. The investments must offer sufficient returns to allow venture capitalists to raise more money for future investments (Gompers and Lerner, 1999). In other words, greentech must allow each stage in the cycle to be completed or VC investment in greentech will end. Most

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importantly, regardless of the social benefits – which may have attracted the VC fund’s initial investors – without sufficient financial success to justify the investment, investors such as pension funds and endowments will discontinue advancing money to the venture capitalists, although governments may invest in VC funds even if the investments are failures as a part of a larger social goal, such as supporting greentech firms. To be sustainable, private greentech investing must be sufficiently profitable to justify continuing funding, and only profitability can ignite a self-reinforcing entrepreneurial dynamic capable of making a difference in the trajectory of global warming and environmental pollution. The basis of the VC industry is to invest in firms early in their life cycle and then to sell these investments to others later in the life cycle – hopefully with capital gains. This chapter deals only with the VC limited partnerships, though the field of investing in small firms includes private individuals or groups (often termed ‘angel’ investors), corporate venture capitalists, and, less frequently, various government agencies. Today’s VC firms generally raise investment capital through partnerships with institutional investors and wealthy individuals who, as limited partners, commit their capital for 10 years. For the limited partners, the attraction is the promise of returns significantly greater than could be achieved with conventional investments. Diversification has also been mentioned as a benefit from investing.2 The venture capitalists are the general partners responsible for the investment decisions. The economic interests of the general partners explain their behavior. The venture capitalists receive an annual management fee of between 2 and 3 percent of the capital managed and a share of any profits (usually 20–30 percent) after the initial capital committed by the limited partners is returned. Prior to the 1980s, average VC fund size was below $100 million. With a 2 percent management fee, a VC firm managing a $100 million fund took in $2 million to pay salaries and expenses. If a VC firm had two active funds, then the income was $4 million per year. If there were five partners and each managed approximately $40 million in 8–10 portfolio firms, then each partner’s share of the management fee was $800,000 minus expenses. In the 1990s the size of the funds mushroomed, and by the mid-1990s it was not unusual for firms to raise $500 million to $1 billion funds. Even if management fee percentages were not raised – and in some cases they were – the management fees grew to between $10 and $20 million per fund. If the venture capitalists managed two funds, the income was $20–40 million per year, and each individual’s share was $8,000,000 minus expenses. Even if the number of partners tripled and each now managed $125 million, the individual partner’s share of the management fee was $2.5 million minus expenses. The new economics meant that each partner received a handsome salary for 10 years (the life of each individual fund), whether the investments were successful or not. Today, a venture capitalists can become wealthy without even generating a good return for the limited partners. Thus the simple act of raising a large fund is a guarantee of a significant income for 10 years. In effect, if the limited partners want venture capitalists to manage a targeted fund, the question of its long-term investment potential is of little importance to the venture capitalists. Note the difficulty that the limited partners may create for themselves: they might be making a long-term largely irrevocable decision to invest in what could be the latest technological fad – a dangerous investment strategy.

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217

GREENTECH VERSUS TRADITIONAL VC-FINANCED INDUSTRIES

Prior to discussing the limited research on VC investing in greentech, it should be noted that in terms of venture investing, there is no definitive definition of greentech. At this time it appears to be an amalgam of a number of industries. If this is so, then consider the obstacles to a sustained program of VC investment. First, venture capitalists will find it difficult to specialize and deeply understand the business space. This suggests that a community of investors may not coalesce, thus limiting an ongoing flow of capital from increasingly experienced investors. This contributes to what may become a second obstacle. Many of the industries in which venture capitalists have been most successful are characterized by firms opening what Joseph Schumpeter termed ‘new economic spaces’ within which there is a swarming of new firms. This also plays to the venture capitalists’ strength, which is the ability to peer just over the horizon to see what the next step in the technology/business evolution might be and to create a firm to occupy the space before incumbents or adjacent existing firms can react (von Burg and Kenney, 2000). The development of the internet space illustrates this. Early browsers such as Netscape allowed more people to discover the fledgling web. This increasing viewership made it possible for market software to build websites. The increase in websites and viewers allowed new entrants to begin online sales, that is, Amazon, eBay, Expedia, Etrade and so on. The growth of the web made it possible to have portals such as Yahoo!, Lycos, and Excite, as well as search engines, for example, Google. After this came webscraping, wikis, blogs, and a myriad of other economic activities (Kenney, 2003). It is these burgeoning technology/economic spaces that create the investment frenzies and the outsize returns for the venture capitalists. Are there greentech technologies or market developments that will allow venture capitalists to invest in the creation of a myriad of firms, thereby sparking the formation of a new ecosystem? To illustrate, in biotechnology, which after information technology (IT) has been the most important area of VC investing, there have been a sufficient number of successes to permit the creation, survival, and reproduction of biotechnology specialist VC firms and an ecosystem of support organizations. In the case of biotechnology, a number of authors have noted that it was the availability of VC that allowed an industry consisting of entrepreneurial firms to be established outside the pharmaceutical industry (Kenney, 1986; Pisano, 2006). The attraction of biotechnology has been the development of new and superior drugs that could demand premium prices in the market. Despite a relative paucity of commercial success, biotechnology firms have offered sufficiently high returns to their VC investors. Will greentech produce venture investing successes such as Genentech and Amgen? What is the likelihood that greentech will produce firms such as Intel, Cisco, Google, and Oracle? For the venture capitalists to have a long-term interest in greentech, it must perform as well as biotechnology. If a sufficient number of such successful investments are not made, then VC investment in greentech is likely to decline precipitously, stranding portfolio firms as the hype ends. Venture capitalists have also invested in other industries outside of the IT and biomedical fields. In fact, they are agnostic regarding industrial areas. So, for example, the well-known firm Federal Express received VC funding, as have a number of airlines such as the now defunct People Express. The San Francisco brewery Gordon Biersch,

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which has expanded rapidly, was also the beneficiary of VC financing. All of these were successful investments leading to important initial public offerings (IPOs), however venture capitalists did not become significant sources of capital for the package delivery, airline, or microbrewery industries. This is not because entrepreneurship is impossible in these industries, but because there is a relative paucity of the types of opportunities that venture capitalists are comfortable funding. Put simply, venture capitalists are not biased against particular industries; rather they invest in opportunities that are appropriate to their organizational goals. There has been comparatively little research on VC investment patterns by industry. What industry-level research exists has been concentrated on biotechnology and the information technologies (on the internet, see Kenney, 2003; Zook, 2005; on biotechnology, see Powell et al., 2002; Baum and Silverman, 2004; on data communications equipment, see von Burg and Kenney, 2000). As a comparatively recent phenomenon, greentech VC investing has received little attention in the scholarly press, but enormous attention in the popular press. The major exception is the important paper by Wüstenhagen and Teppo (2006) examining the available evidence regarding VC investing in greentech firms. Of the four greentech firms they examined that went public on the NASDAQ in 1999 to 2000, one is no longer listed, two are penny stocks (trading under $1), and one was delisted. In the case of three of these firms, the venture capitalists made adequate returns – a situation that is expected if they can make a public offering. The fourth firm Plug Power, which had the best return (not at the time of IPO, but at the end of the share lock-up expiration date), was not VC financed; rather it was a spin-off joint venture. These three successful VC-backed IPOs show that greentech firms can be successful, but does not provide sufficient evidence of the return to total VC investment in the industry. Consider the most successful US solar photovoltaic firm, First Solar, which was founded in 1984. In 1999 it was sold to the Walton family (heirs to the Wal-Mart fortune). The stock was sold to the public in 2006, seven years later – a comparatively long time to IPO. Greentech (formerly alternative energy/environment) has a long history of attracting investors with only limited returns. As Figure 11.1 indicates, from 1995 to 2000, far more capital was invested in the industrial/energy category than was returned in the initial public stock offerings. Unfortunately, we do not have data on the number of mergers that occurred. What this suggests is that more capital was invested in the industrial/ energy category than was returned through exits – not a sustainable situation. The industrial/energy category in terms of investment roughly tracked the collapse in total VC investment, suggesting that it did not perform differently from other VC investing in the aftermath of the internet bubble. Energy-focused VC funds in the European context may offer more attractive returns (Wüstenhagen and Teppo, 2006). This may be because either European venture capitalists require a lower hurdle rate to measure an acceptable return or European entrepreneurs are superior. Also, because European stock markets such as the London AIM have less rigid criteria and require less documentation for exits, smaller firms can be listed allowing venture capitalists to recoup their investments. From an American perspective, there has not yet been a greentech Google, Yahoo!, or Cisco that yields 100 times the original investment and thereby offsets the many unsuccessful VC investments made. To return to First Solar, it had a market capitalization of approximately $12 billion in 2009.

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US$

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140 Total VC investment Silicon Valley VC investment Price per oil barrel

120 100

800,000,000

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20

0

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95 19 –1 95 19 –4 96 19 –3 97 19 –2 98 19 –1 98 19 –4 99 20 –3 00 20 –2 01 20 –1 01 20 –4 02 20 –3 03 20 –2 04 20 –1 04 20 –4 05 20 –3 06 20 –2 07 20 –1 07 20 –4 08 –3

0

Year and quarter

Source: Compiled by author from PricewaterhouseCoopers Moneytree and US Energy Information Agency.

Figure 11.1

Total VC investment and VC investment in Silicon Valley in the industrial/ energy sector and per barrel crude oil price by quarter, 1995-Q1 2009

Despite its success, its value is one order of magnitude smaller than Google, which in 2009 had a market capitalization of $134 billion. In terms of the larger picture, are there many more First Solar level of successes in photovoltaics? In IT there may be another Google. For example, since 2005 there has been YouTube (after 18 months purchased for $1 billion), Facebook (recent valuations suggest it is worth $6 billion), and Twitter (recent valuations suggest it may be worth $1 billion or more). Are the potential returns similar for greentech start-ups? It may be possible that the returns are not as large, but the other question is will they be sufficient? This is more difficult to answer, as it is contingent upon the relative receptivity of public markets to greentech firms, government action, price of alternatives, and the quality of the firms and managers involved. This section has suggested that thus far opportunities as large and lucrative as those in IT have not been created in greentech. Whether there will be sufficiently large returns to justify investment from VC firms operating under the current Silicon Valley model is not yet knowable. It is also uncertain that the VC model can be reshaped to justify lower returns, and how that might be done.

4

GREENTECH AND VENTURE CAPITAL

How do VC economic dynamics apply to greentech? An illustration from recent fund raising may clarify the problematic nature of the current VC environment. Many greentech advocates were excited when in May 2008 one of the elite VC firms Kleiner Perkins Caufield & Byers (KPCB) announced that it had raised a $500 million Green Growth investment fund (KPCB, 2008). As Figure 11.1 demonstrates, KPCB was fortunate as the fund was subscribed at the exact peak of the 2008 oil price bubble and the greentech/alternative energy fever. Regardless of the fate of the fund, as far as returns are

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concerned, KPCB will reap significant benefits as it collects its 2.5 percent annual management fee or $12.5 million per year no matter what the returns are to investors. While venture capitalists are typically agnostic to the industry they invest in, there is a path-dependent component of the practice because they continue and even increase investing in industries where they experience success. In fields in which investment returns are low, there is a marked tendency to throttle back investment, for example, few any longer invest in nanotech firms (and this field was hot less than five years ago). There is a recognition of the importance of path dependence for VC investing in greentech. For example, Wüstenhagen and Teppo (2006) find that VC investment in greentech requires knowledge and experience, but what they overlook is that path dependence requires the building of routines that buttress a path that can only come from the positive reinforcement of previous successes that legitimize the investment field (see von Burg and Kenney, 2000). What is necessary to continue the flow of investment is the tangible possibility of a significant return. It is for this reason that many have called venture investors ‘lemmings’, as they chase after the newest ‘hot’ industry or investment idea. As long as there are successful exits the investment will continue – they only stop investing in the field after experiencing a sufficient number of failures. The difficulties with greentech investments are well described by Scott Carter, partner at Sequoia Capital: There’s going to be a massive amount of money lost in Cleantech over the next few years although Obama’s presidency will probably give it new life for a while. But that doesn’t mean we’re not fans of Cleantech and alternative energy. We’ve been actively investing for three years, but we have one golden rule, which is investing where low capital expenditures are required. That means a big part of the market is a lot less appealing to Sequoia Capital. We view innovation in Cleantech as we do in other technology sectors. If you have great entrepreneurs who are incredibly frugal, who really focus on delivering a product that solves an immediate need, and you apply those principles to Cleantech, then you’re going to make money. (Ernst and Young, 2009: 12)

Carter understands that there is already overinvestment in the sector, which is, of course, dangerous. He goes further in stating that short-term success will be due to government intervention – hardly a strong incentive for public markets or larger firms to acquire a VC-funded greentech firm, particularly if the direction government mandation is unclear or erratic. Carter then states the obvious that many segments of greentech are not interesting to elite Silicon Valley venture capitalists. There is a possibility that these capitalintensive sectors will be interesting to less sophisticated venture capitalists, or to those that have a lower investment hurdle rate; only time will tell. Given that greentech is an enormous and amorphous category, there will undoubtedly be investment opportunities for venture capitalists. Most likely, these opportunities will resemble those that have some of the characteristics of current VC investment areas. In cases where there might be the construction of new infrastructures, there may be significant investment opportunities in providing components or software. For example, though somewhat ill-defined, the roll-out of a ‘smart’ electrical grid could offer significant opportunities for the establishment of new software firms and possibly firms creating communications devices to transmit data through the grid itself. Although most of the focus has been on energy generation, there may be significant opportunities

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100,000,000,000

US$

10,000,000,000

1,000,000,000

100,000,000

Software Industrial/energy Total

19

95 19 –1 95 19 –4 96 19 –3 97 19 –2 98 19 –1 98 19 –4 9 20 9–3 00 20 –2 01 20 –1 01 20 –4 02 20 –3 03 20 –2 04 20 –1 04 20 –4 05 20 –3 06 20 –2 07 20 –1 07 20 –4 08 –3

10,000,000

Year and quarter

Source:

PricewaterhouseCoopers Moneytree.

Figure 11.2

Total, software, and industrial energy VC investment in the US by quarter, 1995-Q1, 2009

in energy efficiency fields where new materials could create significant cost savings in products produced in great numbers. For example, new technologies may create more efficient lighting systems and the volume of such a consumer product is sufficiently large to be able to generate a good return. Finally, there may be superior materials able to receive intellectual property protection that could eliminate serious environmental hazards. Many of these innovations would not be as highly tied to the energy generation paradigm that drives greentech investment thinking every time fossil-fuel energy prices rise. The pattern of VC investing in the industrial/energy category for the last 14 years, as Figure 11.1 showed, is highly correlated with the price of oil. Of course, there is a similar correlation in the interest of public stock markets in industrial-energy firms. The implication for VC investors is that when they make investments predicated upon a high cost of energy, if energy prices fall, so will the value of their portfolio firm. In cases in which their investments are capital intensive, the loss in market value will be immediate, unless some other variable such as government interventions, legal requirements, or subsidies, can overcome the market decision. It is also important to note that when energy prices fall, the hype surrounding greentech firms also falls, thereby discouraging potential follow-on investors including public markets, potential corporate investors, and other venture capitalists. As Figure 11.2 shows, since 1995 there have been two significant bursts of VC investment in the industrial/energy category, 1999–2001 and 2006–09. Each of these was followed by a precipitous investment collapse. The figure also shows that industrial/ energy VC investment has roughly tracked the overall VC market and software except in mid-2005, when it expanded rapidly while software and total VC remained stagnant. This also captures the increasing concern about global warming highlighted in Albert Gore’s movie ‘An Inconvenient Truth’ and the apparent spiral in energy costs attributed to the rise of China and India. Thus, some in the VC community have been led to believe

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that these two factors created a powerful market discontinuity that could be filled by VC. Former Vice President Gore was invited to join one of the most elite VC firms in the world, KPCB, as a special limited partner. In the last 15 years there have been two spikes in VC investment in the industrial/ energy category. In the first case, from 1999 to 2001 there seems to have been an acceptable return on the investment for the promoters and venture capitalists based upon calculations from the greentech IPOs, but public investors who bought these stocks and held them have experienced terrible returns (Wüstenhagen and Teppo, 2006) – a recipe for creating public investors skeptical of greentech promises. The second spike of VC investment began in late 2005 and has declined precipitously due to the stock market crash that began in 2008. The decline is not surprising when one considers that greentech IPOs globally have collapsed (Milunovich, 2009). Even worse is the number of large secondary offerings undertaken as troubled firms were forced to raise capital. Whether this is the result of declining greentech opportunities or larger market forces is unclear at the moment.

5

HISTORICAL PARALLELS?

Energy costs have had an important influence on greentech investment. There are parallels with the increase in oil prices experienced in 2007–08. In the 10 years beginning in 1973 there were, in quick succession, two oil crises due to the 1973 Arab–Israeli War when the Arab world imposed an oil embargo, and then in 1980 when the Shah of Iran was overthrown. Oil prices spiked massively, prompting a belief that global peak oil was imminent and an argument about the necessity of developing alternative energy sources (for example, Akins, 1973; Tanzer, 1974). Today, as then, the question often raised was who should make the investments in alternative energy? Although the data are spotty, when oil prices spiked in the 1970s and early 1980s a number of venture capitalists, believing in the peak oil hypothesis, invested in energy production and alternative energy resources.3 Figure 11.1 indicated that in the 1980s, VC investment in the industrial/ energy category spiked. However, by the late 1980s VC investment in that category dropped dramatically. One aspect of this was the drop in fossil-fuel energy prices, but there are other insights that can be taken from this experience. A simple economic interpretation of the collapse of VC investing in the industrial/ energy category may be too facile. A more detailed explanation is the fact that these types of investments may not suit VC-based investment. In a fascinating article, Raghu Garud and Peter Karnøe (2003) compare Danish and US models for entering the wind turbine industry, providing insight into why the US largely failed, while Denmark successfully built a globally competitive industry. An important obstacle to US success was that the US wind turbine industry adopted a high-technology aerospace development model in the late 1970s and early 1980s, in search for technical breakthroughs – exactly the type of firms that venture capitalists seek to fund. Ultimately, this strategy proved to be inferior to the more collaborative and initially low-technology model adopted by the Danes. The Danish experience applies to the current alternative energy investment boom. Much of the equipment to be produced will require investments in manufacturing, which benefits from incremental improvements and in some cases large capital

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investments. Such firms often exhibit relatively slow growth (5–15 percent per annum) as opposed to the most successful VC-funded firms that grow at 50–100 percent per annum. This slower growth is not as attractive for VC investors. As Garud and Karnøe so effectively describe, the Danish success was a relatively slow evolutionary process where improvements came gradually and in increments too small to justify VC investing. With the wind turbine industry, a cluster of dedicated suppliers formed to supply the turbine assemblers. But these firms were relatively small and often were existing firms operated by skilled craftsmen who simply repurposed their knowledge of material forming for the growth of the wind turbine industry. By contrast, in Silicon Valley a cluster around the rapidly growing semiconductor industry consisting of semiconductor equipment, design software, and materials suppliers also formed, but these were usually de novo firms. Their growth was rapid and profitability was high, therefore justifying VC investment. If most greentech technologies and industries evolve incrementally with few industrychanging breakthroughs, there may not be the same types of investment opportunities that have been seen in the information technologies and university-born human pharmaceuticals. To illustrate the different industry dynamics, the efficiency of wind turbines in converting wind to electricity, or solar photovoltaics in converting sunlight to electricity, have experienced improvements at 1–2 percent per year. Moreover, they are bounded at 100 percent efficiency. In contrast, the electronics industries driven by Moore’s law experience operational improvement of approximately 100 percent in 18 months, and there is no obvious upper limit. The point is not to deny that economically significant improvement occurs in greentech, but rather to observe that they have proceeded rather slowly. A slow pace of incremental improvement may not provide sufficient competitive advantage for a new entrant to overwhelm incumbents. Market growth is also important. As the success of hybrid and electric vehicles demonstrates, the greentech market is expanding rapidly – though this is a relative measure. However, to access these growing markets the greentech start-up must displace incumbents with a similar, though possibly inferior, product. To provide an example, a number of electric automobile firms have been funded by wealthy individuals and venture capitalists. The task for these firms is to unseat existing competitors such as Honda, Nissan, and Toyota, all of which also have significant alternative energy research programs that can be combined with complementary assets such as dealer and suppler networks, capital, and strong manufacturing expertise. Attacking such firms head-on is a risky business strategy. The historical lesson has been that VC investment has been most successful when there are no incumbents or the incumbents have an entirely different business model, hence Netflix, which delivers videos through the mail, outflanked video stores that required customers to travel to the store. Green technologies have significant commercial promise particularly if governments mandate their usage. For the VC investor, though, the obstacles to successful investment are daunting. A high level of manufacturing expertise may be required and the amount of capital investment can be too large. A common solution to this problem for VC-backed electronics firms has been to outsource manufacturing. In cases where the product is entirely new and there is little manufacturing expertise, the establishment of in-house production and an active program of incremental improvement might be necessary – but this consumes capital.

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WAITING FOR GODOT OR GOVERNMENT SUBSIDIES?

There is a long history of argument from alternative energy and greentech supporters stating that since they internalize costs of pollution externalized by fossil fuels they deserve extra-market compensation.4 Again, this is something that this chapter acknowledges but will not dwell upon. Greentech investing is and will continue to be more difficult than IT and even biotechnology due to the dependence of success on non-market factors. Whereas venture capitalists are comfortable dealing with market, technology, and personnel risks, government policy poses another risk for greentech (for another perspective see Bürer and Wüstenhagen, 2008, 2009). In this realm the venture capitalists and their small firms may be competing in lobbying against corporate giants that have more capital and stronger connections to lawmakers. Investing in lobbying is expensive and unproductive for a smaller firm. For a VC investor – whose firms are ‘burning’ cash – waiting for the government mandation of certain standards or technologies or the appearance of subsidies is dangerous. For example, in 2006 Vinod Khosla, a former Kleiner Perkins partner began ‘financing a California ballot initiative to fund alternative energy initiatives through tax hikes on oil companies’ (Associated Press, 2006). Although defeated, it was perhaps the first time venture capitalists had proposed that the public begin subsidizing the firms in which they invested. Today, many venture capitalists are hoping that President Barack Obama’s stimulus will improve the prospects for their portfolio firms. This suggests that venture capitalists have doubts about the financial viability of greentech. In effect, greentech investments may not be able to succeed in the market within which they find themselves, but rather must wait for an outside source to change their market. For advocates of greentech, there is another concern, namely that government regulation will choose winners, commercialization models, or lock-out better alternatives. The US government decision, in large part driven by lobbyists from factory agriculture and large multinationals, to mandate the use of ethanol may be moving the US in the wrong direction environmentally. Another case is the recent decision to provide $500 million in loans to the partially VC-financed, Silicon Valley electric car maker, Tesla Motors, whose sole product is an all-electric sports car. The point is not to critique the bad policy decisions. This discussion recognizes that VC investors will not choose the ‘right’ or beneficial technologies. For example, KPCB has invested in Altra Inc., which is California’s biggest producer of ethanol. KPCB has also testified to the US Congress in favor of mandating greater ethanol usage. Ultimately, venture capitalists are agnostic regarding technologies. Their primary purpose is, as it should be, the capturing of outsize returns that justifies their investment practice – a purpose that can be traced back to the pioneers of the VC industry such as American Research and Development (Hsu and Kenney, 2005). Government incentives meant to encourage VC investment in greentech must be structured to discourage rent-seeking behavior, not to mandate inflexible solutions, and incentivize ‘desirable’ investment. There clearly is a role for the state in encouraging greentech investment, but the test is in the conceptualization and execution of involvement. In the US context, those advocating government regulations and incentives for greentech investment may be disappointed in the outcome, which will be shaped by lobbyists for the existing industries. An alternative history would suggest that VC might operate most efficiently in situations

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where governments made sound macro-level economic decisions such as, for example, a carbon tax, and allowed venture capitalists to sort out what they could effectively support. If VC could not operate in such a climate, then it is likely that other financing mechanisms could be substitutes. Angel investors could be substitutes because many are willing to accept higher risks and receive lower returns. In the case of potentially very profitable smaller projects, particularly in the efficiency area, whose potential returns do not justify the attention of full-time venture capitalists, angel investors could provide the necessary funds. Finally, it may be that the greentech field will require entirely new funding mechanisms.

7

DISCUSSION

Given the political economic changes expected to result from global warming and the putative possibility that peak oil has been reached, there should be ample opportunities for innovation and entrepreneurship in greentech. Although this chapter has been skeptical about the general suitability of VC investing in greentech among US venture capitalists, there is a distinct possibility that there will be interest and opportunities. It is emphatically not a statement that greentech lacks economic potential, is unnecessary, or even that there may not be a few good deals in the general greentech area. Many greentech businesses can grow using self-financing and investments from friends and family. The Danish wind turbine industry is a classic case of such growth. For these firms, there is no need for VC. Greentech will offer many opportunities to existing small and medium-sized firms with strong technical abilities. In many sectors, European and Japanese ‘mittelstand’ firms will have ample opportunity to use their existing knowledge to develop more environmentally friendly products. They will draw upon their existing competences, as did the Danish metal-working firms that were early entrants into the wind turbine industry. Finally, one would expect a number of large existing multinationals such as Siemens, Hitachi, Toshiba, Sanyo, and others to be able to leverage their competences to produce greentech solutions. If there is a problem with VC investing in greentech, it is not that value cannot be created in the industry; rather it is because VC is not organized and structured to support most of the opportunities to create value. As we stated, there will be opportunities providing the returns required by VC and which could benefit from VC. Also, it is unlikely that these will create sectors that allow the powerful feedback loops that occurred in IT and biomedical technologies. This most recent spike in greentech investing is exhibiting the same trajectory as previous spikes. The collapse of global equity markets and the drop in energy prices has halted the flow of greentech IPOs. There is little evidence that trade sales of greentech firms promise to be lucrative. The current retreat of VC investment is not the first. There have been at least two previous alternative energy/environment VC investment bubbles. The first one in the early 1980s had a few successful exits, but when the oil crisis subsided, investment collapsed. The next significant greentech bubble was during the internet bubble of the late 1990s. Wüstenhagen and Teppo (2006) identified four greentech firms that benefited from the wild valuations of the period and went public experiencing excellent returns for investors. However, like so many firms of this period, within three years they had lost nearly

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all of their value. Significantly, there were few other greentech IPOs as the VC industry drew back after the excesses of the internet era. But in contrast to greentech firms, some of the internet bubble firms, such as Amazon, eBay, and Yahoo! survived and changed our world. Each of the previous greentech investment surges has proven to be a bubble that, when popped, left little in the way of a new industry or excellent firms that could form the basis for the next surge of interest in greentech. This brings us to the contemporary wave of greentech venture investing, which has been the largest ever. It is impossible to be certain that VC investing in greentech will continue, or even if the investments already made will survive the suddenly far harsher economic environment of the global economic downturn. Our doubts do not concern the importance of greentech, but whether VC can provide the financial backing necessary to develop new products and services. There may be some green technologies to which the VC model may be well adapted. Often these are related to industries with a tradition of VC investing such as the development of software to manage energy usage, creating energy conscious websites, providing lower-energy consumption electronic components and equipment, and data center management protocols. There also may be interesting opportunities in technology-intensive, energy-efficiency products and a myriad of other areas. Often such firms may not have the potential to grow sufficiently large for an IPO, but may make excellent candidates for trade sales. One area of substantial entrepreneurial opportunity is in the provision of environmentally friendly products to the giant energy economics of China and India. In China, demand for greentech products is driven by the national government which understands the dimension of the nation’s problems. Also, in these nations technical and manufacturing labor costs are sufficiently low that small VC investments could yield large returns. It may be that the most interesting opportunities for VC investment would occur in industries and applications regarding improved efficiency and producing the same products at far less cost, even though these are less glamorous than fuel cells, photovoltaics, electric cars, and biomass conversion. VC investors in greentech will need to identify business opportunities that are not at risk from proximate incumbents and entrepreneurs able to wisely utilize the highpowered capital they invest. The challenge of finding potential market opportunities of sufficient size to provide significant growth and exit opportunities may prove more difficult than many believe. The hype that drove greentech capital raising and investing from 2006 to mid-2008 is being replaced by the sobering problem of finding firms that can reasonably and rapidly become self-supporting, as constant infusions of VC support are no longer possible due to the changing market for exits. This admittedly skeptical perspective on greentech for VC investment is not shared by many. For example, a 2009 survey of global venture capitalists concluded that ‘a majority of venture capitalists (79 percent) anticipate stable levels of investment across all industry sectors with the exception of the clean technology sector where 63 percent of venture capitalists expect to increase their investments over the next three years’ (Deloitte, 2009: 7) Deloitte (p. 8) opined that this increase could be due to ‘an increase in government/political support for Greentech and [venture capitalists] are looking more to government participation in both investments and incentives’. Dependence upon government support to make investment decisions financially successful is a dangerous strategy.

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Greentech investment has been closely correlated with the price of energy and it is uncertain if this linkage will end. Given the highly volatile history of energy prices, investing in greentech can be treacherous if the VC investor’s timing is less than ideal, because when the investment matures it may be difficult to sell the company due to a weak stock market. Expecting VC to play a central role in the commercialization of greentech is unlikely to yield the results that environmental advocates hope. There is a distinct possibility that well-meaning pension funds and endowments seeking to ‘change the world’ with their beneficiaries’ funds may lose their investment in VC firms and not have contributed to environmental improvement. Previous efforts to use VC investing for economic development or other well-meaning causes have often resulted in punishing losses with little advancement of the cause de jour.

NOTES * 1.

2.

3. 4.

I acknowledge the useful comments and suggestions from William Miller, Donald Patton, Henry Rowen and Rolf Wüstenhagen. Teppo and Wüstenhagen (2009) find that many corporate venturers, particularly the energy companies that began operations between 1999 and 2002 had discontinued their operations. They attribute this to a clash between the ventures capitalists and their parent firm’s organizational cultures. An observation that is undoubtedly true, but has also been true in the case of nearly every CV operation over the last 40 years. The sole exception to this is Intel Ventures, which is approximately 20 years old and still active. This chapter is not the place to discuss the notion that ‘diversification’ is, in and of itself, a good investment idea. Were that to be so, buying lottery tickets would be an investment strategy. The available data on VC returns show that it is the top quartile that make the outsize returns, the remainder do not perform as well as the S&P Index (Kaplan and Schoar, 2005). According to Teresa Barger (2002), from 1980 to 1995 an investor who could not have got into the top 25 percent of the VC funds, would have had a 1.9 percent compound annual rate of return in investing in an index fund of listed equities. What this suggests is that if an investor cannot get into a top-tier firm, diversification will only lead to underperformance. This is the mistake that so many make when they allocate x percent to VC investing. Performance is not improved by an abstract median percentage return, but rather by the returns of specific funds. If one cannot enter these funds and since there is little turnover in the investors in the top quartile funds, then investment performance will be poor (see, among others, Kaplan and Schoar, 2005). This chapter takes no position on whether global peak oil has been reached. It is an undisputed fact that fossil-fuel energy in the US has been and continues to be the beneficiary of massive government subsidies.

REFERENCES Akins, James E. (1973), ‘The oil crisis: this time the wolf is here’, Foreign Affairs, 51 (3): 462–90. Associated Press (2006), ‘Venture capitalist taps green technology’, April 12, available at: http://www.msnbc. msn.com/id/12281625/ (accessed October 5, 2010). Barger, T. (2002), ‘Issues in private equity funds’, Private Equity and Investment Funds, International Finance Corporation, Washington, DC, September 14. Baum, J.A.C. and B.S. Silverman (2004), ‘Picking winners or building them? Alliance, intellectual, and human capital as selection criteria in venture financing and performance of biotechnology startups’, Journal of Business Venturing, 19 (3): 411–36. Bürer, M.J. and R. Wüstenhagen (2008), ‘Cleantech venture investors and energy policy risk: an exploratory analysis of regulatory risk management strategies’, in R. Wüstenhagen, J. Hamschmidt, S. Sharma and M. Starik (eds), Sustainable Innovation and Entrepreneurship, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 290–309. Bürer, M.J. and R. Wüstenhagen (2009), ‘Which renewable energy policy is a venture capitalist’s best friend? Empirical evidence from a survey of international cleantech investors’, Energy Policy, 37 (12): 4997–5006.

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Deloitte (2009), ‘Global Trends in Venture Capital: 2009 Global Report’, available at: http://www.deloitte. com/assests/Dcom-Global/Local%20Assests/Documents/tmt_2009vdsurvey.pdf (accessed October 5, 2010). Ernst & Young (2009), ‘From Survival to Growth: Global Venture Capital Insights and Trends Report 2009’. Garud, R. and P. Karnøe (2003), ‘Bricolage versus breakthrough: distributed and embedded agency in technology entrepreneurship’, Research Policy, 32: 277–300. Gompers, P. and J. Lerner (1999), The Venture Capital Cycle, Cambridge, MA: MIT Press. Helm, D. (2002), ‘A critique of renewables policy in the UK’, Energy Policy, 30 (3):185–8. Hockerts, K. and R. Wüstenhagen (2009), ‘Greening Goliaths versus emerging Davids – theorizing about the role of incumbents and new entrants in sustainable entrepreneurship’, Journal of Business Venturing, 25 (5): 481–92. Hsu, D. and M. Kenney (2005), ‘Organizing venture capital: the rise and demise of American Research & Development Corporation, 1946–1973’, Industrial and Corporate Change, 14: 579–616. Kaplan, S.N. and A. Schoar (2005), ‘Private equity performance: returns, persistence, and capital flows’, Journal of Finance, 60 (4): 1791–823. Kenney, M. (1986), Biotechnology: The University–Industry Complex, New Haven, CT: Yale University Press. Kenney, M. (2003), ‘The growth and development of the internet in the United States’, in B. Kogut (ed.), The Global Internet Economy, Cambridge, MA: MIT Press, pp. 69–108. KPCB (2008), ‘Kleiner Perkins Caufield & Byers Launches Green Growth Fund’, May 1, available at: http:// www.kpcb.com/news/articles/2008_05_00.html (accessed July 10, 2009). Milunovich, S. (2009), ‘Cleantech collapse: the horrible outlook for alternative energy in 2009’, available at: http://www.businessinsider.com/cleantech-thus-far-2009-7 (accessed October 5, 2010). O’Rourke, A. and N. Parker (2006), ‘Unearthing Cleantech: US and Canadian VC investments in Cleantech between 1999 and 2005’, Academy of Management Annual Meeting, Atlanta, GA, pp. 1–35. Pack, H. and L.E. Westphal (1986), ‘Industrial strategy and technological change: theory versus reality’, Journal of Development Economics, 22 (1): 87–128. Pisano, G.P. (2006) ‘Can science be a business? Lessons from biotech’, Harvard Business Review, 84 (10): 114–24. Powell, W.W., K.W. Koput, J. Bowie and L. Smith-Doerr (2002), ‘The spatial clustering of science and capital: accounting for biotech firm–venture capital relationships’, Regional Studies, 36 (3): 291–305. Tanzer, M. (1974), The Energy Crisis: World Struggle for Power and Wealth, New York: Monthly Review Press. Teppo, T. and R. Wüstenhagen (2009), ‘Why corporate venture capital funds fail – evidence from the European energy industry’, World Review of Entrepreneurship, Management and Sustainable Development, 5 (4): 353–75. Von Burg, U. and M. Kenney (2000), ‘There at the beginning: venture capital and the creation of the local area networking industry’, Research Policy, 29 (9): 1135–55. Wüstenhagen, R. and T. Teppo (2006), ‘Do venture capitalists really invest in good industries? Risk-return perceptions and path dependence in the emerging European energy VC market’, International Journal of Technology Management, 34 (1–2): 63–87. Wüstenhagen, R., R. Wuebker, M.J. Bürer and D. Goddard (2009), ‘Financing fuel cell market development: exploring the role of expectation dynamics in venture capital investment’, in S. Pogutz, A. Russo and P. Migliavacca (eds), Innovation, Markets, and Sustainable Energy: The Challenge of Hydrogen and Fuel Cells, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 118–37. Zook, M.A. (2005), The Geography of the Internet Industry: Venture Capital, Dot-coms and Local Knowledge, Oxford: Blackwell.

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12 How do business models impact financial performance of renewable energy firms? Moritz Loock

1

INTRODUCTION

Market observation indicates that financial performance of renewable energy firms varies. By the same token, analyst reports and forecasts predict performance differences (for example, Deutsche Bank, 2009; OppenheimResearch, 2009). Yet there is limited empirical evidence suitable to explain such differences. However, financing is one of the most important bottlenecks for the diffusion of renewable energy (UNEP et al., 2008); by nature, investors are curious about firm performance, which highlights the relevance of research being done in that area. In line with current literature, we assume that different business models would explain differences in firm performance. In recent years, academics have proposed business models for analyzing firms (Chesbrough and Rosenbloom, 2002; Magretta, 2002; Hedman and Kalling, 2003; Morris et al., 2005; Osterwalder et al., 2005; Schweizer, 2005; Casadesus-Masanell and Ricart, 2007) and firm performance (Weill et al., 2005; Zott and Amit, 2007, 2008). Scholars also point to the high relevance of business model choice for matters of investor relations and fundraising (Shanley, 2004). A business model has been defined as ‘a mediator between technology and economic value creation’ (Chesbrough and Rosenbloom, 2002: 532). This commonly covers three aspects: a meaningful value proposition for customers, a suitable delivery configuration to fulfill the value proposition and a value-creating logic; hence the revenue model (ibid.: 533; for example, Morris et al., 2005: 729–31; Zott and Amit, 2008: 5). Hereby, scholars often refer to business models within a context of innovation and change (Mitchell and Coles, 2003; Yip, 2004; Chesbrough, 2007a, 2007b; Johnson et al., 2008). Change is a matter of fact for renewable energy. Not only do technological uncertainties drive that change, but the broadly discussed transition from niche to mass markets and the credit crunch do as well. Not surprisingly, renewable energy research has already picked up on business models as a tool for describing renewable energy ventures (Boehnke, 2007; Frantzis et al., 2008; Wüstenhagen and Boehnke, 2008; DISTRES, 2009; Schoettl and Lehmann-Ortega, ch. 8, this vol.). Boehnke, for instance, finds that business models for renewable energy rely on fairly traditional revenue models as system sales dominate the industry, while innovative approaches like leasing or contracting are less common (Boehnke, 2007: 92). Frantzis et al. propose to take different forms of ownership into consideration when distinguishing business models for PV. Nevertheless, literature about business models for renewable energy remains mainly on a descriptive level and has yet to apply business models for the purpose of analyzing firm performance. We contribute to that and ask: how do business models impact renewable energy firm performance? 229

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The structure of the chapter is as follows: in the background section we first expose the business model theory and report from preliminary explorative research to derive our hypotheses (Section 2). In Section 3, on method, we shall discuss our empirical approach, which has been similarly conducted in strategy literature on various occasions (Dowell et al., 2000; Weill et al., 2005; Zott and Amit, 2007, 2008). Using Worldscope data, we have composed a unique sample of 1,017 renewable energy firm-year observations (471 solar and 546 wind). By calculating Tobin’s q for all observations (market value over replacement costs of tangible assets) we arrive at the performance measure. From qualitative business description we can derive business-model characteristics as independent variables for each company using content analysis. Business model–performance relationships are difficult to investigate for early-stage entrepreneurial firms due to only limited access to data. Hence, this chapter looks at publicly listed renewable energy companies as young growth companies to derive insights for practice and research in energy entrepreneurship. We find that firms with business models capturing upstream activities outperform those with business models that focus on downstream activities only. Furthermore, firms with a business model that is led by innovation and/or efficiency outperform fuzzy business models that are not led by such a gestalt theme. Also, firms with innovation-driven business models achieve higher firm performance the more innovation as a gestalt theme shapes the business model. Comparing solar as an emerging industry with wind as an established industry, we find timing important for vertical integration to benefit firm performance: established industries reward fully integrated business models, emerging markets do not. Further, innovation is more beneficial in emerging industries and renewable energy firms achieve a higher performance with efficiency-driven business models in established industries. Additionally, we note that Tobin’s q, as a performance indicator, points to a more realistic valuation of renewable energy companies over time. After discussing our results in Section 4, in Section 5 we draw conclusions and state implications for renewable energy entrepreneurship theory and practice. On the academic level, we contribute a blueprint for further research, so as to gain more knowledge on renewable energy firm performance. On the practical level, our research is set up to guide entrepreneurs, when choosing an appropriate business model.

2

THEORY

In the following, we develop our central argument that performance of renewable energy firms can be distinguished by two business model characteristics, which we utilize as two independent variables. The first is the position in the value chain, the second being the gestalt theme, which dominates the business model. We discuss this model and introduce the main hypotheses. For that we refer to adequate business model literature and report from preliminary explorative research with renewable energy investment practitioners. For our explorative research, we shall report from a body of data collected between March and May 2009. The data encompass 24 presentations from, and in-depth interviews with experts in the area of renewable energy financing (for example, bank analysts, venture capitalists, private equity managers, chief financial officers (CFOs) and others). The interviews and presentation data were collected during the European Pholtovaic

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How business models impact renewable energy firms Raw Material Supply

Production

Distribution

Project Management

upstream

Figure 12.1

Installation

Energy Sales

231

After-Sale Services, Recycling

downstream

Generic value chain for renewable energy

Industry Association (EPIA) PV Investment Conference 2009 in Frankfurt, and from individual meetings in Zürich, Berlin, and Düsseldorf. Moverover, we consulted recently selected published industry reports on renewable energy from major financial institutions.1 The Business Model’s Value Chain Location Business models integrate industry- and resource-based perspectives (Chesbrough and Rosenbloom, 2002; Morris et al., 2005) and thus are compatible with traditional strategy research. One important concept is the Porterian value chain perspective which has been integrated into discussions about business models (Chesbrough and Rosenbloom, 2002; Morris et al., 2005; Schweizer, 2005; Schoettl and Lehmann-Ortega, ch. 8, this volume). Following this concept acknowledges the business model’s value chain location as a market factor, and simultaneously addresses the issue: ‘where is the customer in the value chain?’. It could be described, for instance, as ‘upstream and downstream supplier, wholesaler, retailer, and service provider up to final consumer’ (Morris et al., 2005: 730). According to Chesbrough, a function of a business model is ‘to define the structure of the value chain within the firm required to create and distribute the offering, and determine the complementary assets needed to support the firm’s position in this chain’ (Chesbrough and Rosenbloom, 2002: 533). In addition to the ‘offering’, or the value proposition, Chesbrough also focuses on fulfilling the value proposition, stating that value chain aspects would also impact delivery configuration within business models. Within a renewable energy context, Schoettl and Lehmann-Ortega (ch. 8, this volume) introduce a value chain perspective on business models for PV and describe six generic business models such as a large facility operator, an energy controller or an installation service provider. The authors specify different key competencies for each of those business models. Our explorative research from among renewable energy investment practitioners confirms the relevance of value chain aspects in distinguishing between renewable energy business models. In various company presentations, interviews, and industry reports, investment practitioners commonly use the industry value chain to categorize business models for renewable energy (Figure 12.1). The upstream part of such a value chain runs from raw material supply to production. Downstream activities include distribution, financing, project development, and management, energy sales and even covers after-sale and recycling services. Upstream business models face different opportunities and threats compared to downstream business models. Thus, business models for different parts of the value chain may also differ in regard to their impact on firm performance. On which part of the value chain do renewable energy firms perform better? Theoretically it can be imagined that firms with either upstream or downstream business

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models do. Besides the very basic question on the relationship between supply and demand there are different factors that benefit up- or downstream business models, respectively. Performance drivers for upstream business models can be imagined along the generic manufacturer model, which are ‘integration of supply and production activities to control the cost and maintain the predictability of raw materials and other inputs; disciplined research to create superior products; and a dominant market position to provide economies of scale’ (Wise and Baumgartner, 1999: 134). Those generic upstream performance drivers are also discussed for renewable energy (for example, Frantzis et al., 2008: 4–29). Additionally, upstream business models may outperform downstream business models as upstream activities have higher entry barriers (for example, asset requirements such as high-volume production lines) and thus, may maintain and protect competitive advantages more sustainably, in comparison to downstream business models. Thus, we state: H1a: Renewable energy firms with business models capturing upstream activities outperform those with business models that focus only on downstream activities. However, upstream business models also face different disadvantages compared to downstream activities. First, they are far away from customers (or project developers), which might be a disadvantage as renewable energy industries are in transition to greater maturity and customer power rises. Second, the asset structure might become disadvantageous for upstream business models: ‘Rather than functioning as sources of competitive advantage, large asset bases increasingly tie a manufacturer to obsolete strategies, allowing innovative competitors to swarm in’ (Wise and Baumgartner, 1999: 136). Especially with technological uncertainties within renewable energy, another threat is what Christensen calls ‘innovators’ dilemma’: well-managed firms with upstream business models may be substituted by new technologies (Christensen, 2003), whereas downstream business models may be less affected by those changes in technology. Scholars in general promote a shift in competitive advantage from upstream activities to close-to-customers downstream activities. Wise and Baumgartner state benefits of downstream markets as having higher profit margins and the requirement of fewer assets (1999: 134). Another aspect might be risk. For instance, one industry report states: [T]he broad sell off in the wind sector has hit the turbine and component suppliers harder than their downstream developer and operator brethren. We believe this reflects the lower risk levels linked to the ongoing cash flows the latter companies can expect to generate from their existing turbine fleets while the former’s outlook is solely a function of future growth. (Jefferies, 2008: 1).

Overall, we state as counter hypothesis to H1a: H1b: Renewable energy firms with business models capturing downstream activities outperform those with business models that focus only on upstream activities. Of further interest is whether vertical integration leads to higher performance: ‘Firms integrate vertically so as to minimize the costs that arise from the opportunism and bounded rationality of firms and their suppliers, the uncertainty and frequency of

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transactions, and asset specificity in supplier–firm or firm–customer relationships’ (Afuah, 2001: 1211). The benefit of vertical integration for renewable energy can be found throughout different industry reports from which we state the following example: ‘We believe fully integrated system providers with long term competitive advantages are best positioned overall’ (Deutsche Bank, 2009: 19). However, renewable energy is an industry with technological uncertainties. In the light of technological uncertainties and change, scholars discuss the costs and benefits of vertical integration more differentially with some finding benefits of being vertically integrated and some rejecting those (Afuah, 2001: 1211). Timing seems to be crucial in this regard. Afuah argues [F]ollowing a technological change that is competence-destroying to firms and their suppliers, firms that are integrated vertically into the new technology will perform better than those that are not. At the same time, firms that had been vertically integrated into the old technology will perform worse than those that had not been’. (Ibid.: 1211)

It is beyond the scope of this chapter to differentiate for renewable energy between what Afuah calls ‘new’ and the ‘old’ technology. Nevertheless, the benefits of vertical integration seem to relate to the degree of technological change and uncertainties. Comparing wind and solar as our renewable energy subindustries of this study, we assume wind to be the more established industry with lower technological uncertainties in comparison with solar as an emerging industry with relatively higher technological uncertainty. Thus, we state: H2: Established industries reward renewable energy firms with business models that are fully integrated. However, the value chain by itself is only one aspect of understanding business models. Business models which target the same part of the value chain can also differ considerably. We shall elaborate on that, applying business model gestalt themes (innovation and efficiency) to further distinguish business models for renewable energy. The Business Model’s Gestalt Theme As understood from its roots in theory, business models aim to classify homogeneous organizational structures. Similar ideas have been taken up in literature on various occasions, for example, in discussions about strategy and structure starting with Chandler (1962) to Mintzberg (1979) and others (Chesbrough and Rosenbloom, 2002: 530). Analogical approaches are organizational typologies, like those of Miles and Snow (1978), the work of Teece et al. about corporate coherence (1994) or Miller’s work on configurations (1986, 1996). Miller defines configurations ‘as the degree to which an organization’s elements are orchestrated and connected by a single theme’ and regards it as a source of value-creating competitive advantage (1996: 509). A high degree of orchestration would be advantageous as it helps to leverage synergies, to clarify direction and coordination; furthermore, it also makes imitation difficult, fosters distinctive competence, commitment, speed and drives profitability (Miller, 1996). Zott and Amit

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incorporate these notions into discussions about business models and elaborate on innovation and efficiency as business model gestalt themes which drive performance and ‘reflect fundamental alternatives for entrepreneurs to create value under uncertainty’ (2007: 183): Driving renewable energy firm performance through innovation The potential of innovation to create value and drive performance has been widely considered in literature. Zott and Amit (p. 195) refer to Drucker, who frames innovation as, ‘the specific instrument of entrepreneurship. It is the act that endows resources with a new capacity to create wealth’ (1985: 30). Innovation creates value by exploiting new technologies, services or by creating new markets and further innovation of market transactions. For solar, an example of new value propositions based on new technologies is concentrator photovoltaic (CPV). One interviewee stated that disruptive innovation is the most powerful performance driver for renewable energy. As an example, he referred to thin film, which allows for groundbreaking cost advantages compared to traditional silicon-based PV technologies. The widely used example for this is First Solar. Nevertheless, innovation along the downstream part of the value chain is also considered to drive performance. As a benchmark example, an interviewee pointed out Akeena Solar. Akeena is a US-based installer of residential and small commercial solar power systems. As an example of downstream innovation, Akeena has introduced a new plug and play solar panel technology, ‘Andalay’, which facilitates installations. Driving renewable energy firm performance through efficiency The value-creating potential of efficiency is based on cost reduction. From a production point of view, efficiency activities, for instance, would cover relocation to low-cost production sites (for example, in Asia, where there are low energy, tax and labor costs) or leverage other cost advantages such as lean production, high degree of automation, and reduced logistic and exchange cost on growth markets such as in the US or Europe. In addition to that, Zott and Amit promote a transaction cost perspective. Efficiency, in this regard, would also contain market and sales activities to reduce transaction costs; for instance: through more transparent transactions and better information flow (2008: 23–6). For an example of an efficiency-driven business model, practitioners often refer to Vestas. With its headquarters in Denmark, Vestas is the leading world manufacturer of wind turbines. Anchored in their mission statement, Vestas is constantly seeking to improve processes. The company currently applies management systems such as Six Sigma in order to increase the efficiency and reliability of wind energy. Also for the solar industry, reports discuss efficiency to be success critical and list ‘improving costefficiency, improving process efficiency or improving allocation efficiency’ (DISTRES, 2009: 70) as important aspects in this regard. We find both innovation and efficiency appropriate for driving renewable energy firm performance. They contribute to superior firm performance either by offering added value (new and better products or services) or lower costs (more-efficient production and processes or transactions with customers and other stakeholders). Accordingly, we conclude:

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H3: Renewable energy firms with a business model that is led by one of the generic gestalt themes (be it innovation, efficiency or both) outperform fuzzy business models that are not led by such a gestalt theme. Furthermore, we conjecture that business models which are led by those gestalt themes show different strengths of how those gestalt themes appear, and how by either stronger or weaker innovation or efficiency they shape the business model. In accordance with its theoretical roots, we recall that gestalt themes drive performance and simultaneously help leverage synergies and clarify direction and coordination (Miller, 1996). Therefore we assume that the stronger either innovation or efficiency as a gestalt theme, the more advantageous are business model gestalt themes in this regard. Thus, we hypothesize: H4a: Renewable energy firms with innovation-driven business models achieve higher firm performance the more innovation as a gestalt theme shapes the business model. H4b: Renewable energy firms with efficiency-driven business models achieve higher firm performance the more efficiency as a gestalt theme shapes the business model. Recalling the above stated differentiation between wind and solar, we assume innovation and efficiency to have different impacts on firm performance within different industries. Innovation may be an important asset in emerging industries, such as solar, with high technological uncertainty. Innovation-driven business models may better keep up with technological change. Efficiency might be more advantageous in established industries, such as wind, where technological change is lower. In those industries, general cost reduction capabilities or activities to reduce transaction costs such as improving marketing and sales may directly impact firm performance. Thus, we state: H5a: Emerging industries reward renewable energy firms with a business model that is led by innovation. H5b: Established industries reward renewable energy firms with a business model that is led by efficiency.

3

METHOD

Sample A unique sample of 339 publicly listed renewable energy companies was compiled for this research. We used Thomson One Banker and screened for publicly listed companies, which were both American Depositary Receipts (ADRs) and non-ADRs and contained ‘solar’ and/or ‘wind’ in their business descriptions. Filtering the screening results (with 768 matches initially) according to missing data and content proof of business description, we composed a sample of 339 publicly listed renewable energy companies (157 solar and 182 wind). Geographically speaking the sample consists of 105 companies in Europe (31 percent), 66 US- and Canada-based (20 percent), while Asia accounts for 154 companies

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Handbook of research on energy entrepreneurship 180 Total

154

160

Solar Wind

140 120

105 95

100 80 60

66 48

59

57

40

41 25 14

20

9

5

0 Europe

Figure 12.2

US and Canada

Asia

ROW

Geographical split of renewable energy firms (absolute numbers)

(45 percent), and the rest of the world for 14 companies (4 percent) (Figure 12.2). Regarding sales, the trimmed mean for 2008 was $683 million per company per year.2 Dependent Variable As the dependent variable we used Tobin’s q, the market value of a company over replacement costs of tangible assets. Tobin’s q has been proposed for accounting for firm value on various occasions in organizational and management literature (Lindenberg and Ross, 1981; Chung and Pruitt, 1994; Dowell et al., 2000; Villalonga, 2004). Tobin’s q has been interpreted either as a distinct measure of intangibles or simply as capturing investor expectations of greater returns in general (Villalonga, 2004: 211). It is beyond the scope of this study to go into further details on this topic. However, we deem Tobin’s q suitable to measure renewable energy firm performance, as it reflects investors’ expectations. We presume investors’ expectations would take intangibles as well as non-rational expectations into account (for example, those related to market hype). This simplified interpretation designates the use of Tobin’s q not as an absolute performance indicator but rather for comparing relative performance of renewable energy firms on a business model level. Additionally, Weill et al. report a comparison of alternative performance measures for business models already in place (for example, economic value added, return on invested capital, return on assets, market capitalization and Tobin’s q) and found that they all point to similar results ( 2005: 17). To calculate Tobin’s q we used Worldscope data which we derived via Thomson One Banker. Following Dowell et al. (2000), we proxied for market value by adding market capitalization, total long-term debt and current liabilities. We find the Worldscope database item ‘total assets’ according to its content description suitable for proxying tangible assets. We calculated Tobin’s q for each of the 339 companies for the year ends of 2006, 2007 and 2008, which results in a dataset of 1,017 firm-year observations (Figure 12.3). As Tobin’s q accounts for the market value of a company over its tangible assets, Tobin’s q greater than 1 would refer to overpricing, whereas Tobin’s q less than 1 would refer to an underpriced company (Lindenberg and Ross, 1981; Chung and Pruitt, 1994;

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Tobin’s q Mean

How business models impact renewable energy firms

Figure 12.3

4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00

2006

2007

2008

Total

3.17

1.73

1.30

Solar Wind

4.15

2.02

1.44

2.32

1.48

1.19

237

Tobin’s q mean over time

Dowell et al., 2000; Villalonga, 2004). For solar in 2006, the mean of Tobin’s q was at 4.23, drastically above 1 (see Figure 12.1). For emerging markets in general, a Tobin’s q higher than 1 is not surprising as markets consider what the high opportunities, new technologies or emerging markets would provide. However, if market value exceeds assets by more than four times, like for innovation-driven business models in the solar industry (see Figure 12.3), companies might not be rationally evaluated. Across the timeline (years 2006–08), Tobin’s q moves toward 1, with a value of 1.30 for the total sample by the end of 2008. Our interpretation is that markets evaluate solar companies more realistically over time. Comparing wind and solar, we find this ‘consolidation’ trend to be stronger for solar. However, for the following calculation we followed Dowell et al.’s proposition and used a three-year mean for Tobin’s q. In that way, we intended to minimize effects which are related to possible extreme events within the single years. Independent Variables In line with theory, and as outlined in the background section, we propose two business model characteristics as independent variables: location on the value chain and business model gestalt theme. For the business model’s location on the value chain, we differentiated between upstream, downstream, and fully integrated. For the business model’s gestalt theme we followed the work of Zott and Amit (2007, 2008) and differentiated between innovation-driven business models, efficiency-driven business models, business models that are led by both design themes, and business models without a clear focus on such a specific gestalt theme. To measure the independent variables, we conduct a content analysis of business descriptions for each company: ‘Content analysis assumes that groups of words reveal underlying themes, and that, for instance, co-occurrences of keywords can be interpreted as reflecting association between the underlying concepts’ (Duriau et al., 2007: 6). The business descriptions are provided within the Worldscope database. Hence, data for dependent and independent variables can be derived from the

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Table 12.1

Code definition for independent variables

Independent variable Business model’s gestalt theme

Characteristics (1) Innovation driven (2) Efficiency driven

(3) Both

(4) Not clear

Business model’s location on the value chain

(1) Upstream (2) Downstream

(3) Fully integrated

Code (key words) Innovation, invent, novel, patent, design, research, development, exploration Marketing, brand, selling, sale, promoting, service, support, turnkey, turn key, large scale, low cost Innovation, invent, novel, patent, design, research, development, exploration, marketing, brand, selling, sale, promoting, service, support, turnkey, turn key, large scale, low cost Innovation, invent, novel, patent, design, research, development, exploration, marketing, brand, selling, sale, promoting, service, support, turnkey, turn key, large scale, low cost Manufacture, production, raw material, refining, devices Energy sales, power generation, energy production, project development, installation, constructing, maintenance, investment Manufacture, production, raw material, refining, devices, energy sales, power generation, energy production, project development, installation, constructing, maintenance, investment

same database, which reduces errors and guarantees a rigorous quality of the data (Table 12.1). For the content analysis, we performed two steps: code definition and computer-aided word count. Defining codes for a business model’s value chain location is straightforward as the value chain approach is widely used by renewable energy practitioners. Codes for business model gestalt themes were mainly related to the items as proposed by Zott and Amit and only slightly modified toward renewable energy (2008: 23–6). We performed the word count with Microsoft Word for all keywords within business descriptions of our sample. Table 12.2 shows the frequencies for each business model characteristic.

4

RESULTS

When comparing various business model attributes by their Tobin’s q, differences in standard deviation become apparent (especially for solar with relatively high standard. deviation. and wind with more moderate standard deviation). We regard this as a sign for wind being the more homogeneous industry of the two. Also notable is that in both industries innovation-driven business models achieve the highest Tobin’s q. In respect to value chain location, upstream business models perform best.

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How business models impact renewable energy firms Table 12.2

Frequencies: total (solar, wind) Business model’s location on the value chain

Business model’s gestalt theme

Innovation Efficiency Both Not clear Total

Table 12.3

Upstream

Downstream

Fully integrated

26 (16, 10) 74 (29, 45) 65 (43, 22) 46 (15, 31) 211 (103, 108)

5 (1, 4) 9 (4, 5) 19 (6, 13) 18 (5, 13) 51 (16, 35)

3 (1, 2) 26 (11, 15) 34 (21, 13) 14 (5, 9) 77 (38, 39)

Total

Solar Wind N Total (Solar, Wind)

Total

34 (18, 16) 109 (44, 65) 118 (70, 48) 78 (25, 53) 339 (157, 182)

Performance of business models for renewable energy: Tobin’s q mean (standard deviation) Business model’s gestalt theme

Total

239

3.14 (5.53) 4.84 (7.45) 1.66 (2.16) 339 (157, 182)

Innovation Efficiency 5.92 (10.11) 8.92 (13.03) 2.54 (3.12) 34 (18, 16)

2.36 (3.31) 3.49 (3.57) 1.59 (2.91) 109 (44, 65)

Both 3.76 (6.51) 5.02 (8.15) 1.92 (1.44) 118 (70, 48)

Business model’s value chain location Unclear Upstream

DownFully stream Integrated

2.07 (2.18) 3.79 (3.05) 1.26 (0.81) 78 (25, 53)

1.74 (1.33) 2.78 (1.50) 1.27 (0.94) 51 (16, 35)

3.65 (6.82) 5.62 (8.98) 1.78 (2.68) 211 (103, 108)

2.64 (2.02) 3.59 (2.33) 1.71 (1.03) 77 (38, 39)

Comparing wind and solar, we find a similar pattern concerning how performance relates to different business model characteristics. Differences can be noted regarding the maximum and the range of Tobin’s q’s means (see Figures 12.4a and b). In relation to the business model’s gestalt themes, in both subsamples, purely innovation-driven business models achieve the highest performance, followed by business models that are simultaneously innovation and efficiency driven. Business models that cannot be associated with innovation perform lower. This highlights how important innovation is as a performance driver for both, wind and solar. Considering the business model’s value chain location, business models capturing upstream activities outperform those that concentrate on downstream-oriented activities. Fully integrated business models, on average, underperform upstream business models but perform better than downstream ones.

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Handbook of research on energy entrepreneurship 6 Solar

5 Tobin’s q Mean

Wind 4 3 2 1 0 Upstream

Downstream

Fully Integrated

(a) Business model’s location on the value chain 10 9

Solar

Tobin’s q Mean

8

Wind

7 6 5 4 3 2 1 0 Innovation

Efficiency

Both

Unclear

(b) Business model’s design theme

Figure 12.4

Differences on business model performance between wind and solar

Testing Hypotheses To test hypotheses H1a and H1b we created binomial dummy variables. For testing H1a to determine whether upstream location would impact firm performance, we created a variable called ‘upstream’ for all business models with upstream activities (upstream or fully integrated business models match characteristics 1 and 3 respectively, as shown in Table 12.1). For testing counterhypothesis H1b we analogically created a variable called ‘downstream’. Correlations are plotted in Table 12.4, showing significant positive correlation between Tobin’s q’s mean and the dummy variable ‘upstream’. The results indicate that H1a can be confirmed, whereas H1b should be rejected, that is, renewable energy firms with business models capturing upstream activities outperform those with business models that focus only on downstream activities. A test variable ‘fully integrated’ confirmed the assumption we stated in the theory section, that full integration does not have a clear impact on renewable energy firm

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How business models impact renewable energy firms Table 12.4

Correlation between Tobin’s q and business model characteristics Tobin’s q mean

Tobin’s q mean Upstream

Downstream

Fully Integrated Led by gestalt theme

241

Pearson correlation Sig. (1-tailed) N Pearson correlation Sig. (1-tailed) N Pearson correlation Sig. (1-tailed) N Pearson correlation Sig. (1-tailed) N Pearson correlation Sig. (1-tailed) N

1 339 0.106* 0.025 339 −0.118* 0.015 339 −0.046 0.200 339 0.120* 0.014 338

Upstream

0.106* 0.025 339 1 339 −0.513** 0.000 339 0.224** 0.000 339 0.129** 0.009 338

Downstream −0.118* 0.015 339 −0.513** 0.000 339 1 339 0.693** 0.000 339 −0.039 0.237 338

Fully Orchestrated integrated by gestalt theme −0.046 0.200 339 0.224** 0.000 339 0.693** 0.000 339 1 339 0.066 0.113 338

0.120* 0.014 338 0.129** 0.009 338 −0.039 0.237 338 0.066 0.113 338 1 338

Note: * Correlation is significant at the 0.05 level (1-tailed); ** Correlation is significant at the 0.01 level (1-tailed).

performance in general (see Table 12.4). Due to a smaller N within the subsamples wind and solar, we elaborated on H2 by comparing for both subsamples the ratio of Tobin’s q of fully integrated business models over Tobin’s q of the whole subsample. We assume that a value above 1 indicates that the industry rewards vertical integration, whereas a value below 1 would indicate that it does not. According to the equation below, we find confirmation for H2: q solar int q wind int 3.59 1.71 3    1.03  0.74 q wind total q solar total 1.66 4.84 For testing H3 we created another dummy variable ‘led by gestalt theme’ for business models that are led by a gestalt theme (either innovation, efficiency or both, which match all but characteristic 4 in Table 12.1). Correlations between Tobin’s q and this dummy variable indicate that H3 can be confirmed, that is, renewable energy firms with a business model that is led by one of the generic gestalt themes (be it innovation, efficiency or both) outperform fuzzy business models that are not led by such a gestalt theme. Considering H4a and H4b we counted the codes (keywords) for business model gestalt themes as defined in Table 12.1. In line with content analysis literature, we interpret the number of keywords as a signal of strength for each gestalt theme. Based on that assumption we calculated the correlation between the number of keywords for innovation and efficiency and Tobin’s q. The results are plotted in Table 12.5 and indicate that H4a can be confirmed whereas H4b should be rejected, that is, renewable energy firms with innovation-driven business models achieve higher firm performance the more innovation as a gestalt theme shapes the business model.

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Table 12.5

Correlations between Tobin’s q and strength of difference business model gestalt themes Tobin’s q mean

Tobin’s q mean Strength of efficiency Strength of innovation

Pearson correlation Sig. (1-tailed) N Pearson correlation Sig. (1-tailed) N Pearson correlation Sig. (1-tailed) N

1 339 0.014 0.397 339 0.153** 0.002 339

Strength of efficiency 0.014 0.397 339 1 339 0.308** 0.000 339

Strength of innovation 0.153** 0.002 339 0.308** 0.000 339 1 339

Note: ** Correlation is significant at the 0.01 level (1-tailed).

Surprisingly, we could not conclusively prove that efficiency significantly impacts renewable energy firm performance, although efficiency-driven business models clearly show positive impact on firm performance in other industries (Zott and Amit, 2007) and reports assume efficiency of importance for renewable energy (DISTRES, 2009: 70). Nevertheless, we find one possible explanation for that in the strong importance of innovation for renewable energy. Another explanation could be that efficiency-driven activities for renewable energies may be underdeveloped in comparison with other industries. As a point of comparison, we refer to marketing activities which would target more-efficient transactions and reduce transaction costs. Another possibility is that efficiency could very well pay off in later industry stages. We find support for that when comparing wind as a more established industry with solar as a more emerging industry, characterized by higher technological uncertainty. Our observations support H5a and H5b (see below), claiming that innovation is more beneficial in solar, whereas efficiency more positively impacts firm performance within the wind sample: q wind innov q solar innov 2.54 8.92 3  1.53  1.84, q wind total q solar total 1.66 4.84 q wind eff q solar eff 1.59 3.49 3    5.96  0.72. q wind total q solar total 1.66 4.84

5

DISCUSSION AND OUTLOOK

Reporting from a sample of 339 publicly listed renewable energy firms from around the world, we elaborate on how business models impact renewable energy firm performance. By describing business models for renewable energy firms according to their position in the value chain and their gestalt theme (innovation and/or efficiency), we come up with several main findings. First, in 2006–08, renewable energy firms with business models

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capturing upstream activities outperform those with business models that focus solely on downstream activities. Second, renewable energy firms with a business model which is led by at least one of the generic gestalt themes (either innovation or efficiency, or both) outperform those with business models that are not. Third, renewable energy firms with innovation-driven business models achieve higher firm performance the more innovation as a gestalt theme shapes the business model. Fourth, as a performance indicator, Tobin’s q suggests a more realistic valuation of renewable energy companies over time. Furthermore, although efficiency has been proven to positively impact firm performance in other research, we could not confirm that for renewable energy. One possible reason is that efficiency-related activities (such as marketing activities used for building up efficient transactions) are still insufficiently developed among renewable energy firms. Finally, comparing solar as an emerging industry with wind as a more-mature industry, we find that more-mature industries reward fully integrated business models. Additionally, innovation is more beneficial in emerging industries and renewable energy firms achieve a higher performance with efficiency-driven business models in established industries. Our study comes up against some limitations. In the first place, our sample may not cover all publicly listed wind or solar firms. Due to sample scope, we only include firms in our sample that explicitly mention solar and wind in their business descriptions. Nevertheless, we conducted random tests to prove that our sample represents the majority of renewable energy firms and thus allows for drawing overall conclusions. Second, our study faces the common limitations concerning the use of content analysis as our method of choice for the independent variables. One might ask whether analyzing business description allows us to assume what the company actually does or if it is only ‘communication’. The argument in content analysis literature is that texts reflect underlying structures. However, we propose case studies in future research to better account for those issues. Third, we apply Tobin’s q as the dependent variable. Although Tobin’s q has been widely used in strategy literature to measure firm performance, it has been criticized. For instance, Tobin’s q could refer either broadly to different investor expectations or specifically to a different degree of utilization of intangible assets. Tobin’s q, and therefore our results, are preliminary in this regard and require further investigation with future research. Another limitation is that our dataset considers only three consecutive years, which only allows us to conduct descriptive statistics. Consequently, our findings have mainly an explorative character. Future research should draw from this shortcoming; observations over a longer period and the addition of more performance indicators may further validate our findings. Nevertheless, our study is beneficial in guiding future research and helping to clarify research on business models and renewable energy firm performance. Herewith we contribute to practice and research. Our research may guide entrepreneurial activities such as designing and readjusting business models for renewable energy to achieve high financial performance. We identify five foremost important avenues for entrepreneurs to improve business model design and increase firm performance. First, although big players already exist on the upstream part of the value chain and entry barriers, for instance due to economies of scale and high capital requirements, are relatively high, the performance advantage of upstream business models for renewable energy which our study reports might attract new entrants. Nevertheless, practitioners

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should keep in mind that past performance is not always a good indicator for future performance and that timing of entrepreneurial decisions has crucial impact on firm performance as well. However, upstream business models generically promise constant revenue flows and high entry barriers to protect their competitive advantages. Financial markets seem to be attracted by that. We propose the ‘upstream story’ as well as a benchmark for entrepreneurs who target downstream business models. Downstream entrepreneurs should design business models that propose similar benefits. For instance from retail companies like IKEA or Wal-Mart, we know that economies of scale are not exclusively performance drivers for manufacturers, but they also can lead to competitive advantages for close-to-customers downstream business models. Second, we recommend that renewable energy entrepreneurs should avoid fuzzy business models as we see a strong market signal for clear profile. We propose that renewable energy business models are directly altered, refining them towards innovation, anchoring the efforts of technological or service innovation as well as activities relating to tapping into new market potential. In addition, we know from other industries that efficiency as a gestalt theme might drive firm performance as well. However, efficiency on a business model level has not yet shown to significantly drive renewable energy firm performance. Third, our findings encourage renewable energy entrepreneurs to choose business models that enable innovation. Those business models may tackle either the upstream part of the value chain, developing new technologies, or the downstream part, providing new approaches, for example, for energy sales, project development, investment or constructing and maintenance. We assume innovation to be a superior performance driver as long as technological uncertainty for renewable energy or costs in general are comparably high. Fourth, we encourage entrepreneurs to carefully consider timing for vertical integrating business models. For instance, in emerging industries such as solar, fully integrated business models may face downside risks and entrepreneurs might want to consider alternatives such as cooperations or partnerships that are more flexible (and less cost intensive). Finally, renewable energy entrepreneurs within more established industries such as wind might want to take on business models that target efficiency. We regard business models that propose reducing transaction costs as promising in this regard, for example, service-driven business models. Academically, we contribute to energy entrepreneurship research and firm performance. For the first time, we discuss the link between business models for renewable energy and firm performance. By doing so, this research may serve as blueprint for future work on the intersection of strategy, organizational configuration and firm performance in the field of energy entrepreneurship. In the following we sketch out possible avenues for future research. First, research could take place either over longer periods and/or within shorter periods (months or weeks). Within an event study research could elaborate on whether and how certain events (for example, management decisions about major shifts in business model design) would impact firm value. Second, we encourage future research to cover other dependent variables (for example, growth in assets, performance delays, probability of bankruptcy, probability

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of developing certain strategic patterns and so on). Taking this direction, research could develop and test measures to predict renewable energy firm performance. Third, future research could test other independent variables (for example, certain capabilities, resources – such as management team configuration – value networks, degree of diversification and so on). Such approaches would increase knowledge regarding what factors influence renewable energy firm performance and indicate how important they are in relation to one another. Fourth, research could elaborate on how renewable energy business models and other contingency variables fit, such as certain product/market strategies or policy frameworks. Finally, research should measure the consistency and internal fit of business model attributes for renewable energy, and thus offer suggestions on improving business models for renewable energy in order to increase firm performance. Achieving high performance is important for renewable energy firms to attract investors and accelerate the diffusion of clean technology. We maintain that business model configuration is important in this regard. However, we still need to learn more about what drives renewable energy firm performance.

NOTES 1. To analyze the data we conducted qualitative content analysis led by the following questions, which we derived from business model literature and modified towards renewable energy (Morris et al., 2005: 726– 35): what kind of business models exist for renewable energy and what are their characteristics? What value do business models for renewable energy propose, for which customers and which market segments do they target? What resources, capabilities and know-how do business models for renewable energy exploit to fulfill their value proposition? How do business models for renewable energy make money? What is their revenue model? What opportunities do renewable energy business models face and what are their threats? 2. For the trimmed mean we excluded the 2.5 percent biggest and 2.5 percent smallest companies.

REFERENCES Afuah, A. (2001), ‘Dynamic boundaries of the firm: are firms better off being vertically integrated in the face of a technological change?’, Academy of Management Journal, 44 (6): 1211–28. Boehnke, J. (2007), ‘Business models for Micro CHP in residential buildings’, dissertation, University of St. Gallen. Casadesus-Masanell, R. and J. Ricart (2007), ‘Competing through business models’, IESE Business School, Working Paper, 713: 1–28. Chandler, A. (1962), Strategy and Structure: Chapters in the History of the Industrial Enterprise, Cambridge, MA: MIT Press. Chesbrough, H. (2007a), ‘Business model innovation: it’s not just about technology anymore’, Strategy and Leadership, 35 (6): 12–17. Chesbrough, H. (2007b), ‘Why companies should have open business models’, MIT Sloan Management Review, 48 (2): 22–8. Chesbrough, C. and R.S. Rosenbloom (2002), ‘The role of the business model in capturing value from innovation: evidence from Xerox Corporation’s technology spin-off companies’, Industrial and Corporate Change, 11 (3): 529–55. Christensen, C. (2003), The Innovator’s Dilemma, New York: Collins. Chung, K.H. and S.W. Pruitt (1994), ‘A simple approximation of Tobin’s q’, Financial Management, 23 (3): 70–74. Deutsche Bank (2009), ‘Solar Photovoltaic Industry. Looking Through the Storm’, report. DISTRES (2009), ‘Promotion and consolidation of all RTD activities for renewable distributed generation

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technologies in the Mediterranean region, Task 2.2: Business models and market entry strategies’, report, Copenhagen Business School/University of St. Gallen. Dowell G., S. Hart and B. Yeung (2000), ‘Do corporate global environmental standards create or destroy market value?’, Management Science, 46 (8): 1059–74. Drucker, P. (1985), Innovation and Entrepreneurship, New York: Harper & Row. Duriau, V., R. Reger and M. Pfarrer (2007), ‘A content analysis of the content analysis literature in organization studies: research themes, data sources, and methodological refinements’, Organizational Research Methods, 10 (1): 5–34. Frantzis, L., S. Graham, R. Katofsky and H. Sawyer (2008), ‘Photovoltaics business models’, National Renewable Energy Laboratory, Burlington, VT. Hedman, J. and T. Kalling (2003), ‘The business model concept: theoretical underpinnings and empirical illustrations’, European Journal of Information Systems, 12 (1): 49–59. Jefferies (2008), ‘Clean Technology – Ready for a Post Crisis Bounce’, report. Johnson, M., C. Christensen and H. Kagermann (2008), ‘Reinventing your business model’, Harvard Business Review, 86 (12): 51–9. Lindenberg, E.B. and S.A. Ross (1981), ‘Tobin’s q ratio and industrial organization’, Journal of Business, 54 (1): 1–32. Magretta, J. (2002), ‘Why business models matter’, Harvard Business Review, 80: 86–92. Miles, R. and C. Snow (1978), Organization Structure, Strategy, and Process, New York: McGraw-Hill. Miller, D. (1986), ‘Configurations of strategy and structure: towards a synthesis’, Strategic Management Journal, 7 (3): 233–49. Miller, D. (1996), ‘Configurations revisited’, Strategic Management Journal, 17 (7): 505–12. Mintzberg, H. (1979), The Structuring of Organizations, Englewood Cliffs, NJ: Prentice-Hall. Mitchell, D. and C. Coles (2003), ‘The ultimate competitive advantage of continuing business model innovation’, Journal of Business Strategy, 24 (5): 15–21. Morris, M., M. Schindehutte and J. Allen (2005), ‘The entrepreneur’s business model: toward a unified perspective’, Journal of Business Research, 58 (6): 726–35. OppenheimResearch (2009), ‘Renewable Energies. Winners of the Coming Consolidation’, report. Osterwalder, A., Y. Pigneur and C.L. Tucci (2005), ‘Clarifying business models: origins, present and future of the concept’, Communications of the Association for Information Systems, 16: 1–25. Schweizer, L. (2005), ‘Concept and evolution of business models’, Journal of General Management, 31 (2): 37–56. Shanley, R. (2004), Financing Technology’s Frontier. Decision-Making Models for Investors and Advisors, Hoboken, NJ: Wiley. Teece, D., R. Rumelt, G. Dosi and S. Winter (1994), ‘Understanding corporate coherence’, Journal of Economic Behavior and Organization, 23: 1–30. UNEP, SEFI, NEF (2008), ‘Global trends in sustainable energy investment 2008’, available at: http://sefi.unep. org (accessed 16.1.2009). Villalonga, B. (2004), ‘Intangible resources, Tobin’s q, and sustainability of performance differences’, Journal of Economic Behavior and Organization, 54 (2): 205–30. Weill, P., T. Malone, V. D’Urso, G. Herman and S. Woerner (2005), ‘Do some business models perform better than others? A study of the 1000 largest US firms’, Working Paper 226, MIT Center for Coordination Science, Cambridge, MA. Wise, R. and P. Baumgartner (1999), ‘Go downstream’, Harvard Business Review, 77 (5): 133–41. Wüstenhagen, R. and J. Boehnke (2008), ‘Business models for sustainable energy’, in A. Tukker, M. Charter, C. Vezzoli, E. Sto and M.M. Andersen (eds), System Innovation for Sustainability 1. Perspectives on Radical Changes to Sustainable Consumption and Production (SCP), Sheffield: Greenleaf Publishing, pp. 85–94. Yip, G. (2004), ‘Using strategy to change your business model’, Business Strategy Review, 15 (2): 17–24. Zott, C. and R. Amit (2007), ‘Business model design and the performance of entrepreneurial firms’, Organization Science, 18 (2): 181–99. Zott, C. and R. Amit (2008), ‘The fit between product market strategy and business model: implications for firm performance’, Strategic Management Journal, 29 (1): 1–26.

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PART V COMMERCIALIZING ENERGY INNOVATION

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13 Interfirm relationships in a new industry: the case of fuel cell technologies Stefano Pogutz, Angeloantonio Russo and Paolo Migliavacca

1

OVERVIEW

In recent years the global climate crisis, degradation of ecosystems (MEA, 2005; Metz and Davidson, 2007), depletion of fluid fossil fuels, and high volatility of energy markets all starkly underline the need for change in our energy system. To achieve sustainable development, low carbon technologies are necessary to reduce our ecological footprint. Dependence on relations with and largesse of unstable geopolitical regions, along with the anticipated increase in global demand for petroleum and gas (IEA, 2008), inevitably reduces our confidence in future, affordable access to traditional energy sources, obliging us to refocus our hope on alternative energy sources, new energy carriers, and the development of innovative solutions to the challenge of energy conversion, grateful all the while that alternative sources do exist to replace our dependence on sources that threaten the continued existence of life as we know it on Earth. Hydrogen and fuel cell technologies have emerged as potential solutions to these huge challenges, though controversies over where exactly to focus our most immediate efforts exist within the scientific, political, and industrial communities. Magazines, newspapers, and other media nurture our hope in the potential of this small and light molecule. Governments and policy makers have prepared a large number of white papers and official documents framing pathways toward the ‘hydrogen-based’ economy (CEC, 2003; DOE, 2006; McDowall and Eames, 2006; Solomon and Banerjee, 2006). Moreover, a growing number of firms and entrepreneurs are becoming increasingly aware of the substantial market potential of fuel cell technologies (Pogutz et al., 2009). The transition to hydrogen as an energy carrier clearly represents a ‘sea change’ in our energy infrastructure, wreaking havoc across several industries, fraught as it is with a number of barriers and constraints. Continued research must focus effectively on how to improve the overall performance of these technologies and enhance their competitiveness with other incumbent and emerging solutions. Moreover, no infrastructure has yet been developed to produce and distribute viable hydrogen to end users. A further drawback is the high cost of the production and conversion processes needed to advance fuel cell technologies and hydrogen storage methods; nor have we ascertained where the earliest, most receptive markets exist. Finally, the societal and environmental changes that will accompany our adoption of these new technologies are still unclear and uncertain. At the same time, there are several reasons why the prospect of a hydrogen energy economy is so alluring. First, hydrogen as a carrier is effective in improving air quality and, at the global level, in helping to reduce greenhouse gases. Hydrogen also promises energy security and independence from oil and gas reserves concentrated in sensitive 249

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geographical areas. Further, the proliferation of hydrogen use can support a transition from a centralized energy network to a decentralized, democratic, and more equitable one (DOE, 2002). In light of the above context, this chapter offers a new approach to the analysis on fuel cell technologies. We adopt a network perspective to explore this emerging industry and describe the dynamic formation and the longitudinal evolution of strategic alliances. Alliances among organizations are classified according to different forms of governance: joint ventures, supply and distribution agreements, and research and development (R&D) agreements (Gulati, 1998). The remainder of the chapter is structured as follows. After introducing the technology and the supply chain of fuel cells (Sections 2 and 3), we review the existing literature on management alliances and networks (Section 4). Then, we trace the evolutionary path of the fuel cell network (Section 5). Finally, in Section 6, we provide the conclusions of our study and suggest further research.

2

FUEL CELL TECHNOLOGIES

Fuel cells are generally defined as electrochemical energy conversion devices that generate electricity and heat by combining oxygen from air and a fuel, for example, hydrogen or H2-rich fuels (Simbolotti, 2009). Fuel cells are similar to batteries, but they continue to operate as long as fuel is supplied and can thus be more accurately described as thermodynamically open systems. The conversion process takes place without combustion. When hydrogen is used as fuel, the only byproducts are water and heat; fuel cells are therefore environmentally clean, silent, and more efficient than other combustion systems. This simple structure consists of two electrodes – cathode and anode – separated by an electrolyte. The electrolyte carries electrically charged particles from one electrode to the other. Another key element is the catalyst, such as platinum, that encourages and speeds up the reactions among the electrodes. Individual fuel cells can be combined to produce a useful form of power. This design, called a fuel cell ‘stack’, is the core of the fuel cell system, which includes, in addition the fuel processor and the power conditioner. Fuel cells can be produced in a variety of ways, depending on the nature of the electrolyte and the materials used. A description of the principal features of different fuel cell technologies is provided in Table 13.1. Fuel cells have attracted growing attention in the industrial and financial world for several reasons (Lipman et al., 2004; Brown et al., 2007). First, they produce power with a higher efficiency rate and almost zero environmental impact when compared to other power systems used as internal combustion engines. Second, their flexibility and modular technologies can efficiently generate power in a variety of system sizes. According to Fuel Cell Today (Adamson, 2009), in 2008 deliveries for small power generation fuel cells rose 78 percent, with a production of about 4,000 units (95 percent of which were PEMFC). The amount of MW installed in large power system units, has increased to 20 MW, with an increase in the average size of each installed unit to 1 MW (Adamson, 2008). In the transport industry, a few hundred fuel cell cars and buses are in operation worldwide, while the number of niche transport markets such as marine applications and auxiliary power units (APUs) is growing. In particular, sales of warehouse vehicles

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Interfirm relationships in a new industry: fuel cell technologies Table 13.1

Variants of fuel cell technologies

Name

Description

Polymer electrolyte membrane fuel cell (PEMFC)

This technology uses a solid polymeric membrane as electrolyte and carbon electrodes. Need to use pure hydrogen

Molten carbonate fuel cell (MCFC)

This technology uses a molten-carbonate salt electrolyte and must be fueled with natural gas and biogas This technology uses a ceramic oxide electrolyte. Can be fueled by natural gas and externally reforming heavier hydrocarbons, such as gasoline, diesel, jet fuel (JP-8) or biofuels The technology uses immobilized liquid phosphoric acid. It tolerates a high level of impurities

Solid oxide fuel cell (SOFC)

Phosphoric acid electrolyte fuel cell (PAFC) Direct methanol fuel cell (DMFC)

251

This technology uses a polymeric membrane and methanol as a fuel

Features

Application

Low temperature (80°C). Operational electric efficiency of the cell: 50–70%. Operational electric efficiency of the system: 30–50%. Short start-up time High temperature (>650°C). Operational electric efficiency of the system achieves 60%. Long start-up time High temperature (800–1,000°C). High operational electric efficiency of the system close to 50%. In case of co-generation the overall efficiency can exceed 85%. Long start-up time

Transport and smallscale stationary power systems

Medium temperature (100–250°C). Operational electric efficiency of the system achieves 40%. With co-generation PAFC can reach 85% Low temperature (90–120°C). Low system electric efficiency: 15–30%

Stationary applications. It was the first type of fuel cell commercialized. Now the market perspectives are limited

Large power systems

Large power systems

Portable devices

and forklift applications have stimulated early market growth, including the distribution of a large number of demonstration units in North America and Europe (Agnolucci, 2009). PEMFC is the leading solution for small-scale power units, representing more than 70 percent of the market, while for large stationary units MCFC and PAFC still top the market, but the importance of SOFC is expected to increase in the near future (Simbolotti, 2009). Although fuel cells are considered a key conversion technology for hydrogen, their improved performance is perceived as a major impediment to the diffusion of hydrogen as an energy carrier. Two specific obstacles diminish the effectiveness of fuel cell performance: their durability and cost. Several contingencies influence the durability of fuel cells, including the start-up temperature, fuel purity, and degree of humidification. In any event, to become competitive with other viable solutions, the technology requires

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significant improvement in several areas. To improve fuel cell functionality in transportation the costs per kW must be dramatically reduced (a competitive cost is on the order of $60–$100 per kW, while the current cost of a PEMFC stack exceeds $1,000 kW); in the realm of stationary applications, however, the cost of fuel cells is expected to become competitive within a few years (the target is an installation cost of $1,500 per kW while the current cost of the fuel cell stack is about $5,000 per kW).

3

THE FUEL CELL SUPPLY CHAIN

A careful analysis is needed to identify organizations and competencies to consolidate this new technology. While some companies act as ‘system integrators’ within the industry, focusing mainly on assembling different types of fuel cell components, a much larger number of various other industrial sectors have shown interest in fuel cells. Here, we briefly describe the main players and the relational dynamics of this nascent industry, by means of a simple representation of the supply chain structure (Figure 13.1). A variety of actors from different sectors, while providing specific competencies, are seeking alternatives from specific colleagues. Figure 13.1 specifies the industries involved, beginning with cell basic materials supply to commercialization channels. Materials and components include elements such as catalyst materials, gas diffusion layers (GDLs) and gas diffusion electrodes (GDEs), and membrane electrode assemblies (MEAs). These are usually supplied by a wide and heterogeneous range of providers (from chemicals to textiles and paper, from electronics to nanotechnologies). Companies at this stage vary in terms of their vertical integration and size. Materials, components, and parts are then assembled by highly specialized firms usually called ‘system integrators’, which then produce the complete cell. The fuel

Gas and oil

Government and military application

Financial institutions

Research

Fuel Cell Supply Chain

Materials

Catalysis Electrodes Membranes Gas diffusion layers Nanotechnologies Etc.

Figure 13.1

Components

Stacks Sensors Fuel storage tanks Bi-polar plates Power of plants Balance of plant Etc.

System integrators

PEMFC SOFC MCFC DMFC PAFC

End users

Transport Automotive Others Stationary Small applications Large applications Portable Electronics Back-up and others

Fuel cell supply chain

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cell integrators, small to medium sized, relatively new participants (for example, Ballard, UTC Power, Plug Power, Hydrogenics, and so on), often focus on a specific technological architecture (PEMFC, SOFC, MCFC, and so on). Distributors and industrial users further participate in the dynamics of the supply chain, applying this intermediate technology to products to be sold to final users. Given the great variety of fuel cell potential applications, industrial users comprise three main categories. The transport industry – manufacturers of automobiles, buses, boats, aircraft, trains, forklifts – includes companies such as General Motors, Ford, Toyota, Nissan, and Honda, but also retailers and consumer-goods sources such as Wal-Mart and Nestlé, who are attracted to the technology for logistics applications. Stationary power generation, useful for both centralized production and, more efficiently, for distributed production and consumption, includes small power generation, for example, for individual homes and back-up power units, and larger industrial applications. Portable power generation is useful for electronic appliances such as laptop computers and mobile phones (manufactured by moguls such as Toshiba, NEC, Hitachi, and Casio), as well as military, medical, and recreational applications. Final users are therefore crucial to the overall chain, selecting appropriate architectures and fuel cell integrators, functioning beyond the obvious commercial level. Outside of the supply chain, other important participants in this nascent industry include oil and gas companies, institutional investors, governments and local authorities, and research bodies. With their various interests in industry monitoring and development, they all strongly influence the organizations and dynamics in the value chain.

4

STRATEGIC ALLIANCES AND NETWORKS

Over recent decades research on interorganizational alliances and networks has proliferated in management science, and a growing number of studies by both strategy and organizational scholars have been published. Cooperation strategies have been observed in biotechnology and pharmaceuticals (Arora and Gambardella, 1990; Deeds and Hill, 1996; Oliver, 2001; Niosi, 2003), high-tech (Afuah, 2000; Stuart, 2000), fiber optics (Spedale, 2003), automotives (Dyer, 1996), and multisectoral collaborations (Gulati and Singh, 1998). Gulati (1998, p. 293) defines strategic alliances as ‘voluntary arrangements between firms involving exchange, sharing, or co-development of products, technologies, or services’. Alliances occur as a consequence of many factors and result among a wide range of organizational structures that contribute either capital, technology, or more firm-specific assets. The literature has investigated in depth why firms form alliances. Different interpretations reflect the wide range of theoretical approaches in managerial and economic science (Kogut, 1988; Gulati, 1995). Following the transaction cost economics approach (Williamson, 1985), firms collaborate to reduce the transaction costs of bargaining. Moreover, alliances allow for more flexibility than does integration, reducing economic risks by sharing investments and responsibilities (Pisano, 1990; Hagedoorn, 1993). In the perspective of organization theory collaborations, by sharing knowledge and technology, firms gain specific resources otherwise difficult to access (Gulati, 1995; Borgatti

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and Foster, 2003). Another research stream suggests that alliances offer complementary resources and legitimacy (Stuart, 2000). For example, collaboration with an established firm can lead to new financing opportunities, improves the firm’s reputation among customers, and favors synergies. Finally, scholars focused on the resource dependence theory have highlighted the importance of established relationships and organizational interdependence as a model for strategic alliance formation (Gulati, 1995). Strategic alliances can be considered as a specific form of governance between hierarchies and markets, and the many categories are based on the level of integration among partners and the formal structure of the alliance itself. Different forms of governance structure respond to diverse power asymmetries among partners, perceived uncertainty, and appropriation concerns (Gulati and Singh, 1998). In light of the above context, analysis of networks has increased, and a large number of scholars have advanced from a dyadic perspective, based on firm-single alliances, to a network perspective, finding insights based on firms’ social context and, more specifically, on their positions in networks (Powell et al., 1996; Osborn and Hagedoorn, 1997; Gulati, 1998; Kogut, 2000). In other words, network factors may create constraints or provide opportunities to firms pursuing new alliances (Gulati, 1998) as well as influence their future behavior and performance (Dyer, 1996; Ahuja, 2000). Moreover, a network approach seems to be an efficient means of understanding and ultimately managing a portfolio of alliances, which are in turn of crucial importance for establishing technological standards (Abernathy and Utterback, 1978; Katz and Shapiro, 1985; Lambe and Spekman, 1997), particularly in the case of complex technology (Soh and Roberts, 2003).

5

THE FUEL CELL INDUSTRY: A NETWORK APPROACH

Combining the two perspectives, described above, firms involved in the fuel cell supply chain are very frequently involved in interorganizational relationships. Fuel cells represent a complex system of innovations (Hellman and van den Hoed, 2007), including multiple hierarchical systems and a broad range of actors. Therefore, a network approach can provide insight into actors’ roles and the processes of technological change, enhancing our understanding of the relationship between a firm’s strategic behavior, interorganizational alliances, and the formation of this emerging industry. Our analysis is based on data and information on strategic alliances over the 1999– 2006 period. The information on interorganizational alliances was collected from several sources, including the internet (for example, fuel cell and hydrogen websites), databases, newspapers, technical journals, and other publicly available sources. Most alliance announcements were cross-validated by researching corporate websites, Factiva, and the LexisNexis database. Finally, data and information about the countries and sizes of the organizations in the sample were collected from Amadeus and Thomson One Banker databases, as well as from company websites. The final sample includes 664 worldwide organizations and 755 completed alliances. Figures 13.2 and 13.3 illustrate alliances according to annual registrations, and typology (R&D, supply, distribution, mergers and acquisitions M&A, and joint ventures: JVs). These data show an increasing attention to fuel cell, which seems capable of attracting a large number of firms from around the world. Over the years, the number of alliances

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New alliances per year

255

755

Total alliances

449 336 251

185 93 31 62 2000

31 1999

Figure 13.2

92 2001

66 2002

85 2003

113 2004

193 2005

113 2006

Fuel cell industry alliances 250 193

No. of alliances

200 150 113 92

100

66

62 50 0

113

85

31

1999

2000

2001

2002

2003

2004

2005

2006

Supply

2

12

26

19

20

36

53

31

R&D

18

39

41

31

31

40

94

61

M&A

1

1

2

2

16

19

13

3

JV

3

6

8

3

6

5

25

9

Distribution

7

4

15

11

12

13

8

9

Figure 13.3

Fuel cell alliances per type

has grown, providing evidence of firms’ willingness to establish a partnership to foster the development of this technological device. Moreover, 8 percent of the organizations in the sample have realized more than four agreements in the period of analysis. With regard to the country, US organizations play a central role in the network, comprising about 50 percent of the sample, followed by Japan and Canada (about 9 percent). Germany is the first European country in the sample (about 5 percent of the organizations). Among the alliance types, R&D agreements are the most popular (about 47 percent), followed by supply agreements (26 percent). On the other hand, distribution

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Table 13.2

Main organizations by industry in the fuel cell network

SIC4

Industry

3620

Electrical industrial apparatus Motor vehicles and equipment Combination utility services Executive, legislative, and general government except finance Electrical equipment and supplies, other Commercial economic, sociological, and educational research Investment companies Electric power generation, transmission, or distribution Petroleum refining Motors and generators

3710 4930 9100

3690 8732

6720 4910

2910 3621

1999 2000 2001 2002 2003 2004 2005 2006 Total 7

14

13

15

22

17

21

16

125

5

12

10

11

7

8

9

8

70

1

5

11

6

11

5

5

2

46

0

0

3

0

5

8

11

6

33

1

4

6

3

6

3

5

4

32

1

0

1

1

1

4

14

8

30

3 0

0 4

1 3

2 4

3 1

8 2

5 3

5 0

27 17

0 2

2 1

2 2

1 2

3 2

2 1

2 2

2 2

14 14

agreements are still limited, suggesting that fuel cell technology is still far from being market driven. Moreover, the sample shows that narrow agreements (R&D, supplying and distribution) are much more interesting strategic options than equity-based agreements (JV and M&A). To shed light on the competencies driving network dynamics and consolidating the fuel cell industry, the organizations in our sample have been classified according to the primary four-digit SIC code typically used to describe their activity (Hoskisson and Johnson, 1992; Haleblian and Finkelstein, 1999). Results in Table 13.2 suggest that the fuel cell industry backbone primarily consists of firms belonging to the electric industrial apparatus industry. This industry mainly comprises those companies that assemble different materials and components to manufacture the fuel cell. Relevant interest in the technology is also shown by the motor vehicle and equipment industry and by the combined utility services industry, which includes oil, gas and utility firms. Moreover, starting from the year 2004, strong commitment is also apparent among organizations doing research such as governments and local authorities. In our investigation of the interorganizational dynamics within the fuel cell industry, we use a social network analysis to explore the patterns of alliances and the evolution of networks over time (Wasserman and Faust, 1999). This technique has received increasing attention among scholars, supporting research in organization, strategy, and technology and providing a useful tool to describe a network structure (Powell et al., 1996; Ahuja, 2000; Stuart, 2000; Borgatti and Foster, 2003; Soh and Roberts, 2003).

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Figure 13.4

257

The fuel cell network

From a methodological perspective, we created a binary symmetrical organization-byorganization matrix in which each xij cell represents at least one alliance between actor j and actor i. By using UCINET (Borgatti et al., 2002), we based our analysis on the measures of centrality in the fuel cell network. The use of centrality in networks as a variable reflects the assumption that position in a network has specific advantages when it comes to accessing knowledge flows. The relationship between network position and innovation has been analyzed by several scholars (Powell et al., 1996; Stuart, 1998; Gulati et al., 2000), who found that certain positions correlate with higher innovative performance. Centrality facilitates access to new alliances and is therefore considered important for long-run competitiveness and success. An analysis of centrality can explain how position in a specific network affects performance. Figure 13.4 provides a graphical representation of the fuel cell industry network in the period 1999–2006 period, showing its density and complexity. Three key measures of centrality have been computed. The first is ‘degree’, which refers to the number of ties from one node to others (Freeman, 1978). In a network, degree can be read as the probability of receiving information from other actors in the network, which is crucial to the development of new products and innovation. For example, if a firm in the network is focused on complex R&D projects, a high degree of centrality will be beneficial in that it will enhance the ability to distribute information about new developments within the larger network of partners. Powell et al. (1996) used degree centrality to investigate the relationship between centrality and innovative performance, finding an important and significant relationship.

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Table 13.3

Top 10 organizations in the fuel cell network

Organization US Department of Energy Ballard FuelCell Energy Plug Power Hydrogenics Corporation DaimlerChrysler Nuvera General Motors (GM) Proton Energy Systems Chrysalix Energy

Degree

Betweenness

Closeness

6.17 5.56 5.41 5.11 4.51 3.91 3.46 3.01 3.01 2.71

0.65 0.65 0.65 0.65 0.65 0.65 0.65 0.65 0.65 0.64

10.26 13.78 6.89 11.81 6.97 4.19 3.73 5.84 4.72 4.11

The second measurement is ‘closeness’, which is the distance of a given node from all other nodes (Freeman, 1978). In a diffusion process, a node that has high closeness centrality is more likely to receive information quickly than others will be. Whatever is flowing through the network can be coupled to an index of expected time until arrival to a given node. For example, in a gossip network, the central player hears the novelty first. Closeness, and the consequent time lag, is relevant when the deadlines and lifespan of interorganizational relations are short. Our third measurement of centrality is ‘betweenness’ (ibid.), which is the number of geodesic paths that pass through a node. This relates to the number of ‘times’ that any node needs to reach any other node by the shortest path. In a diffusion process, a node that has higher betweenness can control the flow of information, acting as a gatekeeper. That node may also serve as a liaison between disparate regions of the network. In R&D projects, partners with betweenness might thus have knowledge from different parts of the network and, thus able to integrate from different knowledge sources, obtain higher performance. Organizations in the fuel cell industry have been classified according to their network position during the entire 1999–2006 period. Their likelihood of establishing interorganizational alliances has increased, revealing a higher degree of interest in this specific technological field. Table 13.3 shows the top 10 performers by centrality measures. Most of these organizations, mainly located in the United States, are system integrators or suppliers of components and belong to the electric and industrial apparatus industry (Ballard, FuelCell Energy, Plug Power, Hydrogenics Corporation, Nuvera and Proton Energy Systems). System integrators are clearly key to the development and production stages of this technology – main drivers toward the commercialization of fuel cell technologies. In other words, their position in the network shows that they operate as aggregators of competencies, attracting other organizations through partnership. Moreover, the constant presence of system integrators throughout the whole period of this analysis confirms the relevance of these actors in the formation of the industry. The US Department of Energy is another important organization in terms of centrality measures, and although it entered the fuel cell network only in 2001, it has shown a consistent interest in interorganizational alliances starting from 2003. This organization has promoted partnerships with firms and academia, providing a fundamental

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contribution to overcome the basic technological and economic barriers inevitable at such an early stage of development of an industry. Among this group of top performers, we also count two automotive companies (GM and DaimlerChrysler). Their position in the fuel cell network seems to confirm the commitment of automakers in this technology. Finally, the centrality of a venture capitalist such as Chrysalix Energy shows the importance of investments at this stage of the life cycle of the technology. To sum up, these results provide evidence of the interest that the fuel cell industry might hold for different types of organizations from different sectors.

6

FINAL REMARKS

In this chapter we have adopted a network perspective to explore the fuel cell industry and described the dynamic formation and the longitudinal evolution of strategic alliances among firms. Moreover we used social network analysis to examine the firms’ position in the fuel cell network, focusing on centrality measures. Although our approach is mainly descriptive, we can provide some final remarks. From an industry standpoint, the consolidation of a network of organizations clustering around fuel cells indicates a broad interest in the technology and its market potential. Despite the early stage of its life cycle, companies seem attracted by this very promising technology. The sharp growth in firms involved in alliances over the last decade confirms this attention. Moreover, analyzing the overall tendency, we notice that strategic alliances do not seem to be influenced by rumors and controversial news on the viability of the technology and by the slowdown of market development. Our findings reveal a leading role of North American companies in the network. On the other hand, other studies based on patents have demonstrated that Japanese and South Korean firms lead the rush to fuel cell technology development (Pogutz et al., 2009). We think that this divergence of absolute numbers in alliances is proportional to differences in national GDPs. Furthermore, cultural (for example, attitude toward disclosure of agreements and secrecy of information), organizational (for example, type of governance) and institutional (for example, financial markets) features offer an explanation for this difference. Moreover, this study points out the role of a number of companies, such as Ballard Power Systems, Fuelcells Energy, Plug Power, and Hydrogenics Corporation. These firms occupy a central position in the industry. They seem active in coordinating different organizations and competencies in the network, in order to favor the market development for this technology. The consolidation of the industry, in fact, still requires generous investments and efforts by several players, including institutions, research centers, financial intermediaries, and complementary industries such as oil and gas. Factors that allow a specific firm to occupy a central position are far from being accidental, and the location in the network may provide benefits in terms of performance and competitive advantage. Furthermore, our longitudinal analysis has illustrated that the number of agreements has increased. This affirms that markets are developing, as confirmed by the growth of the number of job orders for fuel cells. On the one hand, our results demonstrate that fuel cells are still at an early stage of the technological trajectory, as firms’ alliances focus

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first on R&D to develop the technology, improve performance, and reduce costs. On the other hand, the focus on supply agreements is also increasing. A key feature in fuel cell markets is now validation of the technology and efficiency of production, as supply agreements are suitable tools to assess and refine the reliability of innovations and increase productivity while reducing costs. To conclude, our study provides a first step in a field of research that demands much more exploration. The fuel cell industry is still at an early stage of its life cycle, with a fluid and dynamic environment. Looking at future research, our study could be coupled with an in-depth analysis of the relation between the fuel cell network and the innovation performance of firms. In other words, drawing attention to patents and R&D investments can be a way to investigate the outcome of the interorganizational strategies that we explored in this study. In more detail, focusing on patents can be a way to provide additional evidence about the performance that alliances and organizations involved in alliances can reveal, while combining their competencies and resources. Moving from an industry to a managerial level, a second stream of research could focus on the examination of the specific resources that companies are seeking through partnerships. The complexity of fuel cell technology and its early stage of development provide an exciting environment to investigate firms’ strategic behavior in the attempt to overcome technological barriers and develop a new market.

REFERENCES Abernathy, W.J. and J.M. Utterback (1978), ‘Patterns of industrial innovation’, Technology Review, 80 (7), 40–47. Adamson, K.-A. (2008), Large Stationary Survey 2009, Fuel Cell Today, available at: http://www.fuelcellto day.com (accessed May 21, 2009). Adamson, K.-A. (2009), Small Stationary Survey 2008, Fuel Cell Today, available at www.fuelcelltoday.com (accessed May 26, 2009). Afuah, A. (2000), ‘How much do your co-opetitors’ capabilities matter in the face of technological change?’, Strategic Management Journal, 21 (3), 397–404. Agnolucci, P. (2009), ‘Early markets for fuel cells: an assessment of their contribution to a future hydrogen economy’, in Pogutz et al. (eds), pp. 152–66. Ahuja, G. (2000), ‘Collaboration networks, structural holes and innovation: a longitudinal study’, Administrative Science Quarterly, 45 (3), 425–55. Arora, A. and A. Gambardella (1990), ‘Complementarity and external linkages: the strategies of the large firms in biotechnology’, Journal of Industrial Economics, 38 (4), 361–79. Borgatti, S.P. and P.C. Foster (2003), ‘The network paradigm in organizational research: a review and typology’, Journal of Management, 29 (6), 991–1013. Borgatti, S.P., M.G. Everett and L.C. Freeman (2002), UCINET for Windows: Software for Social Network Analysis, Harvard, MA: Analytic Technologies. Brown, J.E., C.N. Hendry and P. Harborne (2007), ‘An emerging market in fuel cells? Residential combined heat and power in four countries’, Energy Policy, 35 (4), 2173–86. CEC (2003), Hydrogen Energy and Fuel Cells: A Vision of Our Future, Brussels: Commission of the European Communities. Deeds, D. and C.W.L. Hill (1996), ‘Strategic alliances and the rate of new product development: an empirical study of entrepreneurial biotechnology firms’, Journal of Business Venturing, 11 (1), 41–55. DOE (2002), National Hydrogen Energy Roadmap. Toward a More Secure and Cleaner Energy Future for America, Washington, DC: United States Department of Energy. DOE (2006), Hydrogen Posture Plan. An Integrated Research, Development and Demonstration Plan, Washington, DC: United States Department of Energy. Dyer, J.H. (1996), ‘Specialized supplier networks as a source of competitive advantage: evidence from the auto industry’, Strategic Management Journal, 17 (4), 271–91.

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Freeman, L.C. (1978), ‘Centrality in social networks: I. Conceptual clarification’, Social Networks, 1, 215–39. Gulati, R. (1995), ‘Social structure and alliance formation patterns: a longitudinal analysis’, Administrative Science Quarterly, 40 (4), 619–52. Gulati, R. (1998), ‘Alliances and networks’, Strategic Management Journal, 19 (4), 293–397. Gulati, R., N. Nohria and A. Zaheer (2000), ‘Strategic networks’, Strategic Management Journal, 21 (3), 85–96. Gulati, R. and H. Singh (1998), ‘The architecture of cooperation: managing coordination costs and appropriation concerns in strategic alliances’, Administrative Science Quarterly, 43 (4), 781–814. Hagedoorn, J. (1993), ‘Understanding the rationale of strategic technology partnering: interorganizational modes of cooperation and sectoral differences’, Strategic Management Journal, 14 (5), 371–85. Haleblian, J. and S. Finkelstein (1999), ‘The influence of organizational acquisition experience on acquisition performance: a behavioral learning perspective’, Administrative Science Quarterly, 44 (March), 29–56. Hellman, H.L. and R. van den Hoed (2007), ‘Characterising fuel cell technology: challenges of the commercialisation process’, International Journal of Hydrogen Energy, 32 (3), 305–15. Hoskisson, R.E. and R.A. Johnson (1992), ‘Corporate restructuring and strategic change: the effect of diversification strategy and R&D intensity’, Strategic Management Journal, 13 (8), 46–60. IEA (2008), World Energy Outlook 2008. Executive Summary, Paris: International Energy Agency. Katz, M. and C. Shapiro (1985), ‘Network externalities, competition and compatibility’, American Economic Review, 75 (3), 424–40. Kogut, B. (1988), ‘Joint ventures: theoretical and empirical perspectives’, Strategic Management Journal, 9, 319–32. Kogut, B. (2000), ‘The network as knowledge: generative rules and the emergence of structure’, Strategic Management Journal, 21 (special issue), 405–25. Lambe, C.J. and R.E. Spekman (1997), ‘Alliances, external technology acquisition, and discontinuous technological change’, Journal of Product Innovation Management, 14 (1), 102–16. Lipman, T.E., J.L. Edwards and D.M. Kammen (2004), ‘Fuel cell system economics: comparing the costs of generating power with stationary and motor vehicle pem fuel cell systems’, Energy Policy, 32 (1), 101–25. McDowall, W. and M. Eames (2006), ‘Forecasts, scenarios, visions, backcasts and roadmaps to the hydrogen economy: a review of the hydrogen futures literature’, Energy Policy, 34 (11), 1236–50. MEA (2005), Living Beyond Our Means. Natural Assets and Human Well-Being, Washington, DC: Millennium Ecosystem Assessment. Metz, B. and O. Davidson (eds), Climate Change: Mitigation of Climate Change, Cambridge, UK and New York: Cambridge University Press. Niosi, J. (2003), ‘Alliances are not enough explaining rapid growth in biotechnology firms’, Research Policy, 32 (5), 737–51. Oliver, A.L. (2001), ‘Strategic alliances and the learning life-cycle of biotechnology firms’, Organization Studies, 22 (3), 467–89. Osborn, R. and J. Hagedoorn (1997), ‘The institutionalization and evolutionary dynamics of interorganizational alliances and networks’, Academy of Management Journal, 40, 261–78. Pisano, G.P. (1990), ‘The R&D boundaries of the firm: an empirical analysis’, Administrative Science Quarterly, 35 (1), 153–76. Pogutz, S., A. Russo and P.O. Migliavacca (eds) (2009), Innovation, Markets and Sustainable Energy: The Challenge of Hydrogen and Fuel Cells, Cheltenham, UK and Northampton MA, USA: Edward Elgar. Powell, W.W., K.W. Koput and L. Smith-Doerr (1996), ‘Interorganizational collaboration and the locus of innovation: networks of learning in biotechnology’, Administrative Science Quarterly, 41 (March), 116–45. Simbolotti, G. (2009), ‘The role of hydrogen in our energy future’, in Pogutz et al. (eds), pp. 3–19. Soh, P. and E.B. Roberts (2003), ‘Networks of innovators: a longitudinal perspective’, Research Policy, 32 (1), 1569–88. Solomon, B.D. and A. Banerjee (2006), ‘A global survey of hydrogen energy research, development and policy’, Energy Policy, 34 (7), 781–92. Spedale, S. (2003), ‘Technological discontinuities: is co-operation an option?’, Long Range Planning, 36 (3), 253–68. Stuart, T.E. (1998), ‘Network positions and propensities to collaborate: an investigation of strategic alliance formation in a high-technology industry’, Administrative Science Quarterly, 43 (3), 668–98. Stuart, T.E. (2000), ‘Interorganizational alliances and the performance of firms: a study of growth and innovation rates in a high-technology industry’, Strategic Management Journal, 21 (8), 791–811. Wasserman, S. and K. Faust (1999), Social Network Analysis. Methods and Applications, Cambridge: Cambridge University Press. Williamson, O.E. (1985), The Economic Institution of Capitalism, New York: Free Press.

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14 Challenges of doing market research in the new energy market Roland Abold

1

INTRODUCTION

Following an EU directive, European energy markets are gradually being transformed from monopoly markets into open markets (Matlary, 1996). As the liberalization of the electricity and natural gas markets has filtered down to the consumer level in most European countries since the 1990s, new suppliers and a huge loss of customers for the traditional utilities have changed the market from a supplier into a consumer market. In consequence, energy providers increasingly have to deal with individual consumer profiles and fluctuating buying behaviour. These trends, which are also present on several other markets such as insurance and telecommunications, are now apparent in the energy market. Suppliers must decide whether to focus on price or quality and topics such as environmental protection and sustainability, in order to develop appropriate marketing and communication strategies. The (at least partial) opening of the European markets for power and natural gas has created a growing research area for market researchers and analysts. Initially, customer satisfaction studies as well as market potential and market segmentation studies were the first tools used by a broad range of players in the market (see Kahmann and König, 2000). Now the range of studies conducted in this research field comprises all relevant services relating to customer retention, customer acquisition, identification of new services, product development, price optimization, communication research (testing and measuring the success of communication activities) and strategic brand management. Market research also supports regional sales planning with micro-geographic approaches and other customized studies (see Gohr, 2005). Over the last few years, the energy market itself has changed and new market segments have evolved. Public and political discussions about climate change and (inter)national energy policy as well as new technologies have altered the energy market by creating new products, players and customer segments. For example, the market for renewable energy has grown heavily. In this context, the success of renewable energy sources and its rapid uptake has been attributed to three factors: first, concern over remaining fossilfuel reserves, as well as lowering import dependence and security of supply; second, the concern about environmental pollution; and third, government support and financial incentives (see Held et al., 2006). As a consequence, current energy market research also deals, for example, with water markets, and renewable energy and waste management, in addition to the traditional fields of power, gas and oil supply (see, for example, Jacobsson and Johnson, 2000; Oelmann, 2004). For energy market researchers, these circumstances led to research topics and projects which are highly customized and diverse. Since many standard tools for market research 262

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do not apply in the energy market, modified or new approaches and methodologies have had to be developed. Energy market research needs to deal among others with the specific attributes of the product ‘energy’, the former monopolistic structures in the market, the political regulation, the role of gatekeepers and the limited knowledge of consumers. In this context, this chapter describes the main challenges in doing market research in the energy business, as well as some of the solutions for successful research in this field. Section 2 describes the main challenges for market researchers in the energy sector. After explaining the critical points, Sections 3 and 4 deal with two examples (customer loyalty and market segmentation) of how research can overcome these challenges. The concluding section summarizes the findings and discusses the potential of in-depth market research for the development of the energy business. The arguments and approaches in the text are developed from a practical perspective and can provide some general insight into the daily business of commercial market research in the (new) energy sector. By the end of the chapter, the critical success factors for energy market research should become evident.

2

CHALLENGES OF ENERGY MARKET RESEARCH

Market research in this ‘new energy market’ is confronted by several significant challenges. First, the energy market is divided into several submarkets with different players, behaviours and general circumstances. Researchers creating market segmentations of the power market, for example, need to take into account that this sector consists of two markets: corporate customers (business to business: b2b), who have displayed high switching rates concerning their energy providers since the beginning of liberalization, and private customers (business to customer: b2c), who represent a more loyal customer base for energy providers (for a detailed description of this phenomenon, see Section 3). In general, studies on the research topic ‘energy’ have to deal with several particularities, especially in the b2c sector (see Bier and Schmidtchen, 1997). First, the energy market is a low-involvement market with limited interest and knowledge of private customers. To put it simply, the product ‘power’ has no colour, no taste and no smell. As a consequence the potential for marketing strategies producing differentiating factors between suppliers is very limited. On the other hand, the limited knowledge of consumers about energy leads to buying decisions that are heavily driven by factors beyond pure customer satisfaction (especially brand images of energy companies). Since the public perception of energy companies is mostly dominated by generic issues (‘huge utilities’) and negative emotions (‘that’s a rip-off’) the process of creating a specific brand positioning is quite sophisticated (see Liedtke, 2006). Most consumers are not willing to seek additional information about the market, its products and structures but have a deeprooted suspicicion especially of the big players in the market. In sum: a unique brand positioning is very important but also very hard to accomplish. Second, the low involvement has led to rather slow switching rates for power and natural gas in the past, for example, compared to telecommunications (see Bartle, 2002). In the early telecommunication market liberalization, a significant number of customers switched to new competitors and the market share of the former monopolists began to shrink dramatically. However, in the first eight years after the liberalization of the power

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market only about 6 per cent of German households changed their supplier. The majority of households stayed with the former monopolist and some chose a new special tariff. In particular, the limited possibilities for reducing costs and the (underlying) fears of an interruption of energy supply decelerated the market dynamic. However, since 2007, the situation has changed. With heavily rising prices for power and the market entry of new suppliers, the churn rate for the traditional utilities has reached much higher levels. In addition to new co-brands which were created by the traditional utilities, some independent actors have also entered the market (for example, the company Lichtblick in Germany). The presence of new players also led to a broad range of products and services such as green electricity, price guarantee and combined tariffs for power and natural gas. In effect, customers in Germany and many other European countries are now able to ‘choose’ their supplier, which was not the case a few years ago. Regardless of the fact that the switching rate has changed, the former monopolistic players still have a dominant role in the energy market. Since the main production of power and the transmission of energy are still in the hands of a few main actors, these companies continue to play a significant and special role in the market. Research, therefore has to take into account that most of the suppliers are connected to a larger conglomerate or cooperative to a greater or lesser extent. Many regional or local utilities belong at least in part to the big players in the market. Also mergers and acquisitions are changing the market situation on a regular basis (for example, the acquisition of Nuon by Vattenfall in early 2009). Against this background, research always has to include the market context in which brand strategies should be created or product potentials calculated. Further challenges stem from the general fact that research on new and innovative products in a politically restricted but also heavily changing market is not comparable to studies, for example, in saturated fast-moving consumer goods (FMCG) markets. In particular, research projects on energy efficiency or renewable energy (for example, market potential studies for photovoltaic systems or product development studies for energy-efficient technologies) depend on comprehensive background data and intense secondary research about new or upcoming regulatory requirements or changing circumstances for government incentives and payments (for example, renewable energy feed-in tariffs). Also the role of intermediaries is an important factor, for example, when it comes to the estimation of market opportunities in the sector of innovative heating systems (for example, fuel cells, heat pumps). After government decision makers and public opinion leaders, installers as well as architects and energy consultants play an important role for the success of new technologies. To ascertain the opinion of these special target groups – which are difficult to find and to recruit for a market research project – panel studies (for example, with installers) have been set up. These give market insights and can show new trends in markets over time. At a glance, the energy market is a complex and rapidly changing market. Researchers have to take into account such factors as the role of all kinds of players, the changing legal and political situation and the needs of small start-ups as well as huge multinational companies. Researchers and consultants in this area need not only classical skills in marketing and market research methods but also profound know-how about the processes and actors in the energy market. Over the last 10 years of liberalization many insights have been gained by intense

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research in this field. Methods have been adapted successfully and strategies found to deal effectively with the particularities of the energy market. In this chapter, it is not possible to deal with every kind of achievement in depth. Therefore, the following sections describe two main research areas – customer loyalty measurement and market segmentation. These two fields of research can stand as examples for the highly customized approaches established by market researchers to fit the needs of customers in this market. The information and approaches are mainly taken from research projects in the private household segment, but can also be transferred and adapted to b2b studies.

3

CUSTOMER LOYALTY IN A LOW-INVOLVEMENT MARKET

As mentioned above, energy as a product has some particularities which lead to at least four main challenges in the set-up process of customer satisfaction research and the use of customer loyalty systems. First, power and natural gas as commodities offer very limited possibilities for suppliers to create a unique selling proposition (USP) in the market. Whereas in other markets relevant customer touch points can be identified easily, energy consumption is a low-involvement situation, not comparable to, for example, driving a car. Second, this low-involvement situation can be disturbed by high-involvement incidents, for example a ‘black-out’ or the gas crisis between Russia and the Ukraine. Since energy is one of the main drivers of our economy and our everyday life, a situation where the delivery of power is interrupted or the imports of gas may be endangered is perceived as critical. Thus, the basic factor for a healthy supplier–customer relationship (security of supply) is highly critical and cannot be used in marketing efforts. On the other hand, key drivers which effectively promote customer loyalty and can be strategically used to optimize the marketing activities of an energy company are hard to find. At this point there are some parallels to the insurance market, where most customers are by and large not very interested. In the event of a car accident, customer involvement rises heavily and then drops away again after the case is resolved. Third, customer satisfaction in the energy market heavily depends on customers’ perceptions of energy prices. Public discussions and media reports about climbing costs and energy companies trying to ‘squeeze’ their customers with excessive prices have affected the price perception negatively. Since many new competitors have entered the markets, suppliers can only achieve customer loyalty by offering additional value to their customers (for example, energy-related services, tools for energy saving and energy efficiency and so on). Fourth, the limited knowledge of private customers gives rise to perceptions and decisions concerning the purchase of energy which are not totally based on facts. Most consumers have only a very limited willingness to deal with questions of energy supply, tariff models and cost calculations. Hence, the creation of brand images and positioning can be an appropriate way for players in the market to attract old and new customers. In effect, the budget for advertising spending in the German energy market has more than doubled between 2006 and 2008. Furthermore, sponsoring sports or cultural/ social events and other activities (for example, public relations) become increasingly

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20.5

Electricity Gas 11.0 10.2 Per cent of households

4.3

7.0 4.6

8.0

6.8

4.8

3.7 1.6

2.1 0.4

1999

Source:

2000

2001

2002

2003

2004

2005

2006

1.0

2007

2008

2009

German Energy and Water Association (www.bdew.de).

Figure 14.1

Accumulated switching quota in the electricity/gas market, Germany 2002–2009

important ways to strengthen the ties with existing consumers and to attract new market potentials. Figure 14.1 shows the accumulated switching quota in the electricity and gas markets in Germany between 2002 and 2008. With the market entry of new competitors, customer loyalty in the market has dropped significantly while churn rates are growing rapidly. Today most energy companies deal with this fact and measure customer satisfaction and loyalty over time. Many suppliers have established early-warning systems in order to prevent future customer losses or to identify competitors with unsatisfied customers which can be targeted by marketing efforts. Models for customer loyalty in the energy market normally try to estimate future customer behaviour (for example, by a measured loyalty value or index) and explain it using several independent variables. Here the relevant ‘customer touchpoints’ for the energy market must be taken into account. They range from invoicing, pricing and product portfolio to customer communication by call centre, website and mailings. In other markets or industries, market researchers try to explain loyalty by using a model which is based solely on consumer satisfaction. Hence, measured values for customer satisfaction in all relevant touchpoints are the main explaining variables. Since perceptions in the energy market are heavily driven by factors beyond customer satisfaction, these models are not applicable. In order to explain customer behaviour in this market, emotional variables and brand image perceptions also have to be taken into account (see Figure 14.2). Empirical results over time show that brand image and the perception of prices are the dominating key drivers for customer loyalty in the b2c market. Many suppliers try to influence image factors by advertising and other marketing strategies. In contrast, customer satisfaction with price levels (for example, for power and natural gas) can be

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Challenges of doing market research in the new energy market Relevant set of alternative suppliers

Customer service

Brand perception own supplier

Products and services

Figure 14.2

267

Price perceptions

Customer Loyalty

Security of supply

Explaining variables for customer loyalty in the energy market

increased only marginally. In general, the low level of information in the market has important consequences for the role of price in customers’ decisions. If customers find it difficult to assess a fair price because they lack experience, it is plausible that prices may be less important in the market. This was true for the first years after liberalization. However, when new entrants entered the market with an aggressive price policy, the importance of price increased dramatically, although opportunities for large discounts for utilitarian goods such as energy are generally minimal. The massive advertising activities of new competitors (for example, E-WIE-EINFACH in Germany) as well as the public discussions about ‘exorbitant prices’ for energy made consumers realize that they are paying too much. Today, the willingness to pay for commodities such as energy is generally very low. In this context, energy companies have problems changing the cost/performance ratio, because only the ‘performance’ term can be changed significantly in the customers’ perception. Here the product portfolio and the area of customer information and communication are quite important factors. Since the beginning of energy market liberalization, nearly all utilities tried to optimize their customer service levels. Call centres were modernized, service websites were set up and invoices were simplified. At first, these improvements led to somewhat higher satisfaction levels and, therefore, more loyal customers. But like in other liberalized markets (for example, telecommunications) customers are getting more and more demanding and high service levels have become ‘normal’. In effect, new empirical results show that a high level of customer service has become a ‘must-have’ for customers in the energy market. New products and services offering additional value to the consumer have to be found. Since consumers are becoming more and more heterogeneous, different customer segments need customized products with additional values that fit their needs. Here, market research can provide insights by using product optimization studies as well as customer segmentation projects (see Section 4). As mentioned above, security of supply is the most important must-have factor in the energy market. This means that suppliers cannot gain customer loyalty with high levels of satisfaction in this area. For example, an advertising campaign for a natural gas supplier which cites safety issues of gas transmission as a central theme merely gives rise to fear and negative perceptions of this energy source (for example, gas explosions). On the other hand, real problems with the must-have factor ‘security of supply’ (for example,

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blackouts) may lead to disloyalty very quickly. Hence, customer perceptions concerning these factors need to be addressed in order to detect or better prevent upcoming customer churn. Customer switching (or churn), which is the opposite of customer loyalty, has been studied extensively in market research. As noted previously, liberalized markets have some special characteristics, including the feature that customers could not switch in the past but were forced to stay with the monopolist. Today, households can change to new suppliers in the market, but several important issues complicate this switching decision (see Wieringa and Verhoef, 2007). First, customers in general are familiar only with the former monopolist. Through their experiences with this utility over time, they know what to expect, but have little knowledge of or even to some extent fear the new players in the market. Second, customers in a liberalizing market are not used to switching their supplier. Prior to liberalization, customers had no opportunity to switch to another company, so their inexperience may give rise to habitual behaviour (that is, they will stay with the old supplier) more common. Third, monopolistic suppliers have built long-term relationships with their customers, which promote loyalty and trust. Studies dealing with the change of energy suppliers on a quantitative base normally indicate that satisfied customers are less likely to display switching intentions. So the standard conclusion would be simply to keep all customers satisfied, for example by ongoing customer relationship management (CRM) activities. In reality, churn in the energy market is quite a challenging process. Especially with qualitative studies such as focus groups, the various sequences of churn can be observed in depth. The results show clearly that there are different types of ‘changers’ with different motives. Above all, it can be shown that switching the supplier is a two-step process with a first decision to leave the old supplier. Accordingly, for most unsatisfied customers the primary reason to switch is to get away from their traditional utility. The second step is the search for a new supplier. Here most of the customers refer to price as well as environmental issues as explaining factors for their choice. Specific conjoint models for consumer choices in the power market have shown that after price issues, the power mix (green versus grey power) and regional aspects of power production are also important (see Burkhalter et al., 2009). In particular, the internet has affected the churn rate for energy suppliers significantly. Internet portals which compare different energy providers and calculate the best tariff (such as verivox.de or e-control.at) lower the barriers to switch to another supplier and can be seen as a main force for the rapidly growing churn rate. Today it takes about 10 minutes to switch the power supplier on the internet. Since more and more people have experienced the process to be easy and without any risk, switching the energy supplier has become a normal option for consumers in many European countries (Figure 14.3). All the factors mentioned can be included in an early-warning system by analysing the driving factors for churn. Since most traditional utilities measure customer loyalty over time by using their CRM database, it is possible to locate customers who were interviewed at one point in time and left the supplier at another. Further analysis of these changers (for example, by logistic regression models) can give insights into the most significant trigger of churn. It also allows market research to design scores for a churn probability which can be included in the customer database. Within this process, data security has a high priority. For the customers who where analysed in the first step,

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Low involvement

Figure 14.3

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Selection process

Decision to switch (high involvement)

Choice of new supplier

Process of switching the energy supplier

the churn score already exists. For all other customers the score can be calculated, for example, by using methods of data fusion (with variables which are both in the study and in the database). An empirically generated churn score or other forms of customer loyalty segmentation help utilities to focus on the customers with a high switching risk and start appropriate marketing measures to prevent them from changing. Since customers in the energy market are not homogeneous, one main question is how to find the right strategy for different segments. The following section discusses an approach which has been tested successfully in the German market.

4

MARKETING EFFICIENCY IN A HIGHLY FRAGMENTED MARKET

Energy suppliers (in the markets for power, natural gas and gasoline) as well as other companies in the energy business (producers of photovoltaic modules or heating systems) need to face the challenge of identifying their customers’ needs and attitudes in order to perform effective sales activities and improve customer relationships. Due to very different concepts of life, values and intentions of the modern consumer, classical demographic target group analysis and one-dimensional target group models are too limited to create successful marketing strategies focused on customer needs. This leads to fundamental mission statements for the marketing process in energy companies: market positioning only works through focusing on certain target groups as well as through a diversification of products and services to gain future customers and secure long-term market success. Against this background, marketing and market research has to find strategies to identify specific target groups which have the following features: differentiation, that is, homogeneous within the segment and as different as possible from each other; accessibility, that is, they can be described and identified clearly; tangibility, that is, not just theoretically possible, but actually existing in the market; stability, that is, sustainable in the long-term perspective; and substance, that is, building on all relevant attitudes, requirements. In order to meet the demands of their customers, market research companies invented segmentation tools that have been validated across markets and countries. For the energy market, GfK Energy Mentalities are one approach to achieve a segmentation

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Handbook of research on energy entrepreneurship Need: to have materialism, price orientation Homebodies

Adventurers

Open-minded

Settled

Rational-realists

Organics

Need: peace and security puritanism, security orientation

Need: to live a passionate life hedonism, pleasure

Dreamers

Demanding

Need: to be postmaterialism, quality orientation Source:

Copyright Gfk SE, Lifestyle Research 2009.

Figure 14.4

Consumer segmentation (GfK RCS)

of this special market based on an international validated lifestyle typology – the GfK Roper Consumer Styles® (RCS) (see Enke et al., 2005). The RCS lifestyle map (Figure 14.4) distinguishes customers in b2c markets by means of the two poles materialism–postmaterialism and hedonism–puritanism and consists of eight segments. A GfK study carried out in 2007/08 in 31 countries has shown that irrespective of different national consumer and social groups, the same basic value systems and consumer habits can be found across the globe. Therefore, each of the segments can be found in every country. Mentality-based differences between countries and regions are reflected in the varying sizes of the relevant target groups. The instrument is also validated for the energy market and represents market-specific parameters for topics such as price sensitivity, willingness to switch the provider or renewable energies. Thus, differentiated structures of needs concerning energy supply and perception of energy providers can be taken into consideration. An empirical test carried out by Energy Mentalities in summer 2008 with about 5,000 German households showed clearly that the relevance of brands in the deregulated energy market has increased considerably (see Abold, 2008). In the new energy market, customers base their decisions on brands and brand promises. According to the results of this GfK study, different target groups choose suppliers that are positioned due to their requirements and needs (See Figure 14.5). For example, energy consumers choosing a supplier with a clear ecological positioning (Provider 2) can be found five times as often in the segment ‘organics’ as in all other segments.

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Need: to have materialism, price orientation Dreamers

Homebodies

provider 3

Adventurers

Rational-realists

provider 2

provider 2 Open-minded

Need: peace and security puritanism, security orientation

Need: to live a passionate life hedonism, pleasure

provider 2

Settled

provider 1 Organics

Demanding

Need: to be postmaterialism, quality orientation Source:

Copyright Gfk SE, Lifestyle Research 2009.

Figure 14.5

GfK Energy Mentalities: application in the energy market

With market segmentations such as the GfK Energy Mentalities, utilities and suppliers have the opportunity to adapt appropriately to the changed market conditions. With the help of market research, homogeneous subgroups can be identified on the basis of the segment-specific requirements, attitudes and behaviour of the relevant target group, at which future marketing activities can then be directed. Market research projects in this field normally have three fundamental steps. In a quantitative segmentation study customers of the specific suppliers as well as customers of relevant competitors are interviewed. The questionnaire deals with several statements concerning energy, interests, activities and fundamental attitudes and needs. In a second step, the results are clustered according to a multivariate approach (using factor and cluster analysis). After the segmentation process, the shares of the eight Energy Mentalities in the customer database can be calculated. Here the current positioning of the supplier can be analysed by describing the different subgroups and their characteristics. Using the results of the target group analysis it is possible to gain a small set of variables (for example, through a discriminance analysis) which best identify the different segments. This variable set can be included in all kinds of future market research studies of the supplier to implement the segmentation in other contexts. For an optimal use of the segmentation in the marketing process the target groups can be implemented in the customer database in a third step. The final outcome of this procedure is the segmentation of the whole database. Ultimately, every customer should be connected to one of the segments. Within this process, data security also has

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a high priority. For market researchers in most European countries it is forbidden to deliver personalized individual datasets to their customers. To deal with the rules of data security the process of database implementation is monitored very strictly. For the customers who were interviewed in the first step and in other studies including the described variable set, the segment variable already exists. All other customers can be segmented either by using methods of data fusion (with variables which are both in the study and in the database) or by external micro-geographic databases. The connection of segment variables with customers in the database hereby follows the principle of the highest probability. A segmented CRM database allows suppliers to address their customers with mailings and products according to their interests and needs. Through the connection to pre-existing data sources which are linked to the Energy Mentalities, other information (for example, media use, consumer behaviour in other markets) can be used to optimize the marketing process in terms of efficiency and effectiveness. In effect, energy suppliers can communicate to specific target groups without bothering all other customers. Better products can be created and offered to the consumers. Advertising, sales material or customer magazines can be designed according to the interests and design preferences of the focused target groups. In sum, traditional utilities have to overcome their overall focus of trying to achieve loyal customers with large-scale one-dimensional strategies. In the new energy market successful market positioning works only through focusing certain target groups as well as through diversification of products, services and designations. Through market segmentation, market research has a powerful tool to implement these new strategies.

5

CONCLUSION

The liberalized energy market with its special characteristics presents some significant challenges for market researchers. As in every new field, some existing tools and approaches work satisfactorily while others do not. Researchers have to check carefully which is the best method to solve the research questions of their clients or organizations. The examples of customer loyalty tracking and early-warning systems as well as consumer segmentation are just two of the many research fields in this area. With the opening of several European markets and the growing demand for technologies using renewable energies and intelligent energy infrastructure, the demand for deep market insights has also grown significantly. The experiences of commercial research institutions over the last 10 years show that customized projects and studies together with profound market know-how are the two main success factors. In liberalized markets the search for new insights and opportunities is important for old as well as for new players. Since the market is affected by political decision making and is changing rapidly by internal market processes, the need for reliable information is enormous. On the one hand, former monopolistic energy companies have to face new competitors, changing customer demands and realigning market potentials. On the other, new players need knowledge about market structures and processes as well as estimations concerning future chances and opportunities. Aimed with this information, market researchers and their research-based consultants

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can give energy companies the wherewithall to adapt appropriately to the changed market conditions.

REFERENCES Abold, Roland (2008), ‘Zielgruppenoptimierung im liberalisierten Energiemarkt’, planung&analyse, 6, 22–6. Bartle, Ian (2002), ‘When institutions no longer matter: reform of telecommunications and electricity in Germany, France and Britain’, Journal of Public Policy, 22, 1–27. Bier, Christoph and Dieter Schmidtchen (1997), ‘Liberalisierte Strommärkte: strategische Herausforderung für die Unternehmen und Konsequenzen für die Verbraucher’, Tübingen: Mohr Siebeck. Burkhalter, Andreas, Josef Känzig and Rolf Wüstenhagen (2009), ‘Kundenpräferenzen für leistungsrelevante Attribute von Stromprodukten’, Zeitschrift für Energiewirtschaft, 33 (2), 161–72. Enke, M., A. Geigenmüller, M. Hauck and T. Peichl (2005), ‘Consumer behaviour in a newer, larger Europe’, planung&analyse, special English edn, 28–32. Gohr, Steffanie (2005), ‘Energiemarketing: Volle Kraft voraus?’, Direkt Marketing, 8, 44–8. Held, A., R. Haas and M. Ragwitz (2006), ‘On the success of policy strategies for the promotion of electricity from renewable energy sources in the EU’, Energy and Environment, 17 (6), 849–68. Jacobsson, Steffan and Anna Johnson (2000), ‘The diffusion of renewable energy technology: an analytical framework and key issues for research’, Energy Policy, 28 (9), 625–40. Kahmann, M. and S. König (2000), Wettbewerb im liberalisierten Strommarkt, Regeln und Techniken, Berlin: Springer. Liedtke, Rüdiger (2006), Das Energie-Kartell – Das lukrative Geschäft mit Strom, Gas und Wasser, Frankfurt/ Main: Eichborn. Matlary, Janne Haaland (1996), ‘Energy policy: from a national to a European framework?’, in Helen Wallace and William Wallace (eds), Policy-Making in the European Union, Oxford: Oxford University Press, pp. 257–77. Oelmann, M. (2004), ‘Concepts of competition for the German water and sewage sector: what is the most suitable approach?’, Zeitschrift für Wirtschaftspolitik, 53 (2), 203–27. Wieringa, Jaap E. and Peter C. Verhoef (2007), ‘Understanding customer switching behavior in a liberalizing service market: an exploratory study’, Journal of Service Research, 10, 174–86.

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15 Path dependence, path creation and creative destruction in the evolution of energy systems Raimo Lovio, Per Mickwitz and Eva Heiskanen*

1

INTRODUCTION

Why is it difficult to reorganize our energy system fundamentally, even though the need is today evident to almost everyone? The three combined challenges that most societies face with regard to their energy systems are: sustainability, climate change in particular, security of energy supply and competitiveness. For Europe these goals are addressed in the ‘20 20 by 2020’ initiative (COM 2008/30), but also in the Second Strategic Energy Review (COM 2008/781): reducing greenhouse gas emissions by 20 per cent, increasing the share of renewable energy to 20 per cent and improving energy efficiency by 20 per cent, all by 2020. We address the challenge of reorganizing energy systems by examining the role of path dependence, path creation and creative destruction in the evolution of energy systems. These concepts set the stage for examining the role of different innovation mechanisms and actors – such as new entrepreneurial and incumbent large firms, policy-induced innovations and civic or consumer activism – in the transformation of energy systems. Path dependence is a popular concept in evolutionary economics (David, 1985; Arthur, 1989), but it is also used in anthropology, history and management (Hirsch and Gillespie, 2001), and increasingly also in political science (Pierson, 2004). As it has become more widespread, the use of the concept has widened. In a broad sense, path dependence refers to the fact that ‘history matters’: prior choices place limits on what can be done today. This is because a certain technology becomes dominant – sometimes even due to a very small advantage or random events at an initial stage – and starts to generate increasing returns. It is difficult for new technologies, even if they hold large future potential, to compete with the dominant technology. Path creation is a newer concept, which refers to the active role of entrepreneurs in shaping technological paths by setting in motion processes that actively shape emerging social practices and technologies (Garud and Karnøe, 2001; Garud et al., 2010). This is done by ‘mindfully deviating’ from existing structures to modify the existing path through collective action. Garud and Karnøe (2001) thus argue that old path dependencies can be overcome, and new technological paths can be created by entrepreneurs who disembed themselves from the existing structures. The evolution of technologies and industries can be described as a battle between the old and the new, that is, between the path-dependence forces of the old path and the attempt to create new paths. Path dependence and path creation are thus competing processes in times of technological transition. In this chapter we utilize Schumpeter’s (1942) old notion of creative destruction to provide a comprehensive framework for the analysis of path dependence and path creation phenomena and their relations to 274

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each other. We demonstrate that it is fruitful to analyse the evolution of technologies and technological transitions as creative destructions with a special focus on the relative strength of old (that is, path dependence) and new (that is, path creation) systems in various phases during the transition process. As argued by Geels (2007), destabilization of the old technological system may be the key to a transition towards a new system. In addition, the Schumpeterian vision of creative destruction introduces a historical perspective and allows for some ‘change optimism’ arguing that even deeply entrenched technological paradigms eventually run into inimical problems. The use of fuel oil as an energy source is a good example of this: the more successful it has become and the more it is used, the closer the day comes when we need to disengage with it. Hirsch and Gillespie (2001), Sydow et al. (2005) and Stroebel and Duschek (2007) have examined similar processes of path emergence/creation, path maintenance/extension and path dissolution/deviation from the perspective of new entrepreneurs and incumbent firms. Here, we add the macro perspective of the policy maker to examine how policies can encourage and support the opening of new paths in energy systems. Furthermore, we take into account that the users of technologies have proved to be important innovators in many areas (von Hippel, 2005) and many forms of civic action such as environmental movements may play a catalytic role in transitions. Schumpeter viewed innovation as totally a company business, but today we know that there is more variance in possible innovation mechanisms. This chapter constructs an analytical framework for analysing technological transitions by combining the concepts of path dependence and path creation (Section 2) under the umbrella of creative destruction (Section 3), with a major focus on the relative strength of various forces of change and stability. We construct an analytical framework that includes as innovators policy makers, civil society and the users of technologies, in addition to business companies (Section 4). We then apply this analytical framework to examine the evolution of oil dependence in Finland (Section 5). Section 6 concludes.

2

PATH DEPENDENCE AND PATH CREATION IN ENERGY SYSTEMS

The Theory of Path Dependence Bottom-up engineering models have long shown low cost or even negative costs for existing energy saving or low carbon technologies. The most quoted technology-based cost curves in recent years are those produced by McKinsey (Enkvist et al., 2007; McKinsey, 2009). McKinsey’s calculations indicate that there are tens of technologies with negative costs available, including switching to LED lighting, isolation retrofit and electricity from landfill gas. At the same time macroeconomic top-down economic models are used to argue that these technologies are not cost saving when total costs are considered. One important explanation is lock-in created through path dependence. Path dependence at a general level has been used to imply that ‘history matters’, for example Sewell (1996, 262–3) uses it to mean ‘that what happened at an earlier point in time will affect the possible outcomes of a sequence of events occurring at a later point in time’. Path dependence can, however, also be defined more specifically and the

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literature is full of related but different definitions. Pierson (2004, 20) uses the definition ‘path dependence refers to dynamic processes involving positive feedback, which generate multiple possible outcomes depending on the particular sequence in which events unfold’, while North (2005, 52) states that path dependence ‘is the constraints on the choice set in the present that are derived from historical experiences of the past’. In pathdependent systems there is not just one end state (equilibrium) towards which the system must evolve; instead there are many possibilities and history, and even small events become crucial for the actual development of the system (Arthur, 1989). Although path dependence can be used to study a wide range of phenomena, it emerged in economics to describe technology choice; why is a particular technology dominant when a similar or even superior technology is also available (David, 1985; Arthur, 1989)? The most quoted, but also contested, example is the widespread use of the QWERTY keyboard, even though the Dvorak keyboard would be more efficient (David, 1985). Path dependency is not just about individual technologies; it also concerns technological systems or regimes (Unruh, 2000). Path dependency has been expanded from technologies to concern institutions and organizations, as well as belief systems and ideas (North, 2005). A crucial aspect of path dependence is positive feedback or self-reinforcement. The mechanism of positive feedback within markets, businesses and industries is increasing returns (Arthur, 1996). Increasing returns imply that profits rise when production increases, profiting those ahead and aggravating those companies, technologies or products trying to catch up. Arthur (1994) has argued that there are four major reasons for increasing returns of a technology: (i) large set-up or fixed costs, which are barriers to entry, but also imply that average costs decrease when volumes increase; (ii) learning effects, that is, knowledge from experiences with a technology results in increased returns from continuing to use it; (iii) coordination effects, which imply that the benefits for one user increase when others use the same technology, in other words there are positive network externalities; and (iv) adaptive expectations, which are self-fulfilling expectations that widespread technologies will generate coordination effects. Systems with increasing returns are characterized by lack of predictability, because small events can have such a huge influence, lack of flexibility, they are not ergodic and they are not necessarily path efficient (Arthur, 1989). David (2007a, 123) uses the term ‘path dependence’, to refer to ‘a dynamic property of allocative processes’. It can be defined based on the relationship between the process dynamics and the outcome(s) to which it converges, but it can also be defined based on the limiting probability distribution of the stochastic process under consideration. David (2007a) provides both a negative and a positive definition of path dependence. The negative definition is that ‘Processes that are non-ergodic, and thus unable to shake free of their history, are said to yield path dependent outcomes’ (p. 124). The dynamics of an ergodic process guarantees that it converges to a unique globally stable equilibrium configuration regardless of its initial state. For a stochastic system this would imply that, ‘the eventual limit of the convergent process will be an invariant (stationary) asymptotic probability distribution that is continuous over the entire feasible space of outcomes’ (David, 2007b, 7). The positive definition is that ‘A path dependent stochastic process is one whose asymptotic distribution evolves as a consequence (function) of the process’s own history’ (David, 2007a, 125). David (2007a) has pointed out that ‘market failures’ do not automatically follow

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from path dependence. First, market failures were actually discussed much earlier than path dependence, even in the context of stationary economic models. Second, not all path-dependent systems must theoretically result in market failures. But in general ‘most of the interest in path dependence results from the possibilities that sub-optimal equilibria will be “selected” by a dynamic process’ (ibid., 130) and this is precisely why path dependence is important in the context of energy systems. Path Dependence in Energy Systems Many of the prime examples of path dependence are from the energy field. Arthur (1989) uses the examples that nuclear power could be light-water, gas-cooled, heavy-water or sodium-cooled reactors, but in the US it is totally dominated by light-water reactors. He also uses the examples of the option to use crystalline-silicon or amorphous-silicon technologies for solar energy production and the steam versus petrol car engine competition in the 1890s. Energy systems, not just individual technologies, are largely characterized by path dependence – decisions taken in the past limit the options available today. Current production, emissions and costs are dependent on investments made years or decades ago (Lafferty and Ruud, 2008). The same applies to consumption of energy by industry and households. This is by now both well established and largely discussed especially in the context of carbon lock-in (for example, Unruh, 2000, 2002). In this section we first approach path dependence through the self-reinforcing mechanisms of energy technologies examined by Arthur (1994). We then discuss it in the context of energy systems, central institutions and organizations in the energy field as well as belief systems and ideas about energy production and use. Many types of energy production require large set-up or fixed costs, the most extreme example is nuclear power, but other forms of power generation such as coal or hydro plants are also expensive to build. Typical for energy plants, however, is that the production volumes are restricted by either the fixed technological capacity of the plant or outside factors, such as the water available due to rainfall. Fixed costs are more clearly barriers to entry in the case of the grid or the distribution network of fuels. Learning effects from experiences gained through the use of energy technology are well established (for example, McDonald and Schrattenholzer, 2001). Calculations of experience curves have established that production costs are clearly reduced when production volumes increase and experiences are gained (Neij, 1999). The cost of large, non-modular technologies or plants, for example, coal, nuclear or hydroelectric power plants, tends to decrease more slowly than the cost of small, modular products, such as wind turbines or photovoltaic modules. This has been said to be due to the greater opportunities to improve technology and cut costs in the production of small, modular products than huge plants. Neij (1997) showed that for each doubling of the production of wind turbines, the cost per kilowatt produced was reduced by 4 per cent. Since this figure does not take into account the experiences gained in wind capture, the total earning for windgenerated electricity is even greater. It is obvious that there are a lot of coordination effects related to the production as well as the use of energy. Unruh (2000) defines three important sources of network effects in energy systems: industry and inter-industry forces of coordination such as standards;

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private mechanisms based on financing development and diffusion; and networks based on education and institutions and associations. The car-based mobility system depends on industry and inter-industry networks related to the production and the use of cars, roads and other components of the system. Building cars is dependent on specific supplies of rubber, glass and petroleum, while constructing roads is dependent on asphalt, concrete and specific machinery. The use of cars and roads is supported by services such as gas stations, motels and drive-in restaurants. According to Romm (2006, 2610) the largest barrier to the adoption of alternative fuels for road transport is ‘the chicken and egg problem – who will build and buy the AFVs [alternative fuel vehicles] if a fueling infrastructure is not in place and who will build the fueling infrastructure before the AFVs are built’. Interconnected industry networks are often coordinated through standards, such as 220 V for energy using products or fuel standards for cars and petrol using machinery. Most investments are financed through a firm’s internal cash flows and will thus tend to strengthen established systems. Similarly it is easier to obtain loans for established firms in established networks. The final coordination effect in the energy sector is through formal and informal associations and organizations. In the car industry, these include departments of electrical or automobile engineering at universities and automobile manufacturers’ associations (Unruh, 2000). Due to the large uncertainties in which technologies will be the ‘winners’ in new climate-constrained energy systems, adaptive expectations play a large role in the adoption and market penetration of new energy technologies. As certain technologies start to penetrate the market, users’ uncertainty is reduced as they gain experience in the quality, performance and price stability of new solutions (Foxon, 2007). Network effects also have a role in the adoption process: network benefits grow as an increasing number of users adopt the technology. Fuelling stations for alternative fuels are an obvious example of this. Thus, the competition to be the ‘winner’ also involves self-fulfilling expectations on the users’ side that support the coordination effects of widespread technologies. New energy entrepreneurs need to convince users that their new technology will be one of the ‘winners’. For example, an entrepreneur selling electric cars would have to generate expectations of a growing market in order for consumers to believe that there is a market for used electric cars (Borup et al., 2006). Path dependence concerns not only technology but also ideas and practices in the energy field (Garud and Karnøe, 2001; Smith et al., 2005; van der Vleuten and Raven, 2006). The energy system does not function independently; it is linked to many other systems such as the mobility, the innovation and the industrial systems that use and produce energy. These systems are affected by many different policies, for example, related to energy, innovation, environment and competition. In public administration, horizontal coordination between policies and vertical implementation of key objectives are central challenges (Peters, 2006). Therefore, the interaction between energy and other systems is crucial for the rate of change in energy systems. Path Creation: The Active Role of Distributed and Embedded Entrepreneurs Path dependence is a powerful force in energy systems, but many authors have since tried to specify this process and explore the role of human agency in the creation of pathdependent systems (Garud and Karnøe, 2001). A potential role for agency can be derived

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from the origins of path dependence. According to Lampel (2001), if small events during the early phase of a technology can have a disproportionate impact on its subsequent development (path dependence as a progressive amplification of an early differential advantage), then surely entrepreneurs can actively work to bring about such events? Path creation refers to the active role of entrepreneurs in shaping technological paths by setting in motion processes that actively shape emerging social practices and technologies (Garud and Karnøe, 2001). The notion suggests a reflexive role for entrepreneurs (Sydow et al., 2005; Strobel and Duschek, 2007): entrepreneurs can recognize the factors creating dependency on the currently dominant path, and take action to ‘mindfully deviate’ from existing structures (Garud and Karnøe, 2001). This means that entrepreneurs do not conceive of their technologies as neutral, but understand that they are socially and historically embedded. They thus see the need to create not only new solutions, but also new contexts in which these solutions ‘make sense’. The notion of path creation, however, does not emphasize the role of a lone, heroic entrepreneur – a perspective on innovation that has been criticized in much of the current history of technology. Rather, path creation stresses the role of collective action. Garud and Karnøe (ibid., 14) acknowledge that ‘most deviations are met with apathy at best and resistance at worst’. They stress the need for ‘boundary spanning’ and ‘generating momentum’ in path creation processes. Boundary spanning refers to the ability to translate the emerging innovation in a way that makes sense to and captures the interests of outsiders. Generating momentum refers to consecutive tests of the idea with critical feedback from outsiders. Path creation thus suggests a gradual but mindful management of a coevolutionary process involving the mobilization of diverse sets of objects and people. Garud and Karnøe also stress that not all would-be path creation processes succeed. Indeed, innovation is fraught with risks, and these risks are amplified by the involvement of outsiders. They can either dampen the would-be path through their resistance, or encourage it to spiral out of the entrepreneur’s control. Without outsiders, however, there can be no innovation. Thus, Garud and Karnøe stress that navigating these risks requires social skills to present and modify ideas in order to create a shared collective space. Path creation thus emphasizes agency, but an agency that is reflexive and distributed across heterogeneous actors. As actors become involved in a new technology, they generate inputs that result in the transformation of an emerging technological path (Garud and Karnøe, 2003). The steady accumulation of inputs to a technological path generates a momentum that enables and constrains the activities of distributed actors. This embeddedness is exactly what enables entrepreneurs to create new paths, and not merely individual deviations from an existing path. Entrepreneurship in Energy Systems: From Path Dependence to Path Creation Taking into account the path dependences and their specific foundations gives businesses and entrepreneurs two fundamentally different strategic options: either they may make business based on incremental innovations within a given path or they may attempt to break the lock-in. Sydow et al. (2005) call these ‘path extension’ versus ‘path creation’. The latter strategy is clearly a high-risk but potentially a very high-reward strategy. For a potential entrepreneur embedded in the existing dominant path and its beliefs, it may be difficult to envisage a future that is different from the present (Garud and

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Karnøe, 2001). Incumbent energy companies are likely to invest in paths that balance between the external pressures to reduce carbon emissions while conforming to existing technological paths and sunk costs in infrastructure (Stroebel and Duschek, 2007). While a strategy built around the dominating energy paths might seem like a low-risk strategy, this is not necessarily the case. If, or rather when, the path is broken (see next section for details) due to, for example, innovation or policy, firms and subnetworks that are dependent on the old system will be in serious trouble. For example, vehicle parts that can only be used in heavy and large cars will be in less demand when tighter emission regulations enter into force. The energy market is not likely to have any silver bullet, that is, a single technology that would solve all the problems; it is more likely that several technologies will be used in parallel (for example, IEA, 2008). In this sense, production of heat and power differs from, for example, the car industry, where one technology – the combustion engine – has long dominated the market, even though the situation may change in coming decades. At the same time, energy production is changing and new energy technology is more hightech and knowledge-based than previously, making it possible that research and development (R&D) may result in discontinuous improvements giving a technology or a firm a temporary superior position. In such cases management should become more mission oriented instead of production oriented and the organization should be less hierarchical with smaller and more independent teams (Arthur, 1996). Arthur (p. 104) uses the following analogy to describe competition under increasing returns: [It] is more like gambling. Not poker, where the game is static and the players vie for a succession of pots. It is casino gambling, where part of the game is to choose which games to play, as well as playing them with skill. We can imagine the top figures in high tech – the Gateses and Gerstners and Groves of their industries – as milling in a large casino. Over at this table, a game is starting called multimedia. Over at that one, a game called Web services. In the corner is electronic banking. There are many such tables. You sit at one. How much to play? you ask. Three billion, the croupier replies. Who’ll be playing? We won’t know until they show up. What are the rules? Those’ll emerge as the game unfolds. What are my odds of winning? We can’t say. Do you still want to play? High tech, pursued at this level, is not for the timid.

Innovation in energy production is a lot like this. The rules are largely open at all governance levels from the international negotiation to local planning. But the direction seems quite clear: greenhouse gas regulations will tighten, energy prices will increase and the demand for increased energy security will rise. The demand for new low carbon energy production will be huge as will the demand for energy-saving solutions. To participate in this game requires ‘technical expertise, deep pockets, will and courage’ (ibid., 104) and it pays to hit the market first, in other words to build a low-carbon lock-in. Entrepreneurship based on breaking the present lock-ins in the energy system requires active management of increasing returns (Arthur, 1996; Sydow et al., 2005). In practice, such management could include discounting the price in the beginning to utilize the experience curve. It would require building network alliances; the present petrol carbased mobility system cannot be replaced by any one firm. It would also be crucial to ensure the necessary resources, by either securing the willingness to forgo present profits for future ones or ensuring sufficient outside finances. Active management of increasing

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returns would also require positioning the firm technologically, psychologically and cooperatively. The literature on path creation suggests a number of other strategies that energy entrepreneurs can use to shape the future paths in their favour. Lampel (2001) stresses the role of ‘technological dramas’ – visible and evocative demonstrations – in gaining the commitment of investors and customers to a new technological path. Here, the logic within the dominant path is termed one of ‘critical evaluation’ – investors and customers focus on problems and limitations. According to Lampel, showy demonstrations of new technologies – like those deployed by Thomas Edison to promote electric lighting – shake stakeholders out of their conventional logic so as to get them to envisage the future potential of the new technology rather than focus on its current limitations. Garud and Karnøe (2003) stress the importance of engaging a distributed network of actors. Through an analysis of the emergence of wind power in Denmark and the US, they show how entrepreneurs draw on inputs from distributed actors to transform an emerging technological path. The distributed network, however, not only supplies inputs, it also creates technological momentum that enables and constrains the activities of the distributed actors committed to the technology. Thus, while contributing to the emergence of a new path, they are at the same time binding themselves to the emerging dependencies of this path. Karnøe and Buchhorn (2008) elaborate on the role of policy coalitions in path creation through the example of the Danish electricity system. Today, Denmark is well known for its success in the development of renewable energy, but the energy path was uncertain for many decades. Large industries continued to bank on nuclear power until the 1980s, when the first political targets for renewable energy were set. It was not until the mid-1990s, decades after the first efforts to promote renewable energy had started, that renewables started to gain momentum in the Danish energy system. Financial support for research, development and also deployment remained strong until the late 1990s. This has led to progressive amplification of the early advantage, as wind turbine technology has become a major export industry, providing the wind industry with political and economic power. The origins of these developments go back to small socio-technical experiments initiated by a limited number of actors, but backed by social movements supporting the transition. According to Karnøe and Buchhorn, an important factor here is that the Danish mode of policy making involved hybrid forums for a continuous dialogue among the different actors – users, non-governmental organizations (NGOs), regulators, researchers and producers – and that decisions were made ‘close’ to the actors involved. Regulatory developments have been shaped by collective action by interested parties. In the promotion of renewable-based electricity, for example, the Wind Turbine Owners’ Association was a key political and economic force promoting ‘path creation’ by exerting political pressure for grid access, pricing benefits and favourable siting processes. NGOs have also been central in Denmark, not only in highlighting the problems of a fossil- or nuclearbased energy system, but also in creating legitimacy for renewable energy, and importantly, in advocating for distributed ownership of energy systems (ibid.). Karnøe and Buchhorn’s study highlights the collective and distributed nature of ‘mindful deviation’, which eventually leads to a techno-economic and institutional architecture that gives momentum to the emerging technology.

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CREATIVE DESTRUCTION IN ENERGY SYSTEMS

The Theory of Creative Destruction The Schumpeterian perspective on creative destruction (for more details, see McCraw, 2007; Andersen, 2009) involves three basic tenets. First, it argues that technological and organizational changes are central, inimical and necessary to capitalism. Second, change in this perspective is examined as a battle between the old and the new, or using the current terminology, as a process in which path dependence and the creation of new paths are present side by side. Third, this vision emphasizes temporal variations in the process of change: change is sometimes slow while at times it is violent. The more violent phases start when the development of the old path stagnates and is ossified. Thus, path creation becomes more understandable if we take into account the self-destructive forces within old paths. ‘This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in’, wrote Schumpeter (1942 [1950], 83) in his famous book Capitalism, Socialism, and Democracy. According to Schumpeter, a capitalist economy tends to continually reinvent itself: ‘Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary’ (p. 82). Evolution is driven by forerunner companies’ drive to innovate and gain ‘entrepreneurial profit’. This drive to gain profit through innovations, according to Schumpeter, is the fuel in the engine of capitalism. It is a powerful fuel, because excess profits are always temporary and are gradually eroded under the pressure of competition, which in turn creates the pressure for further innovation. In addition to this purely economic motive, Schumpeter also stressed the other motives that innovators could have, such as the desire to create worlds of their own and the joy of creation and accomplishment. The notion of creative destruction thus helps us to place in perspective the – in itself undeniable – significance of path dependence: in the big picture, violent change in the economy and in technological development has been dominant, rather than preservation of the status quo. Moreover, Schumpeter’s theory stresses the endogenic, inevitable nature of change. Under the conditions of the prevailing economic system, new paths sooner or later overcome the path dependence of old ones. Until now, the discussions on path dependence and path creation have not connected very well. The usefulness of the concept of creative destruction is that it includes both phenomena and thus forces us to examine them both in conjunction. By using the concept of creative destruction, Schumpeter wanted to distance himself from analyses that focused on development in terms of economic growth or productivity improvements. For him, the essential features were structural changes in technologies, products and industries. From this perspective, economic development is essentially the replacement of the old with the new. Moreover, the emerging new system is not an exogenous factor (as in neoclassical growth models), but endogenous: the new is born within the old structure as the old solutions lose their vitality and power to develop. Schumpeter and later, generally speaking, all scholars of technology have characterized creative destruction as an irregular process (punctuated equilibria). Technologies, products and industries have their life cycles. Technologies have stages of rapid development,

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slow development and discontinuity (for example, Tushman and Anderson, 1986). Discontinuous stages are preceded by the destabilization of the old dominant technology, that is, an internal crisis within the dominant path. The destabilization stage can be characterized by, for example, declining growth rates, decreased profit margins for companies, difficulties in further development of the existing technology, exhaustion of necessary raw material sources, or the rise of new needs in society. Thus, the risks in continuing with the old technology increase, and its path dependencies start to unravel. The usefulness of the Schumpeterian concept of creative destruction is that it reminds us of the need to examine change not just as the creation of new paths but also in terms of the dissolution of old solutions. Creative Destruction in Energy Systems The process of creative destruction has certain specific features in the context of energy systems. The most obvious of these is the relative slow pace of change in comparison to some other technologies. For example, we can compare it to the birth and rapid development of information technology since the late 1960s (for more details, see Freeman and Loucã, 2001; Perez, 2002). For example, the diffusion of digital mobile phones from a few million subscriptions to more than 4 billion in about 20 years has been extremely rapid. Energy systems are large technological systems and their renewal is slow because implementing the changes requires large investments (see Section 2). Nonetheless, the process of creative destruction is underway even in the energy system. During the twentieth century, we witnessed the rapid diffusion of fuel oil, the adoption of natural gas, the introduction of nuclear energy and the birth of wind and solar power. It is important to emphasize creative destruction processes in order to avoid excessively simplified views on the slow pace of change in energy systems. When a sufficient number of factors are aligned, even energy systems can change rapidly. In energy systems, the struggle between the old and the new is particularly forceful because the end products themselves (heat and power) remain unchanged. The digital mobile phone replaced the analogue landline phone rapidly because the new technology enables numerous new services, in addition to the original old service (a phone call). Here, the old technology is replaced with a new one that is better in many ways. In energy systems, the changes mainly concern the production and distribution systems, not the energy products themselves. Thus, the competition between the old and the new is characterized by the dominance of price factors, alongside externalities, such as the environmental impacts of production or the noise of an engine. Because environmental impacts derive from energy production and distribution, it is difficult for users to compare energy sources on the basis of anything other than the price of heat or power. Thus, the price competitiveness advantage of old technologies is exceptionally large in the energy sector. The previous observations suggest that an analysis of the destabilization of old technologies is particulary important when examining change in energy systems. Without radical technological leaps, new technologies replace old ones only if the old technologies run into problems that they cannot solve. This is exactly how the current energy system can be characterized: considerable space is emerging for new technological paths, because the path dependence forces of the old, dominant fossil-fuel technologies are turning into forces of destabilization. Increases in oil production have become more

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difficult, the price of oil is rising, the use of oil contributes to climate change and oil is largely obtained from politically unstable regions. Companies’ and consumers’ commitment to this technology is an increasing liability to risk, and thus the old path dependencies are weakening and the focus is turning to new possibilities. Thus, a particular feature of energy system renewal is the fact that inevitability is often an important driver for change, alongside the promise of new lucrative opportunities. In this type of forced change, the role of the state is emphasized, because market mechanisms are less effective than in the case of lucrative innovation-driven change. In addition, policy-induced innovations are needed because the problem of the old paradigm relates to long-term environmental issues. Concrete price and availability factors are more powerful in inducing system change than environmental factors if energy and environmental policy do not support the system change.

4

TODAY’S INNOVATION ACTORS AND MECHANISMS OF CREATIVE DESTRUCTION

It is not easy to generate innovations. Most innovators fail. They are faced with the entrenched interests of incumbent firms, the conservatism of consumers in adopting new products, as well as by the many other obstacles and hindrances due to path dependency. Additionally, the innovator may be wrong in anticipating the future winner among many options, even if the innovator is right in believing that the old system will sooner or later be replaced with a new one. What, then, provides the energy and force to break out of the ‘iron cage’ of the status quo? Figure 15.1 presents a framework classifying potential change factors and innovators in four groups (see Smith et al., 2005, 1499). The literature on creative destruction and Business companies Schumpeter Mark 1: - new companies, - venture capital, - spin-offs

Schumpeter Mark 2: - renewal and diversification of old large corporations

Low coordination

High coordination

Civic activity: - user innovations, - consumer activism, - environmental movements

Policy interventions: - regulations, - taxes and subsidies, - direct investments

Civic society and policy

Figure 15.1

Today’s innovation mechanisms of creative destruction

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innovations has usually focused on business companies as the originators of innovations. This literature usually distinguishes between new small firms and old, large, incumbent firms. The emergence and diffusion of new energy solutions may, however, also be strongly influenced by political measures and by civil society action, such as environmental movements, consumer activism and the users of new energy technologies. The actions of large incumbent firms and state intervention represent change that is centralized and coordinated. Today, however, the importance of dispersed innovation forces has received increasing attention. The role of multiple small companies and civil society increases as distributed energy solutions become more widespread. The importance of these different forces of change needs to be studied, as well as the potentially complementary roles they may take on. In the next four subsections each quadrant of Figure 15.1 will be examined, starting with Schumpeter Mark 1 and Mark 2, continuing with state interventions and ending with civic activity. The linkages between the different innovation mechanisms of creative destruction will also be explored. New Entrepreneurs and Large Corporations as Innovators in Energy Systems The young Schumpeter stressed the role of small new firms as the source of change (Schumpeter Mark 1), whereas the older Schumpeter placed more emphasis on the role of old large companies (Schumpeter Mark 2) (Andersen, 2009). The message of the old Schumpeter was that this new innovation mechanism is more effective than the one he had previously described. Neo-Schumpeterian innovation studies, as well, provide evidence to support the role of large companies as innovators (Lovio, 1993). Their relative role, however, varies by country and by industry. In the energy sector, the large scale of resources needed supports the position of large companies, that is, the first of the self-reinforcing mechanisms resulting in path dependency according to Arthur (1994). It is, however, not self-evident that large companies are in the forefront of developing new energy technologies. Old incumbent companies have heavy sunk costs in the old technologies, and they are not as eager to be first movers in alternative energy sources. There is evidence that incumbent companies tend to develop new alternatives in ways that support and extend the existing path, rather than challenge it (Stroebel and Duschek, 2007). On the other hand, new small companies are likely to be more interested in technologies that challenge the current technological path, especially in the case of small-scale distributed energy production. There is evidence that new entrants are important, particularly, at an emerging stage of market formation (Jacobsson and Bergek, 2004). However, the move to a more mature market requires additional capital and legitimacy, as well as the formation of new networks and institutions to support the alternative technology (Jacobsson and Johnson, 2000; Garud and Karnøe, 2001). Thus, it is not likely that all new market entrants are cut out to be ‘path creators’ or ‘prime movers´ in new energy systems (Jacobsson and Johnson, 2000). New entrepreneurs are likely to be less organized and less able to influence policy processes. Research in energy system innovation has stressed the importance of networks and institutions in the legitimation of new solutions (ibid.; Hall and Kerr, 2003; Jacobsson et al., 2004; Jacobsson and Lauber, 2006). Thus, a key factor of success for

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new entrepreneurs is their capability to form networks and cooperate with pressure groups to effect institutional change. The systemic nature of many energy innovations suggests that they have large impacts on entire value chains (Pilkington and Dyerson, 2006). Thus, instead of competition with incumbent firms, new entrants may also consider collaboration with large firms in order to secure downstream complementary assets – whereas incumbent firms may consider collaboration with new entrants in order to facilitate the selective development and control of new markets (Dyerson and Pilkington, 2005). The importance of collaboration between incumbent firms and new entrants in sustainable entrepreneurship is also highlighted by Hockerts and Wüstenhagen (2009). Policy-induced Innovations Because of the externalities related to the production and use of energy, the role of public policy in enhancing innovations has long been central, and there are numerous studies on the comparative impacts on innovation of different policy instruments (for example, Hahn and Stavins, 1992; Jaffe et al., 2002; Mickwitz et al., 2008). When policies were solely based on a ‘linear innovation model’ the task of public action was merely to provide support for basic education, science and R&D. When the general perception of how innovations emerge has developed into a more systemic model, the emphasis of the policies has also changed. The systemic approach stresses markets and commercialization (Kivimaa, 2008a) as well as the need for a horizontal innovation policy which is embedded in a wider socio-economic context (Lundvall et al., 2002; Smits and Kuhlmann, 2004). There used to be a long-running debate in innovation policy about whether innovations primarily occur because of technology push, that is R&D produces breakthroughs that can be commercially utilized in innovations or through market pull, that is, responses to market demand. Correspondingly there has been an argument about whether policies should focus on stimulating the push or creating pull. Nowadays most studies indicate the need for a combined effort (for example, Rennings, 2000; Kivimaa, 2008a). Policy makers can also contribute to innovation by signalling future requirements (for example, ibid.; Mickwitz et al., 2008). For example, the policy signal that the International Maritime Organization (IMO) would introduce binding regulations on NOx emissions from marine diesels was credible enough to get companies to invest in R&D for achieving this goal many years before the regulation was formally adopted (ibid.). In order to provide incentives for private firms to invest in R&D in more energyefficient processes and products and cleaner energy production, there must be trust that a market for these products, processes or technologies will exist in the future. The type of environmental policies applied makes a difference as to whether Mark 1 or Mark 2 type of innovation is supported. Policies that allow for incremental innovations or the substitution of elements within the existing system tend to support large incumbent companies, whereas policies that require radical and disruptive innovations tend to support new entrants (Pilkington and Dyerson, 2006). Most analyses of attempted technology system change indicate that regulation in practice tends to favour large incumbent companies (Jacobsson and Johnson, 2000; Pilkington and Dyerson, 2006). There are many reasons for this, such as the greater political power of large

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incumbent companies, greater scrutiny of the risks of radical rather than incremental innovation (Hall and Kerr, 2003), but also the very real risks that new entrants will not be capable of filling the ‘gap’ (due to lacking capacity, technological maturity, capital and legitimacy) and bring radically new solutions to the market (Pilkington and Dyerson, 2006). However, regulatory approaches have also emerged that support learning and networking by small companies, such as attempts to create protected spaces in which new path-creating technologies can mature (Kemp et al., 1998; Jacobsson et al., 2004; Jacobsson and Lauber, 2006; van der Laak et al., 2006; Schot and Geels, 2008). Learning and industry formation processes for radically innovative technologies can take a significant amount of time. Furthermore, policy makers aiming to keep a variety of solutions available risk a slow growth in market volumes, as technological competition and market development continue for a long period (Jacobsson et al., 2004). Finally, developing complementarities and synergies between different new technologies or different technological systems (for example, energy, forest, agriculture) may promote the creation of new paths with increasing returns (Raven, 2007; Bergek et al., 2008). While much of the early focus in promoting environmental innovations was on how single policies may induce specific technological innovations, it has shifted towards mixes of policy instruments and system changes (for example, Berkhout, 2002). Examples of such approaches include ‘ecological modernisation’ (for example, Jänicke and Jacob, 2006) and ‘transition management’ (Geels, 2002; Elzen et al., 2004; Smith et al., 2005; Kemp et al., 2007). Policy makers, however, are not ‘outside’ or ‘above’ the framework of innovation mechanisms, which makes the steering of transitions difficult in practice (Shove and Walker, 2007). Technological paths are not exogenous to the policy process, but policy makers are part of the paths that they are trying to steer. Policy making is not merely an engineering exercise of finding the best solution to problems like oil dependency; it is as much a process of defining what is important and of framing problems. User Innovations and Civic Society Activities Recent innovation research has stressed the role of users as sources of innovation (von Hippel, 1976, 1988, 2005). In the age of the internet, users and consumers can also join forces increasingly efficiently. It is thus to be expected that innovative lead users will have a large role in particular in the development of distributed energy technologies (for example, Enzensberger et al., 2003; Rohracher, 2003; Heiskanen and Lovio, 2010). In addition, there is ample evidence of the crucial role of social movements and political pressure groups in the successful emergence of renewable energy technologies in Europe (Jacobsson and Johnson, 2000; Garud and Karnøe, 2003; Jacobsson et al., 2004; Jacobsson and Lauber, 2006; Karnøe and Buchhorn, 2008; Brachert and Hornych, ch. 5 in this volume). There are actually three roles that may be played by users and social movements. Residents and environmental movements can play a crucial role in obstructing the adoption of certain technologies. This has been the case, in particular, for nuclear energy. On the other hand, various social movements have pressured governments to invest more in new alternative energy technologies and they have been central in creating the conditions

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BOX 15.1

SUMMARY OF THE KEY CONCEPTS

Path dependence refers to dynamic processes, involving positive feedback, in which what happened earlier affects the possible multiple outcomes that may occur later (see Section 2). Path creation refers to the active role of entrepreneurs in shaping technological paths by setting in motion processes that actively shape emerging social practices and technologies (see Section 2). Creative destruction refers to the battle between old path dependencies and the creation of new paths, which inevitably at some point will result in the end of old dominant paths (see Section 3). for local experiments (Raven et al., 2008). Finally, users may play an important role in certain stages of the development and diffusion of new energy technologies, as has been the case for particular bioenergy and solar energy applications (Ornetzeder and Rohracher, 2006). Technology users, user movements and civic action have often contributed in various ways to business innovations (Schumpeter Mark 1 and 2). Many new firms are formed directly from user and consumer groups as they are professionalized (Jamison, 2001). However, large established firms are also opening up their innovation processes (Chesbrough, 2003, 2006), especially by engaging lead users. User movements and civic society activities have long had some role in energy and environmental policies – to what extent depends on the case. More recently some countries are also allowing for inputs from users and civic movements in their innovation policies (for example, Rosted, 2005; NESTA, 2008). User and environmental organizations might thus also influence how policies induce innovations. Framework and Research Questions Following the previous lines of thought, it is fruitful to analyse the evolution of energy systems by combining the notions of path dependence, path creation and creative destruction. Our central idea is to focus on the struggle between the old and the new. This struggle includes simultaneous competing processes, which weaken or strengthen old path dependencies and create or fail to create the conditions for the creation of new paths. In order to understand the strength of these present paths and the possibilities for new ones, knowledge is required about the self-reinforcing mechanisms that uphold the present paths – large fixed costs, learning effects, coordination effects and adaptive expectations (Arthur, 1994; Section 2, above). In the spirit of Schumpeter, we stress that even rigid systems are bound to change sooner or later (see Box 15.1). The changes, however, are not automatic. We have classified the forces of change, as presented above, in four groups: Schumpeter Mark 1 and 2, the role of policy and civil society. The relative importance of these different forces depends on the particular case

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and can vary with time, context and technology. Furthermore, they may reinforce and strengthen each other, which facilitates path creation, or they may not match at all, thus weakening the possibilities of path creation. In the following, we apply our framework to an analysis of the development and dissolution of Finland’s oil dependency. We examine two questions: ● ●

5

How path dependent is the oil-based energy system and how and why do new paths emerge? What roles do the various innovation mechanisms, or their combinations, play in the transformation of the energy system in the case of oil dependency?

CASE STUDY: FINLAND’S OIL DEPENDENCE

Oil dependency is a topical example of the struggle between path dependency and path creation. We illustrate these concepts with an example from Finland, which is a country in which oil dependency has decreased significantly more than in other countries in the world. Between 1973 and 2008, global oil consumption grew by 43 per cent, whereas it decreased by 32 per cent in Finland (Statistics Finland, 2008a). The share of oil in total energy consumption dropped from 61 per cent in 1973 to 25 per cent in 2008 (ibid.). Yet Finland still uses large amounts of oil. Among the nations of the world, Finland ranked at 39th place in terms of per capita oil consumption in 2006–07 (NationMaster, 2009). The era of oil dependency is thus not yet over, and the struggle continues between old path dependencies and the creation of new paths. Major Changes in Finland’s Oil Dependence, 1960–2008: Path Dependence and Creation Finland became an oil-dependent country fairly late, not until the late 1960s. At this time, industry grew rapidly, the number of vehicles tripled, and oil replaced wood in space heating. Fossil fuels rapidly grew into the major source of energy. During the 1960–73 period, Finland’s oil consumption grew fivefold, and oil gained a share of more than 60 per cent of total inland energy consumption. Paradoxically, the sudden surge in oil consumption was soon combated vigorously starting right after the first energy crisis, and efforts to reduce oil dependency have continued ever since. Yet it has proved to be much more difficult to reduce oil dependency than it was to drift into it. The 1974–83 period experienced a rapid reduction in oil dependency, development was relatively slow between 1984 and 2003, and another more rapid period started after 2004 (Table 15.1). During 1974–83, Finland’s oil consumption decreased by 27 per cent (that is, 2.7 per cent per year). At the same time, the share of oil in the country’s total energy consumption declined from 61 to 40 per cent. Such a forceful, ‘Schumpeterian’ change was possible due to a number of powerful factors. The real price of oil multiplied during 1974–83. There were thus sound financial motives to reduce oil consumption. Moreover, the reduction of oil consumption was supported by a general decline in the growth rate of total energy consumption: total energy consumption grew by only 1.1 per cent per year during this period. The main reason for

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Table 15.1

Total energy consumption by energy source (%) in Finland 1973–2008 and the target scenario for 2020 by the Finnish government 2008

Energy source Oil Coal Natural gas Peat Nuclear energy Wood fuels Hydro power Wind power, heat pumps, recovered and biofuels, reaction heat of industry Net imports of electricity Total Note:

1973

1983

1993

2003

2008

2020*

61 12 0 0 0 20 5 0

40 12 3 3 19 15 5 1

30 14 9 6 18 16 4 1

25 16 11 7 16 19 2 2

25 10 11 6 17 21 4 3

19 10 9 5 25 23 3 6

2 100

2 100

2 100

1 100

3 100

0 100

* Estimation presented by Long-Term Climate and Energy Strategy, 2008.

Sources:

Finland Government (2008); Statistics Finland (2008a).

this was the slow rate of economic growth, but the energy intensity of the economy also declined significantly during the period. The price spikes caused by the energy crises improved energy efficiency in a variety of sectors. The main reason for the reduction in oil consumption, however, was the adoption of three new significant energy sources: nuclear power, natural gas and peat. Their combined share had grown to 25 per cent of total energy consumption by 1983. Two factors enabled such a rapid creation of new paths. First, the adoption of new energy sources had been prepared for long before the first energy crisis. For example, the construction of the first nuclear power plants was already started in 1971 and 1972 (Auer and Teerimäki, 1982). Second, there was a relatively broad political consensus on the need for new energy sources. The use of peat increased the share of domestic energy sources, natural gas was considered a cleaner fuel than oil, and there was little resistance to nuclear power at that time in Finland. After the rapid ‘Schumpeterian’ drop in oil consumption during 1974–83, the development turned into a slow, path-dependent phase during 1984–2003. During the entire period, oil consumption declined by only 0.5 per cent, that is, by 0.025 per cent per year. The share of oil in Finland’s total energy consumption dropped significantly however, from 40 to 25 per cent. In this respect, creative destruction was still rapidly ongoing. The deceleration of the decline in oil dependence was due to many reasons. After 1984, the real price of oil started to decline, and continued to do so up until 1999. The financial motive to reduce oil dependence was thus much weaker than before. In contrast, the societal significance of environmental issues rose. The political importance of climate change increased, especially after the Rio Summit in 1992, the signing of the Kyoto Protocol in 1997, and the ratification of the protocol by Finland and the European Union in 2002. The Kyoto Protocol, however, did not enter into force until 2005. Climate change was thus a much lesser force for change than the counterforce of low oil prices in the 1990s.

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The reduction of oil consumption was also hampered by the rapid growth of total energy consumption during this period, which experienced annual growth rates of 2–3 per cent. A significant reason for the slow decline in oil consumption during this period was the lack of easily available and suitable alternatives. The popularity of nuclear power warned after the Chernobyl accident in 1986 and the Finnish Parliament decided in 1993 not to allow the construction of a new, fifth nuclear power plant. The capacity of the existing nuclear power plants was expanded, however, and thus nuclear power retained its share in the total energy mix. Instead of nuclear power, other energy sources increased their relative share: natural gas, peat and wood. Increases in the shares of natural gas and peat were hampered, however, by an intensified public debate on climate change. Instead, the use of wood as a fuel experienced an upturn after a long period of decline. In particular, industrial use of wood fuel more than doubled as the forest industry greatly intensified its use of wood byproducts as energy sources. The vested interests of the oil industry are also an important factor in maintaining path dependency. In Finland, the main party representing these interests is the Finnish Oil and Gas Federation, which regularly presents positions in support of oil, for example opposing the use of taxation to reduce oil consumption. As a result, oil dependency has been maintained, in particular, in space heating, even though many alternative technologies are today readily available. During the 2004–08 period, the pressures mounted to reduce oil dependency. Climate change became a concrete challenge as the Kyoto Protocol entered into force in 2005, and the real price of oil grew to unprecedented peaks in 2008. During this period, both economic and environmental pressures converged to promote the reduction of oil consumption. Moreover, changes in Finland’s industrial structure, warm winters, and the financial downturn that started in 2008 facilitated the reduction of oil dependency. During this period, total inland energy consumption in Finland declined by 6 per cent. In spite of the many facilitating factors, oil consumption declined by only 1.2 per cent per year, which is less than half of the rate experienced during 1974–83. Moreover, the relative share of oil in the energy mix did not decline at all, but remained approximately 25 per cent throughout the period. The slow decline in oil consumption is partly due to the fact that alternative fuels still developed slowly in Finland, even though attempts were renewed to create alternative paths. As the pressures to reduce greenhouse gas emissions and ensure security of supply mounted, a new political compromise was forged in which Parliament approved the permission for a fifth nuclear power plant in 2002, and Cabinet granted the construction permission for this private sector-driven project in 2005. Originally, this new plant was supposed to have started production in 2009, but currently it seems that it will not go into production before 2012. Table 15.1 indicates that the use of wood as an energy source continued to increase, and gradually, also new, alternative energy sources (wind, heat pumps) started to gain ground. At present the government’s policy does not focus on actively promoting path creation that would rapidly reduce the oil consumption. In the long-term climate and energy strategy of the government, the target is to reduce oil consumption by 17 per cent from 2005 levels by the year 2020 (Finland Government, 2008, 93). This implies an average annual rate of reduction in oil consumption that is similar to that experienced in 1973– 2008 (0.9 per cent/a).

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Today’s Path Dependencies in Traffic Systems Today, further reductions in oil consumption are difficult to achieve because few easy targets remain for replacing oil with other fuels. Between 1973 and 2008, oil consumption has decreased dramatically in the production of heat and electricity, but at the same time, the use of oil in traffic has grown. Paradoxically, Finland’s transport system has become increasingly dependent on oil during 1973–2008. Foreign transport has grown rapidly and is based almost entirely on oil. Today, foreign transport accounts for about 10 per cent of total oil consumption. In domestic transport, the share of road traffic has grown while the shares of rail and water transport have declined. Approximately two-thirds of all goods transported within Finland are currently carried by road. Passenger cars account for 80 per cent of all passenger transport. Public transport has not increased after 1990, instead, the number of passenger cars crossed the 2 million line in 1993 and in all there are now almost 3 million cars (about 570 cars per 1,000 inhabitants). There are several factors behind this development, for example, increased prosperity and lifestyle changes. The increase in the use of private cars has been affected not only by commuter traffic and service use but also increased leisure mobility. Urban sprawl and regional specialization of functions have for their part increased travel by private car and undermined the possibilities of mass transport. Road traffic per capita in Finland was the third highest in Europe, after Luxembourg and Italy (Statistics Finland, 2008b, 141). The use of alternative fuels (gas, biofuels, electricity) in cars has until now been very limited. The greatest challenge for the coming years is how to dismantle the inherent path dependence in the current transport system. Passenger cars are today scrapped at an average age of about 18 years and the average age of passenger cars is currently 11 years (Finnish Oil and Gas Federation, 2009). In other words, the passenger car stock could in principle be renewed in 15 years, if for example the development and deployment of electric cars were to proceed rapidly. The present path dependencies of the transport system are maintained through several self-reinforcing mechanisms (Arthur, 1994; Section 2, above). These include domestically large sunk costs in roads and supporting infrastructures and even larger costs in the community structure all alternatives require huge fixed costs. Similarly the fixed costs of alternative fuel vehicles are huge in countries that potentially could produce them. Driving, maintaining, buying and selling cars is based on knowledge of gas engines and cars that use them and learning is constantly increasing this knowledge. The networks of gas stations, motels, spare part suppliers, hypermarkets and so on constitute a system that through coordination effects reinforce car dependence or even oil dependence in the transport system. Innovation Mechanisms Creating New Paths in Transport Systems The urgency of transforming transport systems to meet the challenges of climate change was perceived relatively late in Finland. Especially in the transition to biofuels in transport, the domestic market was very slow to develop, and Finnish companies produced biofuels for the export market before they were marketed domestically (Heinimö and Alakangas, 2006). After a slow start, however, both private enterprises and government

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have seized the initiative. Today, various initiatives are stimulating change in the transport system. Fuel efficiency is being improved continually, and Finns have made a rapid shift toward diesel-powered cars. The use of biofuels has risen alongside mineraloil-based fuels. New options are being sought for the further development of electric vehicles. The following illustrations highlight the different roles of government, large incumbent companies, new entrepreneurs and civil society in the creation of new transport energy paths (Figure 15.1). Government, as mentioned above, has not responded as rapidly and decisively to the current crisis caused by climate change as it responded to the energy crisis in the 1970s. Rather, the approach has been incremental. However, starting in 2007–08, a new more vigorous policy has been put in place. Partly, this is due to the Climate Energy Package launched by the European Commission in early 2008, which for Finland requires that the share of renewable energy should be increased from 28.5 to 38 per cent (Directive 2009/28/EC) and that the greenhouse gas emissions from the sectors not covered by the emission trading system (for example, transport) should be reduced by 16 per cent by 2020 compared to 2005 (Decision 406/2009/EC). Oil dependency in transport has been addressed by mandating a certain share of biofuels and amending the motor vehicle taxation to favour low-carbon vehicles. Following EU requirements, minimum requirements are imposed on distributors of motor vehicle fuels regarding the share of biofuels to be supplied annually. More importantly, however, the change in motor vehicle taxation has already reduced the CO2 emissions of new cars sold. For example, the share of new registrations of diesel cars in Finland has jumped from the previous 20 per cent to more than 50 per cent. With regard to the need to reduce traffic, the Ministry of Transport and Communications is increasingly working with the cities and municipalities to improve the public transport system (Kivimaa and Mickwitz, 2009). For example, the ministry has signed an agreement of intent with the cities of the metropolitan region stipulating that the cities will promote the tightening of community structure around main transport routes, whereas the government will aim to support the development of public transport in urban areas. Large incumbent companies, as before, are the major players in introducing new innovations into the transport system. The largest domestic oil company, Neste Oil, is in international terms a very small oil company, which in the early 1990s adopted a strategy of developing cleaner fuels than its competitors (low sulphur and unleaded fuels). Since 2000, the company started to invest in cleaner diesel grades. Later the company decided to invest heavily in biofuels, and it is constructing four biofuel refineries in Finland, Singapore and Rotterdam, on the basis of a proprietary technology. The biofuel projects by Neste Oil reflect a new surge in intrapreneurship within Finnish large companies to reduce oil dependency. As the demand for paper has slowed down, the pulp and paper companies have also gained an interest in developing wood-based biofuels together with Neste Oil. Earlier pulp and paper companies were mainly concerned with producing energy as a sideproduct and mainly for their own needs. Although the bioenergy production by pulp and paper companies increased rapidly, these firms were even working against independent bioenergy production, because they were afraid of competition – internal as well as external – for raw materials. Currently, the situation has changed: Finland’s largest

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forest industry companies, Stora Enso and UPM have both established pilot plants to bring this new type of fuel to the market in the mid-2010s. The energy industry has recently developed an interest in the promotion of electric vehicles. Because the industrial demand for electricity is not growing any more, the until now very conservative energy companies are now becoming interested in creating markets for this new type of technology. For example, the largest Finnish energy company, Fortum, has started to invest in creating infrastructure and technology for electric cars. The Ministry of Employment and Economy recently set up a working group to develop proposals for the promotion of electric vehicles. The working group (MoEE, 2009) proposes to make the manufacture of electric cars into a major export industry and increase the share of electric vehicles of total domestic vehicle sales to 25 per cent by 2020. As key players, the report designates public research and educational institutions, large technology and energy companies and a group of small enterprises. New entrepreneurs were not very visible during the energy crisis of the 1970s. Today, a good example of a new enterprise working to reduce oil dependency is St1, a new privately owned energy company. The company was founded by Mika Anttonen, who worked for Neste Oil Trading in the 1990s. After the liberalization of the oil trade, he started, together with partners, a new trading company, Greenenergy Baltic Ltd, which has since grown into a diversified energy company called St1, with a staff of 170 employees. The company’s energy services range from energy consultancy to heat production solutions and from wind power to new automotive fuels. The company, established in 2006, owns 450 petrol stations in Finland, Sweden and Poland, purchased largely from the Finnish subsidiary of Exxon. In 2009, St1 brought on the market a new domestic biofuel, a high-concentration bioethanol produced from biowaste, Refuel RE85. The company is also active in wind power development. It has recently completed its first wind power plant and has acquired 150 leases for wind power sites. The company has founded a retail chain called St1 Energiamarket, which provides consultancy and renewable energy solutions for industrial and residential customers. Civic activity in the energy sector has been relatively low key for decades, and Finnish citizens do not generally believe that they can have an influence on energy policy (Ruostetsaari, 2009). However, Finland has a long tradition of ‘part-time inventors’. Some of this civic activity is today directed at reducing oil dependency. One example is a citizen-consumer action project called ‘Electric Cars – Now!’. The object of this collective venture is to make electric cars affordable to everybody by converting existing vehicles into electric cars. The project aims to accomplish this objective by assembling a critical mass of consumers who want an electric car. The project has assembled a network of industrial partners and is developing a conversion prototype on the basis of open innovation principles. It is also working on developing an infrastructure of charging stations for electric cars. However, there remains much work ahead in transforming the transport energy system. The oil dependence in the traffic system is related to two other path dependencies in the system: mobility dependence and car dependence. The underlying features for these two dependencies are related and often mutually reinforcing. Mobility dependence means that the modern way of life is based on increasing mobility. The distance that Finns commute to work has increased, as has the share of other travel, for example, for shopping or hobbies. This mobility is largely dependent on the community structure,

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which in itself is quite path dependent. The other path-dependent aspect of the traffic system is car dependence, that is, whether the car is the only means of travel. Car dependence is also largely linked to the community structure: if distances are long, walking or biking is not an option and when population densities are low, public transport is not likely to be available. Car dependence is, however, also linked to lifestyles: how fast do we have to travel and how flexible does time use need to be? The possibility of breaking the oil dependency in the transport system depends on whether the two other path dependencies in the traffic system can also be destroyed. If the current mobility and car dependencies continue, alternative fuels (biofuels, electric cars or hydrogen) are the only available alternative to the present oil dependence in the traffic system. Summary of Responses to Oil Dependency in Finland Immediately following the energy crisis, Finland was very successful in reducing its oil dependence through public policies and innovations produced by large companies (that is, following the Schumpeter Mark 2 model). In contrast, early entrepreneurial innovations (such as the first introduction of ground source heat pumps for space heating) were not equally successful. Finland at that time was a corporatist state with a highly centralized, oligopolistic energy sector (Kivimaa, 2008b). Thus, the field has been dominated by Schumpeter’s Mark 2 type of large companies. However, this industrial and state structure allowed for a rapid transition due to centralized resources and decision-making structures. The responses developed at the time of the energy crisis are no longer available, and deregulation and market liberalization have opened the scene for new entrepreneurs. However, it seems that structures change extremely slowly – as illustrated, for example, in citizens’ perceptions of political power in the energy sector, which are unchanged since the 1980s (Ruostetsaari, 2009). There are thus path dependencies that political reforms or market liberalization cannot easily counter. However, the current climate crisis seems to be provoking a somewhat different and more varied response than the energy crisis of the 1970s. The different innovation mechanisms are more evenly represented. In the past decade, distributed energy systems have become more popular and they have offered small companies the opportunity to join in and start developing new energy sources. New entrepreneurs have emerged to challenge the existing system, either growing in protected niches supported by other policy sectors or building on and gradually expanding on the resource bases and competencies of incumbent companies (for example, St1). In comparison with Germany, Denmark and Sweden, for example, civic activity has been low key. Opposition to nuclear power and the need to develop alternatives gave rise to powerful coalitions and networks of proponents of renewable technologies in those countries, which in turn have provided legitimacy and political support for renewable energy (Jacobsson et al., 2004; Bergek et al., 2008). Civic action in Finland tends toward political consumerism (Ruostetsaari, 2009), which is reflected in the type of civic movements emerging in the country today (such as Electric Cars – Now!). We could thus argue that while there is public support for renewables, there is insufficient opposition towards the incumbent technologies to provide a supportive policy framework for them. Thus, entrepreneurs need to be inventive and search for new forms of collaboration.

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CONCLUSIONS AND IMPLICATIONS FOR ENTREPRENEURS

We have argued that it is reasonable to study the evolution of technological systems simultaneously from the perspectives of path dependence, path creation and creative destruction. Historical development of a specific system depends on how new emerging paths succeed in challenging, weakening and even destroying today’s dominant system. We have identified four innovation mechanisms for path creation processes (Schumpeter Mark 1 and 2, the role of policy and civil society) and our conclusion is that all these are needed at the same time. Intrapreneurship in and diversification of large resourceful incumbent companies may play an important role when the change has started. However, in the very early phases new small companies and entrepreneurs with support of private and public venture capital are often important for discovering and testing new possibilities. Because changes in energy systems are very often highly related to long-term environmental issues such as climate change, it is obvious that we cannot rely only on market forces and initiatives of small or large companies. The role of politics and various policy measures is crucial. In addition, we should emphasize the role of civil society, users as innovators and active consumers. Lead users and active consumers create future markets for companies and also create a political climate which is more open to tighter regulations and increasing investments in new solutions. There is thus a need for a more active transition policy that is able to combine these four mechanisms in order to create a virtuous cycle of mutually reinforcing processes that help to overcome the problems of the past. Our analysis has implications for entrepreneurs. Path creation is not a discrete event of introducing a new technology. It is a process in time, which involves a variety of orchestrating efforts to deviate from the existing system and develop alternative paths. Our analysis suggests that entrepreneurs’ capabilities in analysing their operating context – including recognition of dominant paths and especially the self-reinforcing mechanisms that produce them – and creating supportive networks and institutions can be the key success factors here. There is ample evidence from previous research that entrepreneurs need to understand the nature of the business they are in – not only the technologies and their growth prospects, but also the nature of the value chains and stakeholder networks of both incumbent industries and new entrants. They need to understand which competencies are destroyed and which ones are enhanced by the introduction of radical alternatives (Garud and Karnøe, 2001; Hall and Kerr, 2003; Pilkington and Dyerson, 2006). They may also need to consider collaborating with incumbents – or participating in the incumbent system – in order to secure key assets (Dyerson and Pilkington, 2005). This evidence is supported by our analysis of Finland’s oil dependence, where the ‘big picture’ provides a good explanation for the kinds of firms that have been successful. There is also evidence that entrepreneurs need to invest in the development of networks and institutions. Intra-firm learning is not sufficient, but needs to support the development of complementary competencies with value chains, policy institutions and civil society. New technologies need institutional support, but the political power of new entrants is usually smaller than that of incumbent firms. Cooperation with pressure groups has been one of the successful strategies deployed to enhance the legitimacy

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of new solutions and to create new supportive networks (Garud and Karnøe, 2003; Jacobsson et al., 2004; Jacobsson and Lauber, 2006; Karnøe and Buchorn, 2008). Our analysis of oil dependency in Finland suggests that a relative lack of such capabilities has been one of the factors slowing down the emergence of successful new entrepreneurs. Previous literature, however, has paid less attention to a close analysis of the dominant path, its long-term development and its weak points. The dominant parts of the present energy systems are upheld by self-reinforcement through large fixed costs, coordination and learning effects, as well as adaptive expectations. While path dependencies are strong in energy systems, so are path-destroying forces. We argue that path creation of a new system gains momentum more easily when the old system is already on the decline. As argued by Geels (2007), destabilization of the old system may be the key to transition towards the new system. Destabilization is characterized by a loss of momentum, loss of stability, increased possibilities for lock-out and later decline, and even fossilization. According to Geels, typical phases of destabilization include framing contests in problem definitions and defensive responses within the bounds of the existing regime. As destabilization progresses, defensive hedging starts an initial search for alternative solutions, leading to diversification of the system. It is obvious that the current energy system is in a process of destabilization. Yet in the energy system, the identification of systems dynamics is complex, because multiple technologies operate in parallel. In real life, it is too simplified to conceptualize the transformation of the energy system as a simple shift from one dominant system to another. In addition to understanding their own value chains, entrepreneurs need to envisage the relations between complementary and competing elements of the emerging new energy system. The patchwork nature of the emerging new energy system also suggests that path-creating entrepreneurs can creatively combine elements from old and new competency bases (Garud and Karnøe, 2001). Path dependence is present in energy systems, and oil dependency and carbon lock-in make transformation difficult. Understanding the roots of the present path dependencies better makes it easier to break them and create new paths. In addition, we optimistically argue that all path dependencies are just temporary. By looking at longer timescales and broader systems, more path creation and even ‘creative destruction’ can be observed, which counters the conservative (and depressive) picture generated through the focus on path dependence.

NOTE *

This chapter is an outcome of the project ‘Path Dependence and Path Creation in Energy Systems: A Multi Level Perspective on Technological, Business and Policy Innovations (EnPath)’, financed by the Academy of Finland (Decision 127288). The authors benefited from the feedback from two reviewers and the editors of this volume.

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diffusion of environmentally friendlier technologies: popular claims versus case study experiences’, Journal of Cleaner Production, 16 (1S1): 163–71. Ministry of Employment and the Economy (MoEE) (2009), ‘Sähköautot Suomessa työryhmän raportti’ (Report of the working group for electric cars in Finland), Helsinki. NationMaster (2009), ‘Oil consumption per capita by country’, available at: http://www.nationmaster.com/ graph/ene_oil_con_percap-energy-oil-consumption-per-capita (accessed 26 May 2009). Neij, L. (1997), ‘Use of experience curves to analyse the prospects for diffusion and adoption of renewable energy technology’, Energy Policy, 23 (13): 1099–107. Neij, L. (1999), ‘Dynamics of Energy Systems: Methods of analysing technology change’, Doctoral thesis, Department of Environmental and Energy Systems Studies, Lund University. NESTA (2008), ‘We’re all innovators now: How users are changing the rules of innovation’, UK National Endowment for Science, Technology and the Arts (NESTA) Policy Briefing IN/27, available at: http://www. nesta.org.uk/we-re-all-innovators-now-how-users-are-changing-the-rules-of-innovation/. North, D. (2005), Understanding the Process of Economic Change, Princeton, NJ: Princeton University Press. Ornetzeder, M. and H. Rohracher (2006), ‘User-led innovations and participation processes: lessons from sustainable energy technologies’, Energy Policy, 34 (2): 138–50. Perez, C. (2002), Technological Revolutions and Financial Capital: The Dynamic of Bubbles and Golden Ages, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Peters, G.B. (2006), ‘Concepts and theories of horizontal policy management’, in G.B.  Peters and J. Pierre (eds), Handbook of Public Policy, London: Sage, pp. 115–38. Pierson, P. (2004), Politics in Time: History, Institutions, and Social Analysis, Princeton, NJ: Princeton University Press. Pilkington, A. and R. Dyerson (2006), ‘Innovation in disruptive regulatory environments: a patent study of electric vehicle technology development’, European Journal of Innovation Management, 9 (1): 79–91. Raven, R. (2007), ‘Niche accumulation and hybridisation strategies in transition processes towards a sustainable energy system: an assessment of differences and pitfalls’, Energy Policy, 35 (4): 2390–400. Raven, R.P.J.M., E. Heiskanen, R. Lovio, M. Hodson and B. Brohmann (2008), ‘The contribution of local experiments and negotiation processes to field-level learning in emerging (niche) technologies: meta-analysis of 27 new energy projects in Europe’, Bulletin of Science Technology Society, 28 (6): 464–77. Rennings, K. (2000), ‘Redefining innovation – eco-innovation research and the contribution from ecological economics’, Ecological Economics, 32 (2): 319–32. Rohracher, H. (2003), ‘The role of users in the social shaping of environmental technologies’, Innovation, 16 (2): 177–96. Romm, J. (2006), ‘The car and fuel of the future’, Energy Policy, 34 (17): 2609–14. Rosted, J. (2005), ‘User-driven Innovation: Results and Recommendations’, Report 13, Ministry of Economic and Business Affairs’ Division for Research and Analysis (FORA), Copenhagen. Ruostetsaari, I. (2009), ‘Governance and political consumerism in Finnish energy policy-making’, Energy Policy, 27 (1): 102–10. Schumpeter, J.A. (1942 [1954]), Capitalism, Socialism, and Democracy, 4th rev. edn, Boston, MA: George Allen & Unwin. Schot, J. and F. Geels (2008), ‘Strategic niche management and sustainable innovation journeys: theory, findings, research agenda, and policy’, Technology Analysis and Strategic Management, 20: 537–54. Sewell, W. (1996), ‘Three temporalities: towards an eventful sociology’, in T. McDonald (ed.), The Historic Turn in the Human Sciences, Ann Arbor, MI: University of Michigan Press, pp. 245–80. Shove, E. and G. Walker (2007), ‘Caution! Transitions ahead: politics, practice, and sustainable transition management’, Environment and Planning A, 39: 763–70. Smith, A., A. Stirling and F. Berhout (2005), ‘The governance of sustainable socio-technical transitions’, Research Policy, 34: 1491–510. Smits, R. and S. Kuhlmann (2004), ‘The rise of systemic instruments in innovation policy’, International Journal of Foresight and Innovation Policy, 1 (1–2): 4–32. Statistics Finland (2008a), Energy Statistics Yearbook 2008, Helsinki. Statistics Finland (2008b), Environment Statistics Yearbook 2008, Helsinki. Stroebel, J.C. and S. Duschek (2007), ‘Beyond path dependency: why and how mineral oil companies support the development of sustainable fuels’, paper for the International Workshop Series on System Innovations for Sustainable Development, 2nd Workshop ‘Innovation, Institutions and Path Dependency’, Zurich, 15–18 April. Sydow, J., A. Windeler, G. Möllering and C. Schubert (2005), ‘Path-creating networks: the role of consortia in process of path extension and creation’, paper presented at the 21st EGOS Colloquium, Berlin, 30 June–2 July. Tushman, M.L. and P. Anderson (1986), ‘Technological discontinuties and organizational environments’, Administrative Science Quarterly, 31: 439–65.

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Unruh, G. (2000), ‘Understanding carbon lock-in’, Energy Policy, 28 (12): 817–30. Unruh, G. (2002), ‘Escaping carbon lock-in’, Energy Policy, 30 (4): 317–25. van der Laak, W.W.M., R.-P.J.M. Raven and G.P.J. Verbong (2006), ‘Strategic niche management for biofuels: analysing past experiments for developing new biofuel policies’, Energy Policy, 35: 3213–25. van der Vleuten, E. and R. Raven (2006), ‘Lock-in and change: distributed generation in Denmark in a longterm perspective’, Energy Policy, 34 (18): 3739–48. von Hippel, E. (1976), ‘The dominant role of users in the scientific instrument innovation process’, Research Policy, 5 (3): 212–39. von Hippel, E. (1988), The Sources of Innovation, Oxford: Oxford University Press. von Hippel, E. (2005), Democratizing Innovation, Cambridge, MA: MIT Press.

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PART VI ENERGY ENTREPRENEURSHIP, INSTITUTIONS AND PUBLIC POLICY

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16 Making, breaking, and remaking markets: state regulation, entrepreneurship, and photovoltaic electricity in New Jersey David M. Hart*

1

POLICY MAKERS AND ENTREPRENEURS RESPOND TO CLIMATE CHANGE: A NEW SOCIETAL ‘EXPERIMENT’

In a paper demonstrating that the carbon dioxide concentration of the atmosphere was rising as a result of fossil fuel combustion, Roger Revelle and Hans Suess (1957) stated that humanity was undertaking a ‘large-scale geophysical experiment’. More than 50 years later, the results of that experiment appear ominous, and humanity is beginning to undertake a large-scale societal experiment in response. This new experiment aims to catalyze a transformation in the use of energy, which we rely on nearly as much as the atmosphere itself. The ubiquity and necessity of energy use accounts for the extraordinary complexity and contentiousness of the new societal experiment. Tampering with the forms, availability, prices, and quantities of energy affects livelihoods, profits, and relationships. This complex web of interactions requires that any energy transformation be mediated primarily by markets. As Hayek (1945) articulated and the denouement of the Cold War demonstrated, only markets can effectively aggregate the manifold and diverse responses of individuals and firms to changing supply and demand conditions. Entrepreneurs must play a central part in the response to climate change as well, both in the Kirznerian sense of filling gaps within markets (Kirzner,1973) and in the Schumpeterian sense of creating technological and business innovations that open new markets and make new combinations possible (Schumpeter,1942). Yet, markets, old or new, will only work if they are embedded in a broader ‘soft’ infrastructure of law, public policy, and custom (Granovetter, 1985). Energy markets are more deeply embedded in such an infrastructure than most markets, because of the many perceived market failures that governments have sought to rectify in order to make these markets function better (Cohen and Winn, 2007). Fossil-fuel burning, therefore, is not merely a matter of habit for billions of consumers and the result of some two centuries of investment in physical, human, and organizational capital. It is also ‘locked-in’ (Arthur, 1990; Mokyr, 2002) by political coalitions at the global, national, and subnational levels that stabilize and protect fossil-fuel markets. In short, fossil-fuel burning – as a technological, political, and economic system – has immense ‘momentum’ (Hughes, 1989). If the new societal experiment to stave off cataclysmic warming is to succeed, a lowcarbon energy system will need to acquire comparable momentum. One promising approach to this challenge begins with public policy makers ‘carving out’ a protected institutional space within which new energy markets can operate. Within this space, 305

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entrepreneurial experimentation with technologies and business models may give rise over time to a positive feedback process, as a result of which the costs of new energy sources may decline and confidence in them grow (Sanden and Azar, 2005). Eventually, the protective walls surrounding the new technological system can be removed, and it can first supplement and then supplant the existing system. The process would be somewhat analogous to the transformation of the Chinese economy in recent decades as it ‘grew out of the plan’ (Naughton, 1995) with private enterprise slowly but steadily supplanting the state-owned sector. In this chapter, I explore the early stages of such a process, involving the creation of a market for electricity generated by solar photovoltaic (PV) systems in the state of New Jersey in the US over the past decade. Protection was (and still is) provided by the state’s renewable portfolio standard (RPS), which requires that electricity-generating firms use solar power to supply a designated percentage of their electricity sales. Merely creating this space, however, was not enough to set a PV market in motion and sustain its growth, in large part because PV-generated electricity remains quite expensive. Policy makers have struggled to build a viable institutional infrastructure to support the market, confronting and surmounting (with varying degrees of success) a series of obstacles thrown up by the external environment as well as by market participants and policy makers themselves. My research thus investigates a dynamic process of market creation and maintenance through policy innovation and learning. The entrepreneurial response (Dean and McMullen, 2007) is a key indicator of the ongoing success of this process. The study of PV is warranted because of its promise as a low-carbon, low-maintenance, and easily scalable source of electricity. It has beguiled metal-benders and tree-huggers alike for decades, because of its technical simplicity, converting sunlight into electricity with few moving parts. If – a huge ‘if’ – its costs can be brought down sufficiently, PV promises to be a big component of the energy transformation. The New Jersey case warrants attention in part because of its scale. It now has a larger installed PV capacity than any other US state besides California, which is much larger (and much sunnier). New Jersey has also been a pioneer in a number of respects, notably in its heavy reliance on tradable certificates (known as ‘SRECs’) to reward PV generation. Yet, few researchers seem to be aware of this experience. This study thus adds to a growing inventory of cases (for example, Jacobsson et al., 2004; Luthi and Wüstenhagen, 2008; Taylor, 2008) that begin to provide a basis for comparative analysis of renewable energy market creation and maintenance. The chapter is organized as follows. Sections 2–5 comprise empirical narrative. Section 2 outlines the restructuring of the New Jersey electricity market in 1999, which laid the institutional basis for PV market creation. Section 3 then turns to the state’s Customer On-Site Renewable Energy (CORE) rebate program, which was initiated in 2003 and catalyzed market formation by sparking a significant entrepreneurial response. The troubled solar policy transition that began in 2006, which was brought about by fiscal constraints on the state, is covered in Section 4. Section 5 focuses on the state’s increasing reliance on incumbent electric utilities to support the state’s PV market since 2007. In the conclusion, I sum up the story and return to my key analytical themes.

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307

THE END OF BUSINESS AS USUAL: UTILITY RESTRUCTURING IN NEW JERSEY, 1999–2002

Electricity restructuring in the late 1990s set the stage for the development of New Jersey’s PV market. The Electric Discount and Energy Competition Act (EDECA) of 1999, laid the foundations of the soft infrastructure for this market. Although the EDECA had many elements and motivations – not the least of which was cutting the cost of electricity (Prior, 1995; Twyman and Johnson, 1999) – it carved out a protected space for this market, defined the roles of incumbent electricity generators and distributors in it, provided a resource base for it, and set in motion governance processes that would lead, after a few years, to its dramatic expansion. The state’s recent Energy Master Plan (New Jersey, 2008, 16) describes well the status quo before passage of the EDECA: Electric utilities generated most of the electricity in the State, under the regulation and oversight of the Board of Public Utilities (BPU). The utilities built, maintained, and operated power plants, with the expectation that the BPU would allow them to recover their prudently incurred costs from electricity customers, plus an opportunity to earn a specified rate of return. In this arrangement, the utilities were insulated against the risk of loss that State-approved investments in electric generation might prove unwise; electricity customers bore that risk. In exchange, the utilities bore an obligation and a responsibility to generate, transmit, and deliver electricity to serve those customers.

The most fundamental change made by the 1999 restructuring was to vertically disintegrate the market for electricity generation from the market for electricity distribution. Unregulated electricity generators (known as ‘load-serving entities’ or LSEs) take on the risk of building and operating power plants. Their output is sold through a multi-state wholesale market. The main wholesale buyers for New Jersey are electric distribution companies (EDCs, generally called utilities) which remain regulated by the BPU under state law. Each year, these buyers (including Atlantic City Electric, Jersey Central Power & Light: JCP&L, Public Service Gas & Electric: PSE&G, and Rockland Electric) agree to three-year contracts for roughly one-third of their retail customers’ power needs. This redefinition of markets created opportunities for entrepreneurial entrants in the electricity generation business. The EDECA further segmented this new opportunity space by creating a provisional RPS. The RPS required otherwise unregulated LSEs to provide a designated fraction of their load from renewable energy sources. LSEs could choose to fulfill this responsibility by purchasing renewable energy certificates (RECs) that had been issued to other generators who operated systems powered by renewables, including PV systems. If RECs were too expensive or simply unavailable, an alternative compliance payment (also known as a penalty) would be imposed on the LSEs. (See Figure 16.1.) The RPS went into effect in 2001 with a target of 0.5 percent for that year and a schedule to rise to 4 percent in 2012. The third and final feature of the restructured institutional landscape was a Societal Benefits Charge (SBC). The SBC provided a mechanism for funding renewable energy development and other activities that policy makers anticipated would be squeezed out of the regular budgets of LSEs and EDCs by the new forces of competition (Kushler et al., 2004). Levied through the monthly electricity bills, the SBC was expected to produce

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BPU: Retires RECs

RECs for sale

Power RECs Self-generated or Power

Purchased or Alternative compliance payment Fulfill RPS

Power

LSE: Generates electricity

EDC: Delivers electricity

Must meet RPS

Source:

Renewable energy system owner: generates and consumes electricity Earns RECs

Author.

Figure 16.1

How the New Jersey RPS works: basics

about $1 billion over the first eight years after the EDECA, some of which would be directed to programs that would help fulfill the RPS (Covert, 2000).1 A conflict quickly emerged for control of these funds. A coalition led by the Natural Resources Defense Council (NRDC), an environmental group, and PSE&G, the state’s largest utility, called for the utilities to administer energy efficiency and renewable energy (EE/RE) programs, many of which they were already running, on a coordinated statewide basis. An alternative proposal, developed by the state’s Ratepayer Advocate and its allies, argued that the responsibility should be placed with a new office within the state government (Covert, 2000; Siebens interview). After a year’s delay, the former position prevailed. The BPU approved on March 9, 2001, a $358 million, three-year EE/RE plan to be carried out by the utilities (AP, 2001; Business Wire, 2001).

3

MAKING MARKETS: SOLAR RPS POLICY AND CORE REBATE PROGRAM, 2003–2006

In January 2002, control of the New Jersey governorship shifted to the Democratic Party when James McGreevey was sworn in. McGreevey, who had won wide support from environmentalists in his campaign (Halbfinger, 2001), appointed Jeanne Fox to serve as president of the BPU. Fox quickly seized the opportunity to build the PV market that the EDECA had created. She brought the administration of the SBC-funded programs into the BPU and aggressively developed and expanded them, especially the CORE Program. The response of entrepreneurs and customers to this new policy was rapid and widespread. CORE provided rebates for just 37 PV systems in 2002; in 2006, the figure was 867 (OCE, n.d.b).

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The creation of the New Jersey Office of Clean Energy (OCE) as an arm of the BPU in 2003 responded to criticism from solar power advocates and others that utility administration of SBC-funded programs created a conflict of interest (Ress, 2001). This arrangement, quipped the director of the state’s Sierra Club, ‘was like having Winona Ryder in charge of security at Saks’ (the store where the actress was caught shoplifting) (Parker, 2002). Following an audit that harshly criticized management of the state’s renewable energy programs, the Clean Energy Council, an advisory body to the BPU made up of stakeholder representatives and chaired by Fox, recommended the shift in administrative control (Sullivan, 2002; OCE, Annual Report, 2003). This administrative shift was a prelude to a substantive one, in which the RPS was revised upward and a new ‘solar RPS’ – and thus a protected market for PV-generated power – carved out within it. The new design for the RPS derived from the work of the governor’s Renewable Energy Task Force, which was chaired by Fox and was dominated by renewable energy advocates. Its April 2003 report called for the 2008 RPS requirement to be doubled to 4 percent (the level that had been previously set for 2012) and to hit 20 percent in 2020. The task force also recommended ‘that a comprehensive set of policies be developed that will enable substantial levels of photovoltaic solar generation capacity to be developed in New Jersey’ (Renewable Energy Task Force, 2003, 5). It declined to make a more detailed recommendation, but one of the options that it considered, ‘mandating that a minimum percentage of the RPS Class 1 requirement be met with renewable energy produced from photovoltaic solar sources’, was, in fact, adopted by the BPU, beginning in 2004 (OCE, Annual Report, 2004). The solar RPS mandated that 90 MW of PV system capacity should be installed in New Jersey by New Year’s Day of 2009 (ibid.). A later revision specified that 2 percent of the state’s electricity generation should be provided by solar power in 2020, expanding installed PV capacity to an estimated 1,500 megawatts by that date2 (OCE, 2006). The state’s renewable energy budget, comprised almost entirely of solar programs, quickly surpassed its energy efficiency budget, which had been three times larger when the utilities managed the SBC-funded programs (OCE, Annual Reports; Business Wire, 2001). The SBC was raised to support this spending (Johnson, 2005). In late 2004, Fox’s BPU approved a four-year EE/RE budget of $745 million, roughly 50 percent larger on an annual basis than the budget of the prior administration. Those interviewed for this chapter generally agreed that the state’s leaders, including McGreevey, his successors as governor (both Democrats), and key legislators as well as Fox, shared a vision of the state electricity system in which its carbon footprint grew more slowly, the power of the utilities was reduced, and system reliability was improved. They differ as to why the state focused so heavily on solar power to achieve these goals. Among the reasons offered were the effective advocacy of the solar industry and the relative ease of siting and building PV systems, particularly compared to windmills, especially windmills along or off the shore, where New Jersey’s wind resources are concentrated. At the core of the new solar policy was CORE. (See Figure 16.2.) The rebate provided by this program reduced the capital placed at risk by buyers of PV systems. This risk was a central barrier to the development of the PV market. A PV system that would power a typical house or small business required an investment of $50,000 or more, which was steep hurdle for most owners. CORE initially provided rebates of up to 70 percent of a PV system’s installed cost. Over time the rate was stepped back, so that by the end of

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Funds CORE

CORE rebates

SRECs for sale

Power SRECs Self-generated or

Power

Purchased

Power

or Alternative compliance payment Fulfill RPS

LSE: Generates electricity Must meet solar RPS

Source:

EDC: Delivers electricity

PV system owner: Generates and consumes electricity Earns SRECs

Author.

Figure 16.2

New Jersey Solar RPS + CORE

2006, the highest subsidy in the program had declined to about 50 percent of the installed cost.3 CORE rebates varied according to the type of owner and size of the system. This design was intended to roughly level final unit costs of installation across the various categories. Larger systems received lower rebates per installed watt of capacity, because unit costs decline as systems get larger. Public schools and other public projects received higher rebates than private projects at every system size, since their owners were unable to access federal tax incentives that supplemented the state rebate for many private PV system owners. CORE’s budget was divided into several segments that corresponded roughly with the categories used to set subsidy levels. Segmentation helped to support the soft infrastructure that embedded the New Jersey PV market. Solar power’s most vocal supporters were small system installers and activist residential customers. If the policy had allocated funds to the least expensive projects on a cost per watt basis, this segment would likely have been excluded because of their high unit costs. That in turn would have weakened the coalition behind the solar RPS policy. CORE’s segments also aligned with the ratepayer classes used in regulating utility prices, so that the SBC payments made by each ratepayer class were perceived to flow back to that class via CORE. CORE greatly facilitated access to project financing. An applicant to the program submitted a signed contract to install a PV system and a technical worksheet. If these documents met the program criteria and as long as funding was available within the appropriate segment, the applicant received a commitment letter from the state, certifying eligibility. This letter, in turn, could be used to secure bridge financing, often from

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the equipment vendor, for the amount to be rebated. Once the system had been installed and inspected, the rebate paid back the bridge loan. Even with the upfront capital subsidy provided by CORE, most PV systems would not have been financially viable unless their owners could sell any excess power that they generated to the grid. A residential system owner who is at work on sunny weekdays would lose much of his/her system’s output without this option, or would have to buy expensive storage capacity. A commercial system owner, similarly, benefits greatly from being able to sell power to the grid on the weekend when his/her office is closed. ‘Net’ metering made this two-way flow possible. PV-generated power that is not used by the system owner flows out to the grid and drives the owner’s electric meter backward. When the owner needs more power than the PV system can provide, the meter runs forward, like that of any other customer. In the optimal case, the ‘net’ in net metering is zero, which means that the PV system owner avoids paying for any electricity at all.4 Electricity rates rose about 30 percent, from about 10 cents per kWh to 13 cents per kWh between 2002 and 2006, enhancing this incentive (Summit Blue Consulting, 2008, 46). Ease of interconnection was another element of the soft infrastructure that supported the New Jersey PV market. The use of equipment precertified for safety, minimal fees, and rapid processing of applications by the interconnecting utility all facilitated PV adoption and cut costs (NNEC, 2007). By all accounts, Fox’s BPU did an excellent job of establishing and implementing net metering and interconnection standards. The Solar Energy Industry Association labeled these standards ‘far and away the best framework’ for other states to adopt (OCE, 2005). The annual ‘Freeing the Grid’ report of the Network for New Energy Choices (2007, 2008) gave New Jersey the highest grade of any state. Installers interviewed for this chapter agreed that the interconnection and net metering process had become routine. New Jersey policy makers provided an additional financial supplement to PV system owners by creating a market for solar RECs (SRECs). LSEs were required to fulfill the solar RPS by buying SRECs, just as they met the RPS as a whole by buying RECs (which might be generated by wind, biomass or other renewable energy systems).5 For each megawatt-hour of electricity that a PV system generated, the owner earned one SREC. The BPU successfully established the infrastructure for SREC issuance and trading in the early years of Fox’s tenure. The trading platform went live in August 2004 (Summit Blue Consulting, 2008, 54–7). SREC trading volume grew steadily, as would be expected with the expansion of PV generating capacity.6 Prices ranged from the equivalent of about 10 cents per kWh (about the same as the avoided electricity cost) to about 26 cents per kWh (roughly twice the value of the avoided electricity cost) between the beginning of trading and the end of 2006 (OCE, ‘n.d. d’). Although the promise of eliminating electricity bills and profiting from SRECs in the future figured into PV system purchasing decisions (see Figure 16.3), there is no doubt that the CORE rebate dominated these calculations. As one customer put it, CORE made his project a ‘no-brainer’ (Finne interview). Summit Blue Consulting (2008, 52) reports on a 2006 survey of CORE program participants, who: indicate that the rebate played a pivotal role in their decision to install a renewable energy system. Only 26 percent of survey respondents said they would have installed the system if the

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Source:

Winka (2006).

Figure 16.3

New Jersey solar financing model with CORE rebate, 2006

CORE program rebate was just 25 percent less than they received, and 94 percent of respondents indicated that the rebate made it possible for the investment to meet their simple payback requirements.

In April, 2003, the state Office of Clean Energy replaced the utilities as the administrator of CORE, and in 2004, the PV market took off. The number of projects tripled that year, while the capacity installed and dollar value of rebates approximately doubled. These indicators quadrupled in 2005 and doubled again the following year, even though rebate levels were reduced four times during these two years. About 18 MW of solar PV generating capacity was installed in New Jersey during the program’s last full year of operation, with the help of more than $78 million in state rebates (OCE, ‘n.d. b’). Suppliers and installers of PV systems responded quickly once the soft infrastructure of net metering, interconnection, SRECs, and CORE rebates was in place. National and regional solar energy firms with experience in California, New York, and other states quickly extended their business models to New Jersey. Existing New Jersey firms in businesses such as construction and HVAC (heating, ventilation, and air conditioning) added PV systems to their portfolios (Robilotta interview). Little new knowledge was required to do so; indeed, do-it-yourself installation was feasible for householders with a

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free weekend and a little mechanical skill (Finne interview). Entrepreneurship in the new market was thus primarily Kirznerian in nature, rather than Schumpeterian. Solar entrepreneurs provided something else at least as crucial to the new market as PV hardware and installation services: information and legitimation. They reached out to communities to find customers. They explained the intricacies of the solar RPS policy to customers and took care of the state’s paperwork for them. They helped customers gain confidence in the policy and in a technology that had been something of a novelty item in the past. Financial considerations predominated among both residential and commercial customers, with environmental motivations serving as ‘just a kicker’, rather than a primary rationale (Hyland interview). Buyers judged the investment in a PV system to be a good value, thanks especially to CORE. The outsized response of Kirznerian entrepreneurs to the availability of generous public subsidies and easy, reliable PV system installation, ironically, proved to be the undoing of New Jersey’s policy. The proximate cause of the bust phase of this boomand-bust cycle7 was the exhaustion of CORE’s budget. Despite the steady decline in the value of the rebate on a unit basis, the total value applied for quickly exceeded the amount budgeted by the BPU, thanks to the rapid growth of the market. In February 2006, OCE began to require solar rebate applications for private projects to wait in a queue, pending available funding. In December, 2007, the BPU finally ordered the program suspended, because the amounts requested by applications in the queue totaled more than the funds that remained. By then, the Board was well along in an exploration of new ways to sustain the growth of the market that it had created.

4

BREAKING MARKETS: THE SOLAR POLICY TRANSITION, 2006–2008

CORE’s budget crisis sparked an intense debate about how to maintain the momentum that New Jersey’s solar policy had created. The BPU resolved this debate by adopting what BPU President Fox termed ‘a fiscally responsible market-based approach to solar financing that strives to achieve solar RPS at the lowest annual cost to ratepayer’ (OCE, Annual Report, 2007, 2). The Board’s new approach relied primarily on SRECs and significantly reduced rebates. The transition was not smooth to the new approach. The state’s ‘self-inflicted wounds’ (in the words of one observer) stalled the PV market’s growth, damaged some participants, and left the state far short of its 2009 solar RPS goal. (See Table 16.1.) Mathematically-minded observers of New Jersey solar policy anticipated CORE’s budget troubles even as the program’s proponents lauded its success. Summing up the situation in September 2006, OCE director Michael Winka estimated that relying on rebates to reach 1,500 MW of solar capacity by 2020 would cost about $500 million per year and raise electricity rates by 5–7 percent. Given that PV would be supplying only 2 percent of the state’s electricity in this scenario, the anticipated cost was perceived by the BPU to be too far out of line. ‘Clearly’, Winka wrote, ‘it is not an option to simply “buy” our way to the RPS goals’ (Winka, 2006, 3). BPU Commissioner Joseph Fiordaliso echoed this sentiment, pledging that the PV market would not be ‘a bottomless pit where government money is wasted’ (Johnson, 2007).

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Table 16.1

Actual PV capacity installed and New Jersey RPS goals (in MW) Incremental Actual

EY2001–05 EY2006 E72007 EY2008 EY2009 EY2010 EY2011 EY2015 EY2021

4.5 10.4 17.6 17.7 26.1 31.8*

Cumulative

RPS goal 4.3 20.3 29.6 57 44.4** 61.1** 104.8** 206.6**

Actual

RPS goal

4.5 14.9 32.5 50.2 76.3 108.1*

5.2 9.5 29.8 59.4 116.4 160.8** 221.9** 556.6** 1,542.4**

Notes ** EY2010 actual through October 31, 2009 only (i.e., first five months of the year) and includes systems that have been certified, are being processed, or have selected qualified contractors. ** Future RPS goals reflect proposed revisions based on the Energy Master Plan (New Jersey, 2008). Sources:

OCE, ‘n.d. b’ (for actual data); OCE, 2009b (for RPS goals).

Downward revision of the RPS was not on the table. If anything, the political and environmental rationale for an aggressive state renewable energy policy had grown stronger. Governor Jon Corzine, elected in 2005, promised in his campaign to meet the ‘20 percent by 2020’ RPS target and to reduce the state’s total energy consumption by 20 percent by 2020 as well (Diskin, 2005). He followed up by signing legislation mandating reductions in the state’s greenhouse gas emissions in 2007 (Electric Power Daily, 2007) and implementing New Jersey’s participation in a regional cap and trade system in 2008 (Platts Commodity News, 2008). The state’s Energy Master Plan, released in October 2008, reaffirmed the Corzine administration’s commitment ‘to place New Jersey at the forefront of a growing clean energy economy’ (New Jersey, 2008, 6) and called for the RPS goal to raised to 30 percent by 2020 while holding energy demand at 2008 levels. In May 2006, the BPU established an RPS Transition Working Group to develop solar policy options that would be less reliant on rebates. The group identified two basic alternatives for sustaining the PV market, SRECs and a feed-in tariff. A feed-in tariff (a policy pioneered in Germany and adopted in California, among other places) would require utilities to purchase PV-produced electricity at a higher-than-market rate. Both alternatives shifted the fiscal burden of the solar carve-out from the present to the future and placed it within the utility rate structure, rather than the state budget. They differed in the certainty that they offered system owners for eventually recouping their investments. A feed-in tariff would lock in the return on a fixed schedule. The value of SRECs, however, would only be determined by the market for SRECs at a stream of future dates.8 BPU staff and consultants (Summit Blue Consulting, 2007) worried that this market risk would undermine the SREC policy’s effectiveness. ‘In order to allow for a market-based system’, wrote the director of the OCE, ‘the BPU will need to set the floor price below which all buyers must pay a certain price and no lower’ (Winka, 2006, 4). After more than a year of debate, the BPU settled on a policy that relied primarily

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on SRECs and left their value to be determined largely by the market (BPU, 2007). The policy’s most important innovation was to raise the alternative compliance payment for LSEs that failed to meet the RPS and did not buy enough SRECs to make up their shortfall from $300 to $711 per megawatt-hour.9 This higher ‘penalty’ raises the value of SRECs when they are in short supply, functioning as a price ceiling. The Board also continued the rebate program for small PV systems, but at a much lower level than in the past (declining from $3 per watt in 2009 to 75 cents per watt in 2012) and with a much smaller budget ($53 million over four years).10 More notable was what the BPU did not do: it did not create a mechanism that would yield a price floor for SRECs, nor did it remove the cap on system size in order to take greater advantage of economies of scale (OCE, 2007). Those interviewed for this chapter were uncertain about the exact motivations for this decision. For some, it reflected a market-oriented mentality flowing from Governor Corzine, a former senior executive of the investment bank Goldman Sachs. Others sensed an unspoken imperative to limit the perceived cost of the policy, a view supported by the inclusion of a ‘circuit-breaker’ in the new policy that would freeze the program if its rate impact exceeded 2 percent. State policy makers perceived the proposed feed-in tariff as a form of taxation that created a political vulnerability for the ruling Democratic party, even though the feed-in tariff was strongly supported by some of the state solar industry’s most prominent leaders (Legros interview; Robilotta interview). Unfortunately for the BPU, the predictions of its staff and consultants, rather than the hopes of the Board members, were realized. Many lenders took a conservative view of future SREC earnings and so refused to finance new systems against those earnings. As one executive put it, the New Jersey solar market went on a ‘hiatus’ in 2007 (Zalcman interview). The residential market was particularly hard hit, dwindling, by one account, to a few cash-rich customers who were willing to self-finance their projects (Robilotta interview). The transition ‘wreaked havoc’ on small businesses that had placed residential PV installation at the core of their business model (Hyland interview). Federal tax incentives that were put in place in 2006 buffered the commercial market somewhat from the downdraft caused by the new state policy. The new 30 percent investment tax credit (ITC), supplemented by the ability to depreciate the investment on an accelerated schedule, allowed some projects to reach viability without the state rebate and without an SREC floor price.11 This market was also aided by ‘financial innovation’ (Bolinger, 2009) which created vehicles that allowed investors with ‘tax equity’ to match up with project developers.12 However, the state’s cap on the size of projects that would generate SRECs and be eligible for net metering, as well as the relatively low rates (wholesale prices) paid by the utilities for PV-generated power, limited the reach of this innovation in New Jersey (Zalcman interview). The BPU apparently hoped that LSEs generating power by conventional methods would provide financing for some solar projects by agreeing to purchase their SRECs on a long-term basis. Such deals would fix the LSE’s cost of compliance with the RPS and hedge against fluctuations in the SREC market. However, because New Jersey rebids its base electricity load every three years, generators cannot be confident that they will need SRECs over a longer period than that. ‘Securitization’ of SRECs, as this financing model was called, proved to be a mirage. Anecdotal reports of cancelled projects and failed businesses congealed into hard data

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as the new policy was implemented. New Jersey’s initial ‘20 by 2020’ RPS schedule called for 90 MW of solar capacity to be installed by the end of the 2008 energy year (May 31, 2008) and another 50 MW to be installed in EY 2009 (OCE, ‘n.d. a’). By early 2009, it was clear to all observers that the state was ‘behind schedule’ (Siebens interview) at a minimum. A recent accounting from OCE stated that about 50 MW of PV capacity were installed between the beginning of the state’s program and the end of the 2008 energy year, and another 26 MW were certified during the 2009 energy year. Meanwhile, the RPS goals are being scaled back. Yet, even at the lower levels, the EY 2009 shortfall was about 40 MW of installed capacity or a third of the total (OCE, ‘n.d. b’). (See Table 16.1.) RPS shortfalls should trigger penalty payments. If SRECs stay at their current price, which is at or near the penalty level (a ‘gold mine’ for current system owners, in the words of installer Peter Robilotta), more investors will sense an opportunity in New Jersey solar projects.13 However, the mismatch between the three-year time horizon of LSEs and the 10 years that the BPU used to calculate the penalty level means that the LSEs are unlikely to fill the financing gap even with the threat of penalties hanging over them. The penalties are simply too small to warrant them taking the risk of financing PV systems. The evaporation of tax equity as a result of the financial crisis that began in 2008, which wiped out most of the profits against which tax credits had been taken, has eliminated that source of funding as well.14 The federal stimulus package was seen by some in New Jersey as a potential source of funds for solar projects in early 2009, but its ultimate direct impact proved to be modest. The BPU, in any case, was not content to wait and see whether the nascent positive feedback process that its policies had set in motion before 2007 would be reignited by financial innovation or federal intervention. Instead, it sought to revive the market by tapping into the only off-budget source of funding that it had available: the utilities it regulates.

5

REMAKING MARKETS? THE UTILITIES, ‘PATIENT CAPITAL’, AND SOLAR POLICY, 2008–2009

New Jersey’s utilities began the decade of the 2000s at the center of the state’s EE/RE programs. Even after restructuring, they administered these programs, which were now funded by the SBC that appeared on every ratepayer’s bill. However, the change of partisan control of the state government in 2002 removed the utilities from this position, leaving them with only a few small efficiency-related programs (Siebens interview). The solar RPS shortfall that emerged in energy year 2008 led the BPU to reconsider its relegation of utilities to the sidelines, even as the state’s largest utility, PSE&G, sought to get back on the field for its own reasons. The BPU turned to what it called the ‘patient capital’ of the utilities to bridge the solar financing gap created by uncertainty about future SREC pricing. PSE&G, for its part, proposed building its own PV capacity as well as financing others’ systems, collaborating with smaller firms that had entered the New Jersey market over the past decade as it did so. Its effort revived the New Jersey PV market during the 2009 calendar year. Within a few months after settling on the new SREC-intensive solar policy in

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BPU: Retires SRECs

SRECs for sale

Power

SRECs

Loan

Self-generated or Purchased

Power

or Alternative compliance payment Fulfill RPS

Power LSE: Generates electricity Must meet solar RPS

PV system owner: Generates and consumes electricity

EDC: Delivers electricity SRECs for sale

SRECs repay loan

Earns SRECs

Note: * As noted in the text, a small CORE rebate remains available for residential systems through 2012, but this program is not represented in the figure. Source:

Author.

Figure 16.4

New Jersey solar RPS works + utility solar loan programs*

September, 2007, the BPU felt ‘the gravity and urgency of the situation’ it had created. New Jersey’s solar market had seized up. The credit squeeze, which dated back to the beginning of the transition debate in early 2006, was not eased by the Board’s policy decision, placing it under pressure to do something else. Yet, the BPU was not ready to reopen the core issues. ‘We have our model’, a May 2008 BPU press release quoted Board member Joseph Fiordaliso as saying, ‘and the Board will not consider a feedin tariff or any other non-competitive mechanism involving fixed pricing. We .  .  . are focused on developing a securitization solution expeditiously’ (BPU, 2008a). A central element of that solution was already in sight, in the form of PSE&G’s ‘solar loan’ program. First broached with the BPU in April 2007 and officially announced by the utility in April 2008, the program put aside $105 million to fund up to 30 MW of PV generating capacity over two years. PSE&G agreed to take repayment of these loans in SRECs, and, crucially, it set a floor price of $475 for each SREC that it would receive over the 10-year life of each loan. PSE&G proposed to aggregate these SRECs and sell them to LSEs, which could then use them to meet the RPS. (See Figure 16.4.) If the SREC market price at the time of sale (which must be within two years of the date of SREC’s issuance) was below the $475 floor, the utility would lose money on the transaction. PSE&G made clear that it would not try to maximize its own gains in the SREC market, but would instead sell SRECs in a transparent auction process and credit borrowers with the market price if it was above the $475 floor (PSE&G, ‘n.d. e’). The PSE&G solar loan program built on several precedents established by CORE. It

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offered to fund 40–60 percent of the capital cost of each system. It divided the market into customer segments that bore a strong resemblance to those used by CORE and allocated specific shares of the budget to each. (In fact, residential PSE&G solar loan borrowers generally remained eligible to receive state rebates at the new reduced rates from 2009 to 2012.) As in CORE, PV system scale was limited by interconnection and net metering rules and by the customer’s historical annual energy usage (PSE&G, ‘n.d. b, c and d’). PSE&G’s motivation for offering this program, which seemed to promise at best to break even and at worse to lose money, may have been political. With the state moving toward implementing a mandatory greenhouse gas emissions reduction policy, the company may have wanted to create the public perception that it shared the state’s environmental commitment, even at the risk of taking a modest financial loss. Any loss would ultimately be recouped through the rate base, although that facet of the program was not made explicit immediately. The company may also have seen the solar loan program as a way to learn more about the solar industry and to build business relationships as it considered entering the industry directly. At the same time, PSE&G may well have anticipated that, because the utilities were only the deep-pocketed entities within the reach of the BPU, it would be required to take some action to address the crisis in solar policy and therefore sought to set the terms of such a requirement preemptively. Whether the utility, the solar industry, or the state was the first mover in what one observer likened to a ‘courtship’ prompted by the solar policy transition (Legros interview), the BPU consummated the arrangement with an order at the end of July, 2008, that applied to all four of the state’s electricity distribution companies. The Board required the EDCs to finance 60 percent of the incremental PV capacity called for by the RPS in 2009, 50 percent in 2010, and 40 percent in 2011. The financing was to be provided through long-term contracts for SRECs at prices that would give system owners a payback period of about 10 years (BPU, 2008b). The three EDCs other than PSE&G (JCP&L, Atlantic City Electric, and Rockland Electric) chose to comply with the Board’s order by setting up what amounts to a reverse auction, rather than setting a fixed floor price for SRECs as PSE&G had. Each PV system developer who wants to participate in these utilities’ programs will propose a minimum acceptable SREC price. The utilities will then offer long-term contracts to purchase SRECs from those projects for which the costs over the term of the contract will be lowest, until they have met their Board-mandated capacity quotas (which total 61 MW through 2012). They will recover any costs of this program (net of SREC revenues) through a separate charge on all customers. The program is limited, by BPU order, to systems under 500 kW in size, and the companies have agreed to an ‘aspirational goal’ that 25 percent of the capacity in the program be comprised of systems of 50 kW or less. Like PSE&G, the other utilities will sell SRECs to LSEs through a transparent auction process (Siebens interview, BPU, 2009b; OCE, ‘n.d. c’).15 These utilities would prefer that the size limitation and the associated aspirations to serve the residential and small commercial markets that were imposed by the BPU be removed altogether (Siebens interview). Larger systems have lower unit costs, and therefore their developers should be able to accept a lower SREC price. A smaller number of contracts with developers of larger projects should also lower the programs’

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administrative burden. PSE&G’s experience to date with its solar loan program reveals a bias toward larger systems as well. Although the initial allocation to the residential segment of the program when it was announced was 6 MW out of the 30 MW total, the company reported that it actually funded 28.7 MW of non-residential systems when the program was concluded in late 2009 (PSE&G, ‘n.d. a’). The BPU approved PSE&G’s reallocation, presumably to try to close the solar RPS shortfall as quickly as possible. Through the first five months of energy year 2010 (June 1–October 31, 2009), some 22 MW of PV capacity were installed and qualified contractors were selected for another 10 MW (OCE, ‘n.d. b’). That is roughly twice the pace of the previous year. (See Table 16.1, above.) The Board’s accession to the financial and administrative logic of emphasizing larger PV systems is also suggested by the fact that nine of the 10 largest PV systems in the state (all larger than 1 MW) were approved in calendar year 2009 (ibid.). The Board’s reluctance to give in to this logic altogether16 probably reflects concerns about the fate of smaller solar industry firms (Legros interview). Under the utility solar loan program, ‘residential’, one installer stated, ‘gets screwed’ (Robilotta interview). Perhaps the most consequential move toward large systems made by the BPU was its removal of the cap that limited any entity from receiving SRECs on more than 2 MW of solar generating capacity (BPU, 2009a). This decision coincided with PSE&G’s announcement of a $515 million, five-year program to build 80 MW of PV capacity that it would own and operate. Most of these ‘in-front-of-the-meter’ systems will be built on brownfield sites owned by the company or placed on 200,000 electric poles around the state (Holly, 2009).17 PSE&G expects to build this capacity at a cost of $6.44 per watt, 22 percent less than the $8.25 per watt it estimated that CORE-funded projects cost (PSE&G, 2009). It plans to partner with independent developers on some of the new systems, although it will also use its own personnel. (Figure 16.5.) With this announcement, PSE&G joined a select group of utilities around the US that are making substantial investments in distributed solar power (Wang, 2008). The federal government encouraged this trend in the October 2008 TARP bill, which, in addition to extending the 30 percent investment tax credit for solar power through 2016, permitted utilities to claim the credit for the first time. If, however, federal subsidies and SREC sales fail to allow PSE&G to make back its investment, the investment will be recovered from ratepayers through a separate charge (BPU, 2009d; PSE&G, 2009). This program not only enhances PSE&G’s ‘green’ public image, it also puts the firm back into the power generation business in a relatively risk-free manner. In pursuit of the RPS goals, the BPU has reversed – albeit in a very small way for now – the vertical disintegration imposed by the restructuring of the New Jersey electricity market in 1999.

6

SUSTAINING MARKETS FOR PV ELECTRICITY: LOOKING FORWARD AND OUTWARD

The state of New Jersey has accomplished a lot in the past seven years. Its PV market is in the top tier of US states after California and has regained its momentum after stumbling. The utility programs that are now in place will fulfill much of the required increment to achieve the solar RPS goals over the next couple of years. The soft infrastructure of net

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BPU: Retires SRECs

SRECs for sale

Power

SRECs

Loan

Self-generated or Purchased

Power

or Alternative compliance payment Fulfill RPS

LSE: Generates electricity Must meet solar RPS

Source:

SRECs for sale

Power EDC: Delivers and generates electricity

PV system owner: Generates and consumes electricity SRECs repay loan

Earns SRECs

Earns SRECs

Author.

Figure 16.5

New Jersey solar RPS + utility solar loan and in-front-of-the-meter programs

metering, interconnection, and SREC trading continues to function well. Potential customers seem to view PV systems as an established and reliable product that will give them the services that they expect if the price is right, rather than an exotic and risky proposition. These accomplishments resulted from a cycle of policy innovation, entrepreneurial response, and further policy innovation. To be sure, the cycle produced volatile, rather than smooth, market growth. The positive feedback from the state’s initial rebate program was so intense that even repeated reductions in the rebate levels could not stop installers and their customers from swamping the program. The ‘hiatus’ that followed in 2007–08 challenged entrepreneurs who had entered during the boom phase of the cycle. Yet, the PV industry bounced back in 2009 as PSE&G came to the aid of the BPU with its solar loan and in-front-of-the-meter programs. Ease of entry accounts for much of the New Jersey industry’s resilience. A large pool of nascent entrepreneurs, many of whom have other lines of business (such as HVAC) or who work in other markets, seem to be alert, in the Kirznerian sense, to opportunities to fill gaps in the market. The growth of PV markets in surrounding states, such as Pennsylvania and Maryland, and the expanding federal role in the solar industry surely help in this regard. Yet, the PV technological system remains very reliant on public policy to sustain its momentum. PV-generated electricity in New Jersey is still several times as expensive as conventional electricity. That means that the protected space for the PV electricity market must be maintained. Such protection will be required even if a stronger greenhouse emissions control policy is put in place at the state, regional, or national level. In

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addition, the capital cost of PV systems remains a major barrier for customers. Financial and business model innovation have helped reduce this barrier, but that innovation, too, has been dependent on federal and state subsidies. Sustaining protection and subsidies over the medium term will depend on the strength of the political coalition supporting them. The most recent policy innovations at the state level could have a potentially powerful effect in this regard, by inducing utilities to join the solar policy coalition. As we have seen, the utilities may gain new business and improve their image by doing so. They would probably be able to exert substantial control over this coalition, since they provide so much of the funding for the state’s PV market and are becoming major partners of developers and installers. The strength and stability of any such coalition has yet to be proven. It is likely to be put to the test very shortly. In November, 2009, the voters of New Jersey elected Chris Christie as governor, the first Republican to win the office since 2001. As a candidate, Christie stated: ‘I will push hard on renewable energy’, but he also stated that he would remove the issue from the BPU’s purview and focus solar policy on projects at landfills and in rural areas (Birretteri, 2009). Utility support for continuity in solar policy might sway the new governor, particularly in light of the many other significant challenges that face him, such as unemployment and political corruption. For many environmental advocates and solar entrepreneurs, the idea of making common cause with the utilities may be difficult to accept. Utilities have been pillars of the status quo and often simply the enemy. Yet, it is worth bearing in mind that many technological transitions are hastened when old-technology incumbents gain a share of the opportunities offered by new technologies. At a minimum, they relax or cease resistance to change. In some cases, they become active proponents of innovation, even if they do so only in order to shape the terms of the transition to their benefit. In the longer term, the transformation of the fossil-fuel-burning system will depend on Schumpeterian entrepreneurship that has not yet succeeded in the case of PV electricity. New Jersey is just one medium-sized market in the global context, and it seems that it will take the creation and maintenance of many such markets over many years before true ‘grid parity’ (in which PV and other forms of electricity are equal in price) is reached, if it is indeed reachable. From this point of view, New Jersey’s success in sustaining a PV market will depend much more on the rest of the world’s success in doing the same than the other way around.

NOTES *

1. 2.

Research for this chapter was supported by the Energy Innovation Project at the Industrial Performance Center, MIT, and by the Doris Duke Charitable Foundation. Thanks to Kadri Kallas for research support; Richard Lester, Rohit Sakhuja, Phech Colatat and the IPC project team for support and advice; Dan Sarewitz and Chris Hill for comments, Dennis Wilson for his patience; and interviewees listed in Appendix 16.A (as well as those who provided information without attribution) for their time and knowledge. All conclusions and recommendations are solely my responsibility, and none should be attributed to the interviewees or the MIT team. Utilities had been authorized before the EDECA to impose charges for purposes similar to those of the SBC. The EDECA reorganized the process for setting the charge and using the funds generated. The New Jersey Energy Master Plan (New Jersey, 2008) calls for the solar carve-out to be defined in terms of absolute capacity, rather than as a share of capacity. See Table 16.1.

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322 3. 4. 5. 6. 7. 8. 9. 10. 11.

12. 13. 14. 15. 16. 17.

Handbook of research on energy entrepreneurship Summit Blue Consulting (2008, 6) calculated that the average cost of the rebate per watt over the program’s lifetime was $3.88. Total installation costs remained flat throughout the program, averaging around $8 per watt. A PV system’s size is typically limited in New Jersey so that it produces no more than the annual consumption of the customer installing it. In other words, the net meter cannot run in the customer’s favor over the course of a year. LSEs could also earn SRECs by installing their own solar systems or pay the alternative compliance payment (ACP) to meet their RPS obligations. See Figure 16.2. Summit Blue Consulting (2008, 56) notes, however, that many owners of PV systems apparently do not sell their SRECs. Spain experienced an even larger solar boom-and-bust cycle (Luthi and Wüstenhagen, 2008) and some predict that Germany may be on the cusp of one, too (Shah, 2009). Under both alternatives, the system owner had to absorb the risk that the system might not produce enough electricity to earn an adequate return (technology risk) and the risk that policy makers might change course in ways that would diminish the return (policy risk). An eight-year declining schedule was established for the penalty payment on the assumption that system prices would also decline over that period. The rebate levels have recently been revised downward to a range of $1.00 to $1.75 per watt for eligible PV systems. See Renewable Energy Incentive Program Guidebook (OCE, 2009a). The ITC was renewed for a year in late 2007 and then for eight years in 2008. The uncertainty associated with these renewals created temporary disruptions in the market during part of this period. The 30 percent ITC was capped in 2006 at $2,000 for residential systems, which was too small a share of the total cost of most residential systems to significantly impact the financing decision. The cap was removed in 2008. Accelerated depreciation is known formally as the Modified Accelerated Cost Recovery System (MACRS). ‘Tax equity’ is a presumptive tax liability that investing in a solar project allows the investor to avoid. Financial institutions accruing large profits in this period, such as banks and investment houses, were typical tax equity investors. Monthly prices can be reviewed on the OCE website at . Many trades during 2009 were reported in the high $600 range. Lehman Brothers, which went bankrupt in September, 2008, was one of the biggest tax equity investors. The first reverse auction for this program was held in September 2009, and yielded contracts for 1.6 MW of solar capacity, about 10 percent of what had been anticipated (Powers, 2009). In PSE&G’s second solar loan program, which was approved by the BPU in November 2009 and will fund 51 MW over two years, the 500 kW size limitation and allocation of capacity across categories were reinstituted (BPU, 2009c). The floor prices for SRECs in this program will also decline over time. PSE&G originally proposed another 40 MW of capacity that it would build for municipalities and school districts, but this component of the program was rejected by the BPU. Some 15 MW of the 80 MW approved will be placed at third-party locations and in urban enterprise zones.

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BPU (2009b), ‘JCPL and ACE Solar Financing Order’, 27 March, available at: (accessed 13 May 2009). BPU (2009c), ‘Solar Loan II Order’, 10 November, available at: (accessed 3 January 2010). BPU (2009d), ‘Solar4All Order’, 29 July, available at: (accessed 31 December 2009). Business Wire (2001), ‘New Era in New Jersey for renewable energy and energy efficiency launched at Energy Futures Forum’, 18 April. Cohen, Boyd and Monika I. Winn (2007), ‘Market imperfections, opportunity, and sustainable entrepreneurship’, Journal of Business Venturing, 22: 29–49. Covert, James (2000), ‘Utilities, consumer groups square off over funds in New Jersey program’, Dow Jones Business News, 11 February. Dean, Thomas J. and Jeffery S. McMullen (2007), ‘Toward a theory of sustainable entrepeneurship: reducing environmental degradation through entrepreneurial action’, Journal of Business Venturing, 22: 50–76. Diskin, Colleen (2005), ‘Environmentalists back Corzine’, Bergen County Record, 15 October. Electric Power Daily (2007), ‘New Jersey OKs bill to cut GHG emissions’, 25 June. Granovetter, Mark (1985), ‘Economic action and social structure: the problem of embeddedness’, American Journal of Sociology, 91: 481–510. Halbfinger, David (2001), ‘Sierra Club endorses McGreevey for Governor’, New York Times, 23 August. Hayek, Friedrich (1945), ‘The use of knowledge in society’, American Economic Review, 35: 519–30. Holly, Chris (2009), ‘New Jersey boosts solar profile with PSE&G project’, Energy Daily, 31 July. Hughes, Thomas P. (1989), American Genesis, New York: Viking. Jacobsson, Staffan, Bjorn A. Sanden and Lennart Bangens (2004), ‘Transforming the energy system – the evolution of the German technological system for solar cells’, Technology Analysis and Strategic Management, 16: 3–30. Johnson, Tom (2005), ‘Consumers will fund state’s promotion of technologies’, Newark Star-Ledger, 5 January. Johnson, Tom (2007), ‘Officials approve Jersey’s solar push – the system is part of goal to reduce state’s pollution’, Newark Star-Ledger, 13 September. Kirzner, I.M. (1973), Competition and Entrepreneurship, Chicago, IL: University of Chicago Press. Kushler, Martin, Dan York and Patti Witte (2004), ‘Five Years In: An Examination of the First Half-Decade of Public Benefits Energy Efficiency Policies’, American Council for an Energy Efficient Economy Report U041, April. Luthi, Sonja and Rolf Wüstenhagen (2008), ‘Effective deployment of photovoltaics in Mediterranean countries: balancing policy risk and return’, paper presented at DEMSEE, September 22. Mokyr, Joel (2002), The Gifts of Athena, Princeton, NJ: Princeton University Press. Naughton, Barry (1995), Growing Out of the Plan: Chinese Economic Reform, 1978–1993, New York: Cambridge University Press. Network for New Energy Choices (NNEC) (2007), Freeing the Grid, New York: NNEC. Network for New Energy Choices (NNEC) (2008), Freeing the Grid, New York: NNEC. New Jersey (2008), New Jersey Energy Master Plan, October. OCE, Annual Report, various years. OCE (2005), ‘Nations’ best standards bring solar boom to New Jersey’, press release, 25 April, available at:

(accessed 6 May 2009). OCE (2006), ‘New Jersey leads the nation with expanded commitment to solar and clean, renewable energy’, press release, 12 April, available at: (accessed 5 May 2009). OCE (2007), ‘FAQ: NJ Solar Financing Program (December 17, 2007)’, available at: (accessed 13 July 2009). OCE (2009a), Renewable Energy Incentive Program Guidebook, 9 January, available at: (accessed July 13, 2009). OCE (2009b), ‘Discussion only Draft RRPS Rule Amendments Solar’, 9 July, available at: (accessed 3 January 2010). OCE (n.d. a), ‘Latest OCE estimate of RPS-driven demand for RECs & SRECs’, available at: (accessed 2 January 2010). OCE (n.d. b), ‘NJ solar installations as of 103109’, available at: (accessed 22 December 2009). OCE (n.d. c), ‘SREC-based financing FAQs’, available at: (accessed 13 May 2009). OCE (n.d d), ‘SREC pricing’, available at: (accessed 6 May 2009). Parker, Akweli (2002), ‘New Jersey Governor wants to make state a model of clean energy consumption’, Philadelphia Inquirer, 18 December. Platts Commodity News (2008), ‘New Jersey lawmakers pass GHG bill over green groups’ objections’, 7 January. Powers, Mary (2009), ‘Two New Jersey utilities receive eight proposals in first solar certificate program’, Electric Utility Week, 5 October. Prior, James T. (1995), ‘Modifying the monopolies: utilities embrace deregulation’, New Jersey Business, 1 September. PSE&G (2009), ‘Solar 4 all petition’, 10 February, available at: (accessed 13 February 2009). PSE&G (n.d. a), ‘Current capacity commitments’, available at: (accessed 22 December 2009). PSE&G (n.d. b), ‘Frequently asked questions (FAQ) – non-residential’, available at: (accessed 3 February 2009). PSE&G (n.d. c), ‘Frequently asked questions (FAQ) – residential’, available at: (accessed 3 February 2009). PSE&G (n.d. d), ‘Program rules’, available at: (accessed 3 February 2009). PSE&G (n.d. e), ‘PSE&G Solar Loan Program’, available at: (accessed 13 May 2009). Renewable Energy Task Force (2003), ‘Report submitted to Governor James E. McGreevey’, 24 April. Ress, David (2001), ‘Price of New Jersey’s cleaner power programs is 1 percent rate hike’, Knight Ridder Tribune Business News, 2 March. Revelle, Roger A. and Hans E. Suess (1957), ‘Carbon dioxide exchange between atmosphere and ocean’, Tellus, 9: 18–27. Sanden, Bjorn A. and Christian Azar (2005), ‘Near-term technology policies for long-term climate targets – economy wide versus technology specific approaches’, Energy Policy, 33: 1557–76. Schumpeter, Joseph A. (1942), Capitalism, Socialism, and Democracy, New York: Harper. Shah, Vishal (2009), ‘The future of photovoltaic energy’, paper presented at NJ Clean Energy Conference, 22 October. Sullivan, John (2002), ‘Trying to save energy may come at a price’, New York Times, 16 June. Summit Blue Consulting (2007), Preliminary Review of Alternatives for Transitioning the New Jersey Solar Market from Rebates to Market-Based Incentives, Boulder, CO: Summit Blue. Summit Blue Consulting (2008), Assessment of the New Jersey Renewable Energy Market, Vol. I, Boulder, CO: Summit Blue. Taylor, Margaret (2008), ‘Beyond technology-push and demand-pull: lessons from California’s solar policy’, Working Paper GSPP 08-002, Goldman School of Public Policy, University of California Berkeley. Twyman, Anthony and Tom Johnson (1999), ‘Energy shopping bill takes key step – Republicans speed utility deregulation’, Newark Star-Ledger, 8 January. Wang, Ucilia (2008), ‘Duke Energy eyes residential rooftops’, Greentech Media, 9 June, available at: (accessed 18 February 2009). Winka, Michael (2006), ‘White Paper’, in White Paper Series: New Jersey’s Solar Market Transition to a Market-based REC Financing System, 25 September, 2–7.

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APPENDIX 16.A INTERVIEWS Bradford, Travis, Prometheus Institute, March 16, 2009. Finne, James, December 19, 2008. Hyland, Owen, Alternative Energy Associates, December 19, 2008. Legros, Susan, Mid-Atlantic Solar Energy Industry Association, February 17, 2009. Robilotta, Peter, EVCO Mechanical, December 19, 2008. Siebens, Chris, Jersey Central Power & Light, December 22, 2008. Taub, Steven, GE Energy Financial Services, March 3, 2009. Zalcman, Fred, SunEdison, March 20, 2009.

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17 International entrepreneurship and technology transfer: the CDM situation in China João Aleluia and João Leitão

1

INTRODUCTION

The Kyoto Protocol is one of the most important milestones achieved so far by the international community in the effort to curb climate change. Coming into effect in February 2005 after Russia’s ratification, this Protocol determines that a set of industrialized countries reduces their combined emissions of greenhouse gases by an average of 5.2 per cent below 1990 levels until 2012. The Protocol does not specify how these reductions should be achieved, but it proposes three flexible market-based mechanisms to help industrialized countries meet their commitments: emissions trading scheme (ETS); joint implementation (JI); and clean development mechanism (CDM). The CDM allows countries that have accepted emission reduction targets to develop or finance projects that reduce emissions in developing countries in exchange for reduction credits called certified emission reductions (CERs) (Dechezleprêtre et al., 2008). By providing financial and technological assistance to these countries, the CDM not only contributes to the mitigation of climate change effects and sustainable development needs, but also enables developed countries to achieve lower compliance costs on their greenhouse gas reduction commitments (Castro and Michaelowa, 2008). Having the CDM as the core topic of our analysis, this chapter has one main goal, which is to frame the CDM in the state of the art of the literature on international entrepreneurship and technology transfer. The contribution of this chapter to the literature on energy entrepreneurship is twofold: (i) to present foreign direct investment (FDI) as a potential mechanism for international technology transfer, in a context of an increasingly globalized market; and (ii) to shed some light on the role played by energy start-ups in contributing to reaching sustainable development goals, regarding the increasing entrepreneurial activity observed in developing countries, such as China. The Chinese situation is considered a suitable laboratory for assessing the role played by the CDM as a mechanism of international technology transfer. Consequently, several implications are provided to policy makers, and recommendations are also presented for future action by managers and practitioners engaged in energy start-ups located in China. The focus on China is justified for three main reasons. First, China is currently the world’s largest emitter of greenhouse gases (IEA, 2007), making the deployment of low-carbon technologies imperative. Second, Chinese policy makers are increasingly aware of the unsustainable path the country is following, and have been directing efforts to address this issue, including the setting up of an energy efficiency programme and a renewable energy law. And third, China has the highest share in the world of CDM 326

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projects implemented so far (Schneider et al., 2008), making it important to examine the Chinese CDM framework in terms of its adequacy in fostering the investment of foreign entrepreneurs and the international transfer of technologies. The remainder of the chapter is organized as follows. After this introduction, Section 2 reviews the international linkage between entrepreneurship and technology transfer. An overview of these two crossing research streams is provided, and the section ends with an assessment of relevant mechanisms for international technology transfer. Section 3 situates both the Kyoto Protocol and the CDM in the context of global efforts to curb climate change, highlighting the role of public policy makers and the need to disseminate so-called ‘environmentally sound technologies’. Then the focus turns to the CDM: its basic concepts are briefly reviewed and its importance as a technology transfer mechanism is analysed. This section ends by assessing the CDM situation in China. Finally, Section 4 concludes and also provides implications and recommendations for policy makers, managers and practitioners engaged in the areas of energy entrepreneurship and technology transfer.

2

ENTREPRENEURSHIP AND TECHNOLOGY TRANSFER: THE INTERNATIONAL LINKAGE

International Entrepreneurship Entrepreneurship is one of the driving forces of endogenous growth in modern economies. As a primary source of job creation, economic competitiveness and innovation, governments are increasingly aware of its importance, and have been shaping public policies to foster entrepreneurial activities (Acs and Szerb, 2006; Leitão and Baptista, 2009; Monitor Group, 2009). The importance of public policy oriented to entrepreneurship is underlined, for example, in the EU Commission’s acknowledgement that one of the current challenges faced by the EU is to identify the main factors that determine an enabling environment for entrepreneurial initiatives across all sectors of the economy (EU Commission, 2003). With respect to a sector related to the transition towards a low-carbon economy, Jacobsson et al. (2009) observe that such concerns should be taken into consideration in the EU’s renewable energy policy, which should be designed to secure attractive conditions for new entrants and entrepreneurs across the value chain of the energy industry and for a broad range of technological solutions. The identification and exploitation of business opportunities lies at the core of entrepreneurship (Brown and Kraus, 2009). While for many years opportunities available to entrepreneurs were confined to domestic borders, globalization of markets has expanded the scope of opportunity exploitation to the global arena. This has enabled many companies to adopt a global focus from the outset and pursue a rapid path of internationalization (Oviatt and McDougall, 1994). As a result, the study of international entrepreneurship has gained considerable interest among academics and practitioners in recent years, emerging as an independent field of academic studies. According to several authors (for example, Stearns and Hills, 1996; Wennekers et al., 2005), no single definition of entrepreneurship exists. Grilo and Thurik (2004) contend

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that entrepreneurship is a multidimensional concept, whose definition largely depends on the focus of the research undertaken. Concurrent with this view, the OECD considers that entrepreneurship manifests itself in many different ways, with the result that several definitions have been proposed and no single definition has been generally agreed upon (OECD, 2008). Regardless of the notion adopted, there is some consensus that entrepreneurship revolves around the process of change (Audretsch, 2002) and innovation (Michael, 2007). Audretsch (2002, 2007) asserts that entrepreneurship is about change, since entrepreneurs are agents of change. However, such conceptualization poses considerable complexity, as the concept of change relates to some reference or benchmark, that is, what may be perceived as change to an individual or organization may not imply any novelty to the related industry. As such, the concept of entrepreneurship is embedded in the local context. While ‘invention’ can be defined as the creation of something new, ‘innovation’ refers to an invention which is brought into use (Bozeman and Link, 1983). Taking into consideration this notion, authors such as Dimitratos and Plakoyiannaki (2003) and Michael (2007), contend that innovation is at the heart of entrepreneurship, with the entrepreneur bringing innovation to the customer whenever it takes place and, in this sense, exploiting opportunities based on needs that are not perfectly addressed or perceived by the competitors. It should be noted at this stage that the efforts to curb climate change provide entrepreneurs with special kinds of opportunities. These opportunities are intended to be special because they result from a market failure – climate change – which, following the vision of Stern (2007), is the greatest market failure the world has ever seen. In common with many other environmental problems, climate change is an externality at its most basic level, and requires public intervention in order to be corrected. As Cohen and Winn (2007) and Dean and McMullen (2007) noted, market failures that contribute to environmental degradation are important to entrepreneurs because they provide significant opportunities for introducing new technologies and innovative business models. One of the most consensual and quoted definitions of international entrepreneurship was proposed by McDougall and Oviatt (2003: 7), who assert that ‘international entrepreneurship is the discovery, enactment, evaluation, and exploitation of opportunities – across national borders – to create future goods and services’. In a similar vein, Zahra and George (2005: 6) consider international entrepreneurship as ‘the process of creatively discovering and exploiting opportunities that lie outside a firm’s domestic markets in the pursuit of competitive advantage’. Based on these definitions, we can conclude that the concept of opportunity is present in all of them, as well as the idea of crossing borders. This comes as no surprise because, as already observed, the notion of opportunity exploitation lies at the core of entrepreneurship research, and international entrepreneurial firms should have the ability to identify and exploit opportunities in an increasingly globalized market (Dimitratos and Plakoyiannaki, 2003). In short, irrespective of the definition adopted, it is widely agreed that international entrepreneurship broadly involves the recognition and exploitation of overseas opportunities (Spence et al., 2008). The challenges posed by climate change are opening a wide range of opportunities to entrepreneurs, nationally and internationally, with policy makers worldwide seeking

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to create the right environmental settings to encourage exploitation of these opportunities. The CDM, one of the most innovative tools originating from the Kyoto Protocol, should be mentioned as having been specifically designed to stimulate entrepreneurs in developed countries to cross national borders and invest in greenhouse gas reduction projects in developing countries. By doing so, they are also facilitating the transfer of technologies to developing countries and contributing to the achievement of sustainable development goals. The act of internationalizing is inherently entrepreneurial and, as such, the theoretical framework of international entrepreneurship encompasses the actions undertaken by companies regardless of their size, age or sector of economic activity (Di Gregorio, 2005; Mtigwe, 2006). However, international entrepreneurship practitioners and researchers’ main focus has been on ventures that internationalize from or near inception (Karra et al., 2008). This phenomenon has been researched under several terms (Thai and Chong, 2008), and in Table 17.1 we provide a brief overview of the main types of venture studied in the international entrepreneurship literature. In the table, we present, for each type of venture, the authors who have coined and studied the concept, its definition, the theoretical framework(s) explaining its emergence and behaviour, the mode(s) of foreign entry, and the criteria suggested by the authors for distinguishing their venture from other venture typologies. From the types of venture examined in the table, it is worthwhile noting that the concepts of ‘born global’ and ‘international new venture’ are the ones most frequently used in the literature on international entrepreneurship (McDougall and Oviatt, 2003). In addition to the similarities that exist between these two concepts, Gabrielsson and Kirpalani (2004) define born globals according to the concept of the international new venture originally proposed by Oviatt and McDougall (1994). This is one of the reasons why several authors use the two concepts interchangeably (for example, Rialp et al., 2005; Thai and Chong, 2008). International Technology Transfer The ‘North–South divide’ is an expression frequently used to designate the economic and socio-political division that exists between the world’s wealthy nations, known as the ‘North’, and the poor developing countries, known as the ‘South’. One of the aspects contributing to this rift is the profound technological gap that exists between developing countries and their developed counterparts. However, historical and empirical evidence suggests that latecomer countries are able to progress significantly in their technological evolution by effectively harnessing an international pool of existing technologies already available from more technologically advanced nations (Radosevic, 1999; Magic, 2003; Hu et al., 2005). It is against this backdrop that the study of international technology transfer assumes special importance. Technology transfer is a key element for economic development across all levels of economic activity and is a fundamental mechanism for fostering economic growth and research and development (R&D) intensity (Radosevic, 1999; Morrisey and Almonacid, 2005). According to Maskus (2004), international technology transfer can be defined as a comprehensive concept that embraces a set of mechanisms for shifting information

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Knight and Cavusgil (1996)

Oviatt and McDougall (1994)

Bell et al. (2001)

Johnson (2004)

Born global

International new venture*

Born-again global

International start-up

Authors

A business organization that, from inception, seeks to derive significant competitive advantage from the use of resources and the sale of outputs in multiple countries Well-established firms that have previously focused on their domestic markets, but which suddenly embrace rapid and dedicated internationalization A new venture that exhibits an innate propensity to engage in a meaningful level of international business activity at or near inception, with the intent of achieving strategic competitive advantage

Small, technology-oriented companies that operate in international markets from the earliest days of their establishment

Definition

Transaction cost theory Resource-based view Network theory Knowledge-based view Network theory Resource-based view Knowledge-based view Internationalization process model Knowledge-based view Network theory

Knowledge-based view Network theory

Theoretical constructs used

Exporting

FDI Acquisition Franchising Exporting

Licensing Alliances (e.g. JVs, use of agents, distributors) Exporting Exporting FDI Alliances

Mode of foreign entry

Typology of new ventures studied in the framework of international entrepreneurship

Type of venture

Table 17.1

Firms internationalize within 5 years of founding, and International sales represent a minimum of 20% of total revenue

Firms that are global from inception or internationalize within 2 years of establishment Begin with a proactive international strategy Predominantly, ‘traditional’ firms, whose internationalization process was prompted by a ‘critical incident’

Begin exporting one or several products within 2 years of establishment

Criteria

331

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Micromultinational

Companies that, from their inception, engage in either home-base-augmenting (HBA) or home-baseexploiting (HBE) activities or both, thus viewing their operating domain as international from the initial stages of the firm’s operation A small or medium-sized firm that controls and manages value-added activities through constellation and investment modes in more than one country

The ventures are built from one rather than several home bases Rapid growth of the venture

In comparison to large multinationals, micromultinationals possess a lower level of resources; have a lower degree of value-added activities abroad; and tend to engage in higher degrees of networking

HBA activities and/or HBE activities

‘Constellation and investment’ modes, such as licensing, franchising, JV or strategic alliances

Knowledge-based view Network theory

Network theory Resource-based view Knowledge-based view

Source:

Own elaboration.

Note: * These authors distinguish 4 types of international new ventures: (i) import-export start-up; (ii) multinational trader; (iii) geographically focused start-up; and (iv) global start-up.

Kuemmerle (2002)

International venture

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across borders and its effective diffusion into the host economies. In line with the vision of Graham (1982), international technology transfer can also be understood as the reception and use by one country of technology developed in another. An important definition of technology transfer to be taken into consideration in the scope of this chapter is the one proposed by the Intergovernmental Panel on Climate Change (IPCC, 2001). Drawing on climate change concerns, technology transfer is described as a broad set of processes covering the flows of know-how, experience and equipment aimed at mitigating and adapting to climate change involving different stakeholders such as governments, private companies, non-governmental organizations and research institutions. In its definition of technology transfer, the IPCC also includes the concept of technology diffusion, which refers to the extent to which a technology is used, that is, the number of people or entities that have adopted the technology. As the content of the technologies transferred can vary significantly, Bell (1987) proposes a typology to classify them. According to this author, technology flows can be classified into three categories: (i) capital goods and technological services, such as the purchase of machinery and equipment; (ii) skills and know-how for operation and maintenance; and (iii) knowledge, expertise and experience for the generation and management of technological change. A commonly used distinction pertains to technology being classified as explicit or implicit. Whereas technology that can be codified into formulas, patent applications and the like can be deemed as explicit, uncodified technology – uncodified in the sense that it requires some degree of implicit know-how from the human resources that handle it – can be regarded as implicit technology (Maskus, 2004). This distinction is important, since whereas explicit technology can be quickly transferred across organizational contexts, the transfer of implicit knowledge poses more difficulties (Duanmu and Fai, 2007). The definitions of technology transfer found in the literature of reference do not take into consideration specific modes of transfer (Radosevic, 1999). However, to overcome this caveat reported in the literature, there are numerous dimensions that can be used to classify technology transfer modes. One relevant modality or dimension of analysis pertains to the maturity of the technology that is transferred. The movement of an established technology from one entity to another is usually known as a horizontal transfer. In contrast, vertical transfers are those technologies that are transferred directly from the R&D to the commercialization stage (Andersen et al., 2007; Ockwell et al., 2008). Another important modality is related to the institutional path through which technology transfers flow. The IPCC (2001) identifies three technology transfer pathways: government driven, private driven and community driven. Government-driven pathways are technology transfers initiated by governments to fulfil specific policy goals. Private sector-driven pathways essentially involve transfers between commercially oriented privately owned organizations; and community-driven pathways are those transfers involving community organizations with a high degree of collective decision making. Technology transfers do not necessarily occur through market interactions. As such, another modality of transfer stems from the market versus non-market dichotomy. The non-market alternative involves acquisition of technology without the consent of the provider, such as through imitation, internet research or industrial espionage (Maskus, 2004; Andersen et al., 2007).

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We can draw some conclusions from the above on the complexity of technology transfer flows. In effect, to capture all these dimensions in a comprehensive model or analytical framework is a difficult task and indeed, few authors have endeavoured to undertake such a challenge. One exception is worthy of note, the work developed by Reisman (2005), where a taxonomy to classify technology transfer modalities is proposed, to provide a broad understanding of the conceptual depth of this topic. Adopting what he calls a ‘cross-disciplinary meta-approach’, the author concludes that technology transfer can be characterized by 173 attributes, which in combination, make up a large array of technology transfer possibilities. We have shown in the above paragraphs that there are several dimensions associated with the modes of technology transfer, which emphasize different aspects of the transfer process. In spite of this, and following Radosevic (1999), most researchers and practitioners have focused their attention on examination of the mechanisms – that is, the channels – that lead to the transfer of technologies. Due to their importance for the current approach, we examine them in the next subsection. Mechanisms for International Technology Transfer Drawing mainly on the categorization proposed by Maskus (2004), which stems from a market versus non-market dichotomy, in the following paragraphs we briefly go through the most important mechanisms for international technology transfer identified in the reference literature. We start with those that can be considered market mechanisms, and then we turn to those that can be considered non-market. We end with other mechanisms that do not necessarily fall into either of these categories. The first and most traditional mechanism for transferring technology, on an international basis, concerns trade of goods and services across borders. In fact, exports carry some potential for the transmission of technological information, not least because they can be studied for design characteristics and reverse engineering (Maskus, 2004). A second mechanism for international transfer of technologies is FDI. In fact, companies that invest abroad are expected, in some way, to transfer some form of technological information to the subsidiaries located in the host economy (ibid.). Taking as reference the approaches of Radosevic (1999), Vishwasrao (2007) and Leitão and Baptista (2011), and in the context of an increasingly globalized market, FDI can be presented as a potential mechanism for transferring technology among affiliated firms that usually involves large resource commitments and provides a high degree of control over the technology that is transferred. A third market-based international technology transfer mechanism is technology licensing. Licensing consists of permission by the owner of a patented invention given to another person or legal entity to perform, in a certain country and for the duration of the patent rights, one or more of the acts covered by the rights to the patented invention in that country (WIPO, 2004). Licensing contracts can vary in several ways, which may affect the degree of control the licenser can retain over the technology, as well as the profits he/she can obtain from the licensee (Vishwasrao, 2007). Franchising is a contract-based organizational structure which, in general, involves two parties: a franchising firm that agrees to transfer a business concept it has developed; and a franchisee, who will implement this business concept in a non-domestic market

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(Teegen, 2000). Franchising is a type of licence agreement between parties, in which there is a transfer of rights and some form of know-how between the franchiser and the franchisee (WIPO, 2004; Welsh, 2007). This process of transfer can assume various guises, namely, in the form of direct franchising, area development franchising or master franchising (Teegen, 2000). Another type of cooperative contract is the one that implies the creation of joint ventures (JVs), which are based on the creation of an entity that embraces two or more firms that pool a portion of their resources in order to create a separate jointly owned organization. As an international technology transfer mechanism, JVs are likely to lead to effective technology transfers, as the technology owner has an incentive to ensure that the underlying tacit knowledge is effectively transferred (Stern, 2007). In addition to the above, there are other noteworthy cooperative and commercial means of international technology transfer that the World Intellectual Property Organization (2004), considers, namely: assignments; consultancy arrangements; and turnkey projects. First, an assignment consists of the sale by the owner of all his/her exclusive rights to a patented innovation, and the corresponding purchase of those rights by another entity. Second, a consultancy arrangement means providing advice and the rendering of other services concerning the planning for, and the actual acquisition of, a given technology that is required by entities located in other countries that do not possess that technology. Third, a turnkey contract arrangement is one in which a party designs and installs a system and transfers it to another party who will then operate it. With regard to non-market mechanisms, a spin-off can be defined as a new company that is created by individuals who were former employees of a parent organization, with technology transferred from the parent organization. According to Rogers et al. (2001), spin-offs represent the transfer of a technological innovation to a new entrepreneurial firm that is formed around that technological innovation. Another non-market mechanism for international technology transfers that is worth mentioning is imitation, which is defined as the process through which rival firms learn the technological secrets of other firms’ products or services (Maskus, 2004). Imitation can be carried out by means of product inspections or reverse engineering, for example. An alternative way to acquire technological information without compensation is to study publicly available information about those technologies. By reading patent applications, for example, rival firms can obtain knowledge about the underlying technologies, which may enable them to develop alternative technologies that do not violate the rights of the original applicants (ibid.). In the reference literature, other important international technology transfer mechanisms can be found that do not necessarily fall into the market versus non-market dichotomy. For instance, so-called ‘Cooperative Research and Development Agreements’ (CRADAs) are an example of cooperative arrangements established between an R&D organization and a receptor organization for technology transfer purposes (Rogers, 2002). As defined by the same author, CRADAs concern the transfer of technologies from federal R&D laboratories in the US to private companies. However, in the context of international technology transfer this type of agreement can be approached as a type of strategic technology alliance. Another means of international technology transfer is to move people who have the technology into receptor organizations. This can be observed in either a market

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or a non-market situation. For example, it can happen when human resources with knowledge of a certain technology leave the firm and join a competitor based on that knowledge. We finish this subsection by summarizing in Table 17.2 the most relevant of these mechanisms, providing a brief description and outlining their strengths and weaknesses, both from the perspective of the transferor and the technology host.

3

CLIMATE CHANGE AND TECHNOLOGY TRANSFER

Background Climate change is one of the most important challenges humanity currently faces. The warming of the planet due to the emission of anthropogenic greenhouse gases is now considered unequivocal (IPCC, 2007), and international collective action is fundamental to address this challenge (Stern, 2007; World Bank, 2008). The first noteworthy event held at international level was the World Climate Conference of 1979, which called attention to the increasing quantities of carbon dioxide being released into the atmosphere. In 1988, the United Nations Environmental Programme (UNEP) and the World Meteorological Organization (WMO) jointly created the Intergovernmental Panel on Climate Change (IPCC), whose main purpose is to assess the latest scientific, technical and socio-economic literature produced on climate change, in order to assist governments in their policy decisions (IPCC, 2009). In 1992, at the Earth Summit Conference held in Rio de Janeiro, concerns over climate change led over 150 nations to sign the United Nations Framework Convention on Climate Change (UNFCCC). The UNFCCC sets out the global framework for action with the goal of stabilizing greenhouse gas concentrations in the atmosphere at a level that avoids dangerous anthropogenic interference with the Earth’s climate system. The Convention came into effect in March 1994, and has achieved near universal ratification to date. The UNFCCC establishes key principles for the collective international response, highlighting the fact that the greatest share of the responsibility to achieve greenhouse gas reductions is assigned to the so-called ‘Annex I countries’. These include 27 industrialized economies and 12 ‘transition economies’, as they are the source of most greenhouse gas emissions. The UNFCCC established the Conference of the Parties (COP), the supreme body for decision making and implementation of the Convention, which is convened on an annual basis. The most significant meeting on climate change so far was the Third Conference of the Parties (COP-3), which was held in Kyoto in December 1997. The outcome of this conference was the agreement on the first international treaty binding Annex I countries to reduce greenhouse gas emissions: the Kyoto Protocol. Now ratified by almost every country in the world, the treaty came into effect in February 2005. The Kyoto Protocol determines that Annex I countries reduce their combined greenhouse gas emissions (excluding those controlled by the Montreal Protocol1) by an average of 5.2 per cent below 1990 levels between 2008 and 2012, which is called the ‘first commitment period’ (Olsen, 2005). The Protocol does not stipulate how these reductions

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Table 17.2

International technology transfer mechanisms

Transfer mechanism

Description

Foreign direct investment (FDI)

An investment abroad, where the company being invested in is controlled by the foreign corporation

Joint ventures (JVs)

An entity that is created when two or more firms pool a portion of their resources and create a separate jointly owned organization

International trade

The exchange of services and goods across international borders

Licensing

Contractual agreement granting permission to another party to use intellectual property under specific conditions

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Strengths and weaknesses FDI provides a high degree of control over the technology which is transferred Due to the above, FDI is more appropriate to the transfer of recent, complex and costly technologies FDI often raises awareness among local companies of the new technological possibilities brought by the foreign firm FDI creates a situation whereby foreign firms may fight with local companies for highly skilled personnel Compared to other mechanisms, JVs are likely to lead to effective technology transfers, as the technology owner has an incentive to ensure that the underlying tacit knowledge is effectively transferred In a JV context, the technology receptor has access to the technology and know-how, as well as capital and market access Allows the spread of costs and risks, as well as different parties learning new skills from each other All exports carry some potential for the transfer of technological information, and as such they can be studied for design characteristics and reverse engineering The transfer of technological inputs to be incorporated into production processes can improve production processes, thereby accelerating technological change in the host economy The acquisition of technology does not ensure its effective transfer Technology transfer that is limited to capital goods can hardly lead to the development of technological capabilities by the receptor Low risk method for technology owners to obtain additional returns from their investments in R&D Licensors keep significant control over the dissemination, use, and protection of proprietary rights The technology licensed may experience some sort of inefficiencies if there are

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(continued)

Transfer mechanism

Franchising

Assignment contract

337

Description

A contractual-based arrangement involving a franchisor and a franchisee, where the former commits itself to transferring a business concept and some knowledge to the latter Sale, by the owner, of all his exclusive rights in a patented innovation to another

Consultancy arrangements

Provision of advice and services by specialized professionals in a certain area

Turnkey projects

A party designs and installs a system and transfers it to another party who will then operate it

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Strengths and weaknesses no representatives in the host economy providing warranty or maintenance services Licensing is a preferable strategy for companies which do not have sufficient resources to enter a foreign country by means of FDI The benefits of licensing largely depend on the latter’s ability to negotiate the conditions of the agreement Licensing may be more appropriate for less complex technologies Low risk method for technology owners to enter a new market Franchisors keep significant control over the dissemination, use, and protection of proprietary rights Long-term commitment to commercialization of the underlying business concept, by both the franchisor and the franchisee Technology suppliers do not retain any significant control over the use of the technology transferred For the technology supplier, it is the most appropriate means of technology transfer if he/she finds it impractical to impose restrictions on the use of the technology Consultancy arrangements usually do not entail the consultant being responsible for the results They do not provide means of continuous involvement by the technology supplier so that upgrades to the technology transferred can be more easily facilitated to the host Does not include measures to provide resources that may be needed for further growth of the host firm It can be advantageous in the case of large projects that require sophisticated planning and coordination skills Turnkey projects are frequently ill-adapted to local conditions They do not provide means of continuous involvement by the technology supplier so that advances in the technology transferred can be more easily facilitated to the host

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Table 17.2

(continued)

Transfer mechanism

Description

Mobility of personnel

Movement of people who have the technology to receptor organizations

Spin-off

A new company that is established by individuals who were former employees of a parent organization, using a technology that is transferred from the parent organization

Source:

Strengths and weaknesses The transfer of specialized personnel, even if just for a limited period, is likely to enhance the effectiveness of the technology transfer The parent organization may, in some cases, support the spin-off firm, by providing either physical assets or financial resources Problems with the transfer of intellectual property rights from the parent organization to the new company may arise

Own elaboration.

should be achieved, but it proposes three flexible market-based mechanisms to allow Annex I countries to meet their commitments: (i) emissions trading scheme (ETS); (ii) joint implementation (JI); and (iii) clean development mechanism (CDM). Multilateral frameworks such as the UNFCCC and the Kyoto Protocol are one ‘dimension’ of the international collective action required to mitigate climate change. According to Stern (2007), two other ‘dimensions’ should be considered: the role of organizations, partnerships and networks such as the International Energy Agency (IEA), or the recently established International Renewable Energy Agency (IRENA), which facilitate and support coordinated international action; and the existence of domestic policy goals that support mandatory initiatives to reduce greenhouse gas emissions (ibid.). The IPCC (2007) highlighted the need for three fundamental policy instruments in order to decarbonize world economies: carbon pricing; traditional regulation (through mandates and subsidies); and innovation policy. As observed in a Deutsche Bank (2008) report, the potential regulation tools outlined above can be considered as major drivers of investment opportunities in climate change. In fact, there are a number of measures that governments can undertake in order to create a suitable environment for investing in solutions that address climate change issues, either serving mitigation or adaptation purposes. These include, for example, the assignment of subsidies to renewable energy generation, taxes on fossil fuels, and the enforcement of environmental standards (Moore and Wüstenhagen, 2004). Worth mentioning in this regard is Germany’s renewable energy law (EEG), which was very successful in increasing the share of renewable energies in the country’s electricity mix, and also enabled the country to achieve leadership status in terms of installed wind power capacity (Wüstenhagen and Bilharz, 2006). Such types of policy measures are likely to open a wide array of opportunities to entrepreneurs, who can reap great benefits if they are able to exploit them quickly. As we shall see below, the CDM is an

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Solutions for addressing climate change issues

Categories Clean energy

Environmental resource management Energy & material efficiency Environmental services

Source:

339

Subcategories Power generation (e.g. renewable energy technologies; clean coal technologies) Clean-tech infrastructure Power storage technologies Biofuels Water (e.g. desalination/purification; wastewater treatment) Agriculture (e.g. irrigation innovation, clean pesticides, seeds) Waste management (e.g. recycling, energy from waste) Advanced materials (e.g. advanced coatings, lightweight substitutes) Building efficiency (e.g. insulation, micro-generation) Power grid efficiency (e.g. storage, smart-metering) Environmental protection (e.g. land conservation, sea defence, forestry) Business services (e.g. insurance, consultancy/advisory, intellectual property, microfinance, ‘green’ focused banking)

Adapted from Deutsche Bank (2008).

example of a policy-driven mechanism which was specifically tailored to stimulate international entrepreneurs. To address climate change, the Deutsche Bank (2008) report proposes four main categories of solutions: (i) clean energy; (ii) environmental resource management; (iii) energy and material efficiency; and (iv) environmental services. Throughout this chapter we shall use the designation ‘environmentally sound technologies’ (ESTs) to encompass the first three categories of solutions (see Table 17.3). A fundamental aspect of public policy action in the global fight against climate change pertains to technology transfer issues. In fact, the transfer of environmentally sound technologies to the developing world has been a clear mandate under the UNFCCC, and this is included in Article 4, paragraph 5 of the Convention: The developed country Parties and other developed Parties included in Annex II shall take all practicable steps to promote, facilitate and finance, as appropriate, the transfer of, or access to, environmentally sound technologies and know-how to other Parties, particularly developing country Parties, to enable them to implement the provisions of the Convention. (UNFCCC, 2009a)

Public policy in this area is particularly important because, as observed by Less and McMillan (2005), one of the main differences between the transfer of environmentally sound technologies and ‘normal’ technologies is that the former are more reliant on regulation and public policy. As many climate-friendly technologies already exist in developed countries (Pascala and Socolow, 2004), their transfer to developing countries will enable them to leapfrog some stages in the technology development process (Stern, 2007; Popp, 2008). The main motivation associated with the support of developed countries in transferring environmentally sound technologies is threefold. First, they are more dependent on

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climate-sensitive sectors (for example, agriculture and forestry). Second, they lack the resources and/or infrastructure to respond to the effects of climate change. Third, these countries have to deal with social challenges related to poverty reduction and, therefore, they may be reluctant to adopt policies that could limit their economic growth (Stern, 2007). The success of the Montreal Protocol has been due, to a large extent, to the process of continuous technological innovation and transfer. Although the climate change challenge is different in scope and dimension, the major stakeholders involved should learn from the Montreal lessons,2 as both problems share a set of basic similarities: they address an externality; they are based on the principle of common but different responsibilities between developed and developing countries; and they rely on technology for their successful resolution. The next subsection analyses the CDM and highlights its importance as a mechanism for the international transfer of environmentally sound technologies that can contribute to reaching sustainable development goals, especially in terms of the entrepreneurial activity observed in developing countries. The Clean Development Mechanism The CDM is one of the three flexible mechanisms under the Kyoto Protocol. The CDM has two main aims: (i) to allow Annex I countries to invest in projects that reduce emissions in developing countries to offset a part of their domestic obligations; and (ii) to assist non-Annex I countries in achieving sustainable development goals. CERs are the CDM’s currency and they are used as the measure of the quantity of greenhouse gas emissions that has been avoided by CDM projects. Notwithstanding the fact that the CDM does not have an explicit technology transfer mandate, one of the sustainable development benefits that CDM projects are expected to bring is the use of technologies and know-how that are not available in the host countries (de Coninck et al., 2008; Doranova et al., 2009; Seres, 2007). In the COP-7 held in Marrakech in 2001, rules were established governing the CDM. Among the most important of these rules are the concepts of ‘additionality’ and ‘baseline’. Concerning the first concept, a CDM project is considered ‘additional’ if the anthropogenic emissions of greenhouse gases are reduced below those that would have occurred in the absence of the project. Reference needs to be made in relation to a ‘business-as-usual’ scenario – the ‘baseline’, the second concept – which represents the greenhouse gas emissions that would occur in the absence of the proposed CDM project. If the emissions of the planned CDM project activity fall below those of the appropriate baseline, the project can be considered additional (see Figure 17.1 for an illustration of the concept). There are three main approaches to developing a CDM project: bilateral, unilateral and multilateral. A bilateral approach is observed when an Annex I country or one of its legal entities invest in projects in partnership with a non-Annex I country (Yamin, 2005). Unilateral projects are those where there is no foreign investment and the project is developed entirely in the host economy (Wilder, 2005). A multilateral approach is where an international financial institution or intermediary puts together a portfolio of CDM activities on behalf of others (Yamin, 2005). One key aspect related to the CDM is that it is intended to stimulate private sector

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Emissions Baseline Emissions reduction Emissions after project implementation Project start Source:

t

Adapted from Lütken and Michaelowa (2008).

Figure 17.1

The principle of the ‘baseline’

investments in climate-friendly projects, because at its core is the generation of credits (the CERs) which have market value and can be sold for a profit (ibid.; Stern, 2007). In this sense, if we exclude unilateral project types from our analysis, then CDM projects can be considered as a form of international entrepreneurship. In fact, the CDM laid out an institutional framework that enables and stimulates firms that own some type of climate-friendly technology to proactively seek new markets for their technologies and at the same time benefit from the extra revenues provided by the sale of CERs. By installing in a certain country a technological solution that leads to the reduction of greenhouse gases, entrepreneurs are moving innovations across borders, bringing change to where it is needed, and also being expected to contribute to local sustainable development goals. As already observed, CDM projects are expected to contribute to technology transfer by financing greenhouse gas reduction activities that use technologies not available in host countries. In one section of the Project Design Document (that is, the standard template document that describes the CDM project), the project developers are required to include a description of how environmentally sound technologies are going to be transferred to host countries. Moreover, certain host countries, such as China, India and Brazil, require some sort of technology transfer to occur for the CDM project to be approved by the respective Designated National Authority (DNA), the entity that supervises the CDM process at a national level (Seres, 2007). According to van der Gaast et al. (2009), it remains to be seen how important CDM’s contribution is in the transfer of environmentally sound technologies to developing countries. Nevertheless, we can find in the literature some studies that have analysed technology transfer issues within the CDM. For this purpose, most of these studies use data collected from the analysis of Project Design Documents. Haites et al. (2006) concluded that technology transfers occur in one-third of the projects analysed (860), accounting for two-thirds of the CERs generated. Seres (2007), making an analysis of the 2293 projects in the CDM pipeline, found technology transfer to be very heterogeneous across project types, varying in terms of reliance on imported technology, knowledge and equipment flows, and the countries where the technology came from. The results obtained pointed out that technology transfer is more common in larger projects, and also in those that count on some sort of foreign participation (that is, bilateral and multilateral projects). Dechezleprêtre et al. (2008) concluded that the probability of transfer is 50 per cent

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higher when a CDM project is developed by a subsidiary of an Annex I country. The study also confirms that the technological capabilities of the host country strongly influence the likelihood of technology transfers, but only in the energy and chemical industry sectors. In the case of agriculture, the authors concluded that technological capabilities reduce the likelihood of accomplishing effective technology transfer. Other studies in the literature about energy entrepreneurship and technology transfer are worth mentioning. Doranova et al. (2009) investigated the sources of technology transfer in CDM projects, and found that in more than half the projects reviewed, the whole package of technology was deployed in the host country. The authors also point out the existence of South-to-South technology transfers in CDM project activities. Adopting a different approach, based on the main factors that characterize technology transfer and interviews with experts, the study by Schneider et al. (2008) corroborates some of the conclusions of previous studies. They observe that the transfer of technology occurs in terms of both equipment and know-how in CDM projects, although they vary considerably depending on technology type, geography and project size. In addition to this, a study elaborated by the ENTTRANS (2008) consortium is also noteworthy because it proposes an approach to support host country DNAs in building the capacity to assess which CDM projects could contribute to the countries’ low-carbon sustainable development needs and priorities. While recognizing improvement opportunities in the CDM as a mechanism for the transfer of environmentally sound technologies, most studies in the reference literature have been moderately positive about the results achieved by the mechanism so far. However, due to the different regulatory stances adopted by CDM host countries, it is important to examine CDM’s potential contribution to technology transfers on a caseto-case basis. In the next subsection we analyse the CDM situation in China, in order to assess the role played by the CDM in promoting international technology transfer and reaching sustainable development goals, in terms of the increasing entrepreneurial activity observed in this developing country. The CDM Situation in China China is the world’s most populous and fastest-developing country. Its economy grew at an average of 8 per cent per year in the 1980–2001 period, and its per capita income is expected to more than treble by 2020 (Li and Oberheitmann, 2009). Notwithstanding the improvement of the economic welfare of the Chinese population in the past three decades, this staggering economic growth has engendered some serious negative sideeffects, most particularly the growing emissions of greenhouse gases. According to the World Watch Institute (2009), China’s carbon dioxide emissions are now estimated to be about 24 per cent of the total amount, higher than the US contribution of 21 per cent. Given the fact that China is among the world’s largest energy consumers and producers of greenhouse gases, its policy makers have been directing efforts to drive the country towards a more sustainable path. Policies include the implementation of ambitious programmes oriented to energy efficiency and the setting up of a renewable energy law in early 2006. The transfer of environmentally sound technologies from developed countries into China is also one of the objectives of Chinese policy makers and the CDM is

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considered an important instrument to support this goal (EU–China CDM Facilitation Project, 2009). As of 22 April, 2009, around 75 per cent of the CDM projects registered by the UNFCCC were located in four countries – China, India, Brazil and Mexico – with China accounting for around one-third of the total (UNFCCC, 2009b). This trend is expected to continue, as at the end of 2008, 73 per cent of CDM projects in the pipeline were located in these four countries (UNEP Riso, 2009). China was a relative latecomer with regard to its CDM policy, defining a first draft in 2004 and adopting a final version as late as November 2005 (Lütken and Michaelowa, 2008). The Chinese CDM set-up has some noteworthy features, some of them without parallel in most CDM host countries. In this regard, two essential aspects should be noted. First, the obligation for all Chinese CDM projects to have a minimum of 51 per cent Chinese ownership stake. And second, the existence of a minimum purchase price for the CERs generated by the project activity (IGES, 2009). This is to protect project owners from price dictations imposed by foreign buyers of CERs (Schroeder, 2009). In addition to this, there are other aspects that are specific to the Chinese CDM regulatory framework. Article 4 of the ‘Measures for Operation and Management of CDM Projects in China’ (the law defining China’s internal CDM policy) defines priority areas for developing CDM projects to reach sustainable development goals, namely energy efficiency improvement; development and use of new and renewable energies; and methane recovery and utilization. In Article 10, it is stipulated that CDM project activities should promote the transfer of environmentally sound technologies to China. In Article 16, the role played by the DNA is assigned to the National Development and Reform Commission (NDRC). And finally, according to Article 24 the Chinese government is entitled to a certain percentage (by means of a levy) of the CERs generated by the project activity (CCChina, 2009). In the case of a priority area or a forestation project, the government’s levy is just 2 per cent. In the case of HFC and N2O projects, the levy charged is 65 and 30 per cent, respectively. Given this overview of the Chinese internal framework regarding the CDM, it is important to draw some conclusions about its adequacy in stimulating foreign entrepreneurs to invest in China and in promoting international technology transfers oriented to sustainable development goals. In both areas, contributions through the CDM are likely to be modest and this is due to the two requirements mentioned above that make the Chinese framework so unique: the obligation for any CDM project to have Chinese majority participation, and the existence of minimum purchase prices for the CERs generated by the project. On the one hand, for foreign entrepreneurs who consider venture control as an important factor in their investments, they will not turn to the CDM as a means of entering China. As a consequence, projects that are more in need of the technological capacities brought by the foreign participant through the CDM are likely to be considerably hampered. On the other hand, the obligation to negotiate CERs with Chinese stakeholders taking as reference a minimum price floor potentially narrows the profit margins. As such, this is likely to deter investment in projects where financing significantly relies on the revenues resulting from the sale of CERs. One implication from the above is that the Chinese framework for the CDM encourages the development of projects of the unilateral type, that is, a situation where host country companies develop CDM projects on their own with limited or no foreign

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participation. Such a finding is corroborated, for example, by Lütken and Michaelowa (2008), and this confirms the inadequacy of the domestic framework to stimulate inward FDI through the CDM. Consequently, there is more reduced scope for international transfers of environmentally sound technologies into China. Despite not being directly related to the Chinese CDM framework, there is one aspect which is bound to reduce the extent to which international technology transfers might occur through the CDM in China: the existence of a local content requirement for some renewable energy technologies. This requirement is applied to low-carbon technologies such as wind power, solar photovoltaic installations or highly efficient coal power plants. In the case of wind farms, for example, Chinese law requires 70 per cent of local content to be sourced into the equipment used. As observed by Schroeder (2009), such a requirement sets high restrictions on the amount of foreign technologies that can be channelled into China by means of CDM projects in the renewable energy sector. This is likely to be further aggravated by the poor enforcement of intellectual property rights protection in China (Levy, 2007). As a corollary of the above, if the transfer of environmentally sound technologies is to be successfully achieved without changing the internal CDM framework, alternative mechanisms to the CDM will have to be encouraged and adopted. These alternatives can be identified either within or outside the scope of the UNFCCC. Projects implemented under the Global Environmental Facility (GEF) are an example of a technology transfer mechanism within the scope of the UNFCCC. In this respect it should be underscored that China receives more support than any other country from the GEF, which has considerable experience of providing assistance to China in renewable energy development (Heggelund et al., 2005). Outside the UNFCCC jurisdiction, private sector mechanisms such as those already pointed out in Table 17.2 are worth mentioning, and these include FDI, JVs or Licensing. The presence in China of companies such as Vestas and Novozymes – the former engaged in the production of wind turbines, the latter in the synthesis of enzymes for biofuel production – illustrates how diversified FDI contributions can be to the transfer of environmentally sound technologies into China. Indeed, while the contribution of Vestas can be summarized in terms of some degree of explicit knowledge to local suppliers, Novozymes has established an R&D unit in China which is likely to contribute to the vertical transfer of technologies and therefore lead to enhancement of the local technological capacity (Radosevic, 1999; Delman and Chen, 2008; Vestas, 2009). Summing up, the CDM in its current form is not expected to deliver its goals of stimulating investment by international entrepreneurs in China and the promotion of international technology transfers with effective goals of sustainable development, through energy start-ups located in the host economy.

4

FINAL REMARKS AND IMPLICATIONS

This chapter presents the CDM as a potential mechanism for international technology transfer, by taking as reference two literature streams, that is, international entrepreneurship and technology transfer. We have contended that the CDM is a public policy tool for stimulating private investments in developing countries in the low-carbon sector,

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potentially contributing to the transfer of technologies across borders. Furthermore, we have argued that the CDM can be positioned as an international technology transfer mechanism due to its crucial role in promoting knowledge spillovers and disseminating environmentally sound technologies in developing countries. Due to the central stage occupied by China in the global efforts to curb climate change, we examined the Chinese situation for the development of CDM projects. We concluded that the Chinese domestic framework significantly hinders the contribution of CDM projects to the international transfer of technologies and attraction of inward FDI by energy entrepreneurs. This issue is likely to be aggravated by the local content requirements stipulated by Chinese law in the use of renewable energy technologies in domestic facilities. The implications of this study for policy makers are twofold. First, if the CDM is to be used as a tool to stimulate inward FDI, the Chinese framework regulating the CDM will have to be reviewed, namely with regard to the minimum capital requirements for the Chinese partner participation and the existence of floor prices for purchase of the carbon credits generated by the project activity. Moreover, given the importance of technology transfers for the reduction of China’s carbon intensity, encouraging alternative mechanisms to the CDM will have to be considered by policy makers. Furthermore, we recommend that managers and practitioners – that is, small international entrepreneurs engaged in the energy sector and considering investing in CDM projects in China – take into consideration the extent to which venture control is an important factor for them. If this is deemed to be a critical issue, then other countries should be analysed as alternatives for the project in question, specifically those with a relatively stable and predictable business and regulatory environment, such as Brazil, Mexico and India. Although the design of the chapter aimed to frame the CDM in the state of the art based on the crossing streams of the literature on international entrepreneurship and technology transfer, a potential limitation stems from the absence of empirical case studies to support our findings, implications and recommendations. For future research, several guidelines are proposed: (i) to develop a benchmarking tool to evaluate different mechanisms for the transfer of environmentally sound technologies, which is a caveat identified in the literature; (ii) to study the importance of the CDM for the reduction of China’s carbon intensity; (iii) to analyse the role of the CDM in China concerning the constitution of an internal domestic carbon market in the vision of a post-Kyoto architecture; and (iv) to use a benchmarking approach to analyse case studies in developing countries (for example, China, Brazil, Mexico and India), in order to assess on a comparative basis the contribution of different mechanisms to accomplishing an effective international technology transfer.

NOTES 1. The Montreal Protocol is an international treaty designed to protect the ozone layer by phasing out the production of chemicals that destroy it. In addition to destroying the ozone layer, these ozone depletion gases are also greenhouse gases, with a global warming potential thousands of times greater than CO2 (Andersen et al., 2007). 2. Which include taking mitigation actions early, the development of a ‘visionary’ technology assessment,

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the encouragement of multinational corporations’ leadership in mitigation efforts, and the importance of the financial mechanisms of the Montreal Protocol, among others. For further information on this, see Andersen et al. (2007).

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18 Incentive prizes to stimulate energy innovation and entrepreneurship Neil Peretz and Zoltan Acs

1

RESURGENT INTEREST IN PRIZES: THE X PRIZE AND THE NEW PHILANTHROPISTS

There is a ‘renaissance of prize giving in our own era’ (Scotchmer, 2004). Much of this stems from the publicity surrounding the success of the $10 million first X Prize. Aerospace designer Burt Rutan and billionaire Paul Allen won the prize for building and launching a spacecraft capable of carrying three people to an altitude of 100 kilometers twice within two weeks (X Prize Foundation, n.d.). From the perspective of the organizers, the X Prize focused on goals that were simultaneously ‘audacious and achievable’, with a time horizon limited to three to five years in order to hold the attention of sponsors (Powers, 2008). The X Prize was a ‘highly leveraged’ contest (ibid.), featuring 26 teams from around the world, who collectively spent more than $100 million (X Prize Foundation, n.d.). In the process, tremendous publicity was achieved, yielding over 5 billion media impressions (Schroeder, 2004 at 3; Powers, 2008). The X Prize’s ‘leverage’ stems from the contestants’ aggregate expenditures exceeding the prize purse, and the contingency condition that requires the prize donor to only pay if someone achieves the prize goals (Kalil, 2006). Dr Peter Diamandis, co-founder of the X Prize, describes the prize as ‘an exothermic economic reaction – something that gave off more than it consumed’ (Hoffman, 2007). Inspiration for the X Prize traces back to the Orteig Prize, which was won by Charles Lindbergh for completing the first non-stop flight between New York and Paris, and the scores of other prize contests for aviators (National Academy of Engineering, 1999, at A-4; Davis and Davis, 2004, at 8–11). The idea of inducement prizes for innovations dates even farther back, however, to the 1700s (Davidian, 2005a; KEI Research Note, 2008; Masters and Delbeq, 2008). These ranged from Napoleon’s Food Preservation Prize of 1795 to the famous British Latitude Prize Competition (Sobel, 2005). And Lindberg’s success fostered new aviation competitions, such as the Kremer Prizes for a Human-Powered Flying Machine (Krohmal, 2007). While some may view funding a research prize as pure philanthropy, Ms. Ansari saw it as an investment in establishing a new industry: private space travel. According to Rick Tumlinson of the Space Frontier Foundation, investment in space travel by the wealthy is fueled by both a desire to fulfill a childhood fascination with space and the need to have the latest ‘geeky status symbol . . . [i]t’s not good enough to have a Gulfstream V . . . Now you’ve got to have a rocket’ (Schwartz, 2005). Diamandis prefers to view the phenomenon from a commercial perspective: for the first time in history, certain individuals possess enough wealth ‘to start serious space efforts’ (ibid.). Moreover, advances in computational power enabled the creation of the winning X Prize ship by a group of 350

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20 engineers and the computing power of a laptop – a tremendous cost reduction from the days when fluid dynamics models required a room-sized computer (Olsen, 2007). The individuals involved in today’s prize contests are more likely than past philanthropists and investors to believe that, ‘Well, if I can really cause a breakthrough in this industry, perhaps I can do something in space’ (ibid.). Ego may also play a motivating role, as ‘[t]he quest for prestige and wealth has been an age-old motivator for would-be explorers’ (Platt, 2007). George Mason University economist Tyler Cowen concurs, attributing the increased interest in prizes to: (i) philanthropists trying to be innovative; (ii) the growing wealth of the super-rich; (iii) lower affinity with one’s alma mater; and (iv) ‘the celebrity factor’, which was amply demonstrated by the fundraiser held at Google for the X Prize Foundation, which raised over $2.5 million from attendees such as Tipper Gore, Robin Williams, Arianna Huffington, and Ted Waitt (founder of Gateway Computers) (Businesswire, 2007; Cowen, 2007). A common trend among the aforementioned private space race investors and donors is that they are all technologists who built their fortunes in high-technology industries. Accordingly, it is not a surprise that they wish to channel their newfound wealth into technological, as opposed to social engineering, innovations aimed at challenges they perceive to be facing humanity. The need to expand the human habitat beyond earth is not the only hallmark of this preference for technological solutions. Back on earth, it is ‘the [Bill and Melinda] Gateses’ conviction that science and technology hold the best solutions to the health problems of the world’s poor. A malaria vaccine would be the ultimate technological fix for a disease so entrenched in Africa that health crusaders once abandoned it as a lost cause’ (Doughton, 2008). And eBay founder Pierre Omidyar targets much of his philanthropy toward enabling ‘technology that allows people to come together, make informed choices, and take action on the issues that matter to them’ (Omidyar Network, n.d.). This emphasis on philanthropy through technology investment and sponsorship is a contrast to the philanthropic efforts of a previous generation of the ultra-rich. Industrial giants like Carnegie, Rockefeller, and Ford built their fortunes through the establishment of vast, often vertically integrated monopolistic or oligopolistic enterprises (Krass, 2003; Chernow, 2004; Watts, 2006). Being titans of organization, they channeled their wealth largely into institutions, such as universities and other research institutes. The Rockefeller Foundation, for example, distributed the vast majority of its annual funding to: Yale University, Washington University School of Medicine, the Graduate Institute of International Studies in Geneva, the University of Toronto School of Nursing, the University of North Carolina, the Social Science Research Council, the University of Chicago, the Johns Hopkins University School of Medicine, and the Washington University School of Medicine (Science, 1939). In many ways, prize competitions build on the same legend and imagery as that of the entrepreneur: ‘they pit a protagonist of low stature (i.e., common people, aka “mere mortals”) against the antagonist of a very hard, sometimes very dangerous, and often seemingly-impossible feat (e.g., flying across the English Channel, flying across the Atlantic Ocean, or autonomously navigating over a desert without human intervention)’ (Davidian, 2005b). NASA’s Prize Program manager points out that both prize contests and entrepreneurship reward values considered to be uniquely intrinsic to the American national character, such as:

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Handbook of research on energy entrepreneurship Democracy: anyone can participate and, potentially, win. Creativity: by focusing on results, rather than methods, the door is open to any idea or approach, no matter how wild. Inventiveness: combining older methods and technologies to create a new solution Persistence. Risk-taking: financial, professional, and personal (Davidian, 2005b).

In light of the growing importance of prizes to the New Philanthropists, this chapter seeks first to lay out the key theories and levers of ex ante prizes and show how they can contribute to innovations; and, second, to demonstrate the variety of prizes being created to deal with the twin challenges of energy scarcity and climate change. These prize competitions vary widely in their focus: from energy efficiency to hydrogen power; and in their role in the innovation cycle: from raw invention to commercialization. And prize sponsors include governments, universities, and the private sector. Finally we examine the future integration of incentive prizes in the United States with traditional mechanisms designed to encourage small business and entrepreneurship, such as National Science Foundation (NSF) grants.

2

THE THEORY OF PRIZES

Studies of incentive prizes by the National Academies, Newell and Wilson, and others reveal important guidelines for the effective establishment of ex ante innovation prizes. (Newell and Wilson, 2005; National Research Council, 2007). Financial and Time Requirements Must be Carefully Calibrated: Not Everyone Is a Billionaire Ideally, prize contests should be designed by breaking problems into discrete components to minimize their capital requirements to the level that true enthusiasts can either afford or fundraise by themselves. The NASA Astronaut Glove competition exemplifies this approach. The winner was an unemployed engineer living in Maine, who ‘[built] his glove prototype, using materials bought locally as well as via online auction sites’ and designed his own test equipment and metal parts and handled his own fabrication (Boyle, 2007). In a field where there are many commercial competitors, a higher capital threshold may be required, however great efforts should be made to make the contests as minimally capital intensive as possible in order to maximize the number of participants. From a societal economics perspective, it may also be important to avoid overinvestment by contestants. Charging competitors an entry fee or forcing collaboration in later stages of a contest is one way to reduce excess duplication of effort by contestants (Brutscher et al., 2009, at 25). Because the most important result from a prize contest is the pooling of diverse human ingenuity, minimizing capital requirements enables the widest range of skilled individuals and teams to participate. According to an X Prize Foundation executive instrumental in running the first contest, four to eight years is the optimal time horizon for a prize contest (Powers, 2008). A major

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goal of prize offerings is to raise awareness of a challenge and to motivate competitors by putting them in the public eye. However, the media and public have a limited attention span. If a contest takes too long to complete, both the public and the media will lose interest, causing the motivation and funding of contestants to flag. A long lead time for a prize is also detrimental to the prize granting institution because it postpones the reputational boost that the accomplishment and awarding of the prize gives to it (Schroeder, 2004, at 19). Prizes perceived to be unattainable also fail to attract many competitors (ibid., at 19). A Rockefeller Foundation Prize for a 99 percent accurate diagnostic test for gonorrhea and chlamydia suitable for use in developing countries, for example, has been criticized as too strict (Kremer, 1998, at 1164). While this could be addressed through a longer time horizon, that might cause the aforementioned loss of interest. Kremer suggests that a better solution might be to require more flexible criteria to win. At the same time individual contests should have a foreseeable time horizon, organizers should consider assembling a series of contests that build progressively upon each other. This is valuable for multiple reasons. First, ‘the prizes must be offered reliably and for a period long enough to build the technology pipeline, rather than create a windfall for those already there’ (Bodde, 2006). Second, akin to the way multi-stage grants allow funds to evaluate progress over time, multi-stage prizes allow goals to be adapted and revised over time (Newell and Wilson, 2005, at 10; Bodde, 2006). Accordingly, prize contests should institutionalize learning and adaptation when composing goals for future rounds. Third, running a contest in multiple rounds allows for the gradual reduction of competitors, thus reducing the potential for duplicative effort inherent in prize competitions (Davis and Davis, 2004, at 19). Problem Definition Drives Results According to some observers, ‘[a]t present, ex ante prizes are used largely for trivial purposes . . . or for glamorous, but socially unimportant problems (such as the X Prize)’ (Davis, 2002, at 14). To address this criticism, this subsection contains suggestions for identifying relevant prize topics. The mere fact that there are social benefits in excess of private benefits for a particular technology or product is insufficient to warrant a government prize. A study by Yale Economist William Nordhaus shows that less than 5 percent of the value of innovations in non-farm industries have accrued to the inventors; however, that has not brought innovation to a screeching halt (Nordhaus, 2004). In order to warrant a government prize, a technology or product should be either neglected by industry because of a potential misperception about its intermediate term feasibility, or stalled in its development due to the application of insufficient resources or perspectives. If virtually none of the productivity gains from a technology can be captured by the inventor in the foreseeable future, perhaps due to an inability to patent the invention or to charge a profitable price for it, yet such gains ‘can be recouped by government through taxation of those consumers’, then prizes may be warranted if the prospective societal gain is large enough (Masters and Delbecq, 2008, at 11). Likewise, building on Coase’s theory of the firm, a government prize may be warranted if the challenge addressed by the prize or the prize solution itself possesses externalities not sufficiently dealt with by the market (Coase, 1960; Davis, 2002, at 15). A corollary for prize offering is the axiom: ‘Don’t get out in front of parade’ (Morgan,

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2008). If there is a sufficient private sector incentive and interest to pursue the prize goal independent of the prize offering, such as the battery prize suggested by John McCain, money and public attention may be better spent elsewhere. Examples of fields that may be particularly appropriate for prize contests are: ● ●

●

agricultural research and development (R&D) suitable for developing countries, which yield a high return for each dollar invested (Masters, 2005); climate change reduction technologies, which provide a societal benefit that may far outweigh the private benefits of such technologies, yet the marketplace for such technologies is particularly uncertain due to their reliance upon future government regulations (Newell and Wilson, 2005, at 2, 9); and renewable energy technology that is not yet cost-effective enough to compete with fossil fuels (Schroeder, 2004, at 20–21).

When pursuing any of these broad goals it is important to remember that some of the most effective prizes may be for enabling technologies – even if they are from unrelated fields (Bodde, 2006). There is an inherent tension between targeting prizes toward long-term versus shortterm goals. The fact that inventors and the public have a limited attention span and resources suggests that prizes should be focused on situations where time is of the essence to meet particular goals. On the other hand, prizes often serve to educate the next generation of technologists, investors, and the general public about long-term societal needs and challenges. For example, the DARPA Challenge had a dedicated class at MIT and scores of universities participating (Whitaker, 2008). To ensure that today’s contest participants are learning about challenges of the future, rather than the past, prize contests that can be won in the short run should still be a step toward a broader, longer-term societal goal, such as ‘energy independence’ (Silva, 2008). Critics of government science funding suggest that the ‘bias toward basic research is misplaced and that much can be gained from technology deployment and adoption programs’ (Heaton et al., 2008). Prizes present an opportunity to focus on applied projects goals. This has multiple advantages. First, applied projects may require less capital because they involve the assemblage of existing technologies. Software engineering problems, for example, largely represent applications of (computing) technology. As a result, software has a ‘low requirement of capital as the open-source movement has proved time and again’ (Saar, 2006, at 67). Second, in the area of applied research, incentives are more likely to be misaligned between the government and grantees, rendering a prize contest potentially more appropriate. (Newell and Wilson, 2005, at 9). For basic research, both the government and research grantees share the goal of maximized spillover of new knowledge through publishing and presenting at conferences because many researchers derive their status through such disclosures. For applied projects, by contrast, Newell and Wilson posit that there is risk that researchers who receive a grant may focus on basic research, despite the grant’s requirement of applied research, because those researchers want to enhance their personal stature in their field. Third, it is easier for the public to see the relevancy of an applied research project to a broader societal aim. This will amplify the publicity attendant to the contest. To

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the extent that basic research is the subject of a prize competition, the organizers need to make a greater effort to explain the contest’s relevancy. ‘[T]he public is likely to understand the visible aspects of some prize contests better than laboratory-based work funded by grants and contracts’ (National Academy of Engineering, 1999, at 8–9). Fourth, the National Academy of Engineering cautions that prizes for applied research may result in ‘stretch[ing] existing technologies by demonstrating their usefulness’ in ‘address[ing] neglected social problems’, such as air pollution and adult illiteracy (ibid., at 8–9). Basic research, on the other hand, may be less likely to leverage past scientific developments. Prize organizers may wish to consider some limits on the degree of commercialization required to win a particular contest, however, because start-up companies and less financially endowed inventors may have sufficient capital to create a proof of contest, but not refine an invention up to the point of mass production. At the same time, however, it is important to verify that the winning entry is not too expensive to ever be commercialized (Kalil, 2006). Of course prize objectives need to be fair and clear (National Academy of Engineering, 1999, at 6; National Research Council, 2007). This has the dual benefit of focusing contestants and reducing the possibility of subjective political influence on contest results. Public choice economists observe that most research ‘subsidy programs allow government officials to dole out goodies to special interests and constituents’, regardless of the social benefit created (Adler, 2007). Prizes for a well-defined goal limit the flexibility of government officials by focusing of results over patronage. George Mason University economist Robin Hanson empirically verified this phenomenon by analyzing the prize contests and grants of 135 eighteenth-century societies. He found that grants were a more preferred innovation incentive than prizes in democratic societies where funding sources are local, likely because such patrons are more likely influenced by political considerations than autocratic non-local governments (Hanson, 1998, at 17). Prestige and Data May Be Worth More than Money Seemingly insufficient prize money should not be a barrier to the creation of certain prize contests because, for many prize contestants, ‘[c]uriosity and pride motivate them as much as prize money’ (Travis, 2008, at 1750). ‘[P]restigious nonpecuniary prizes can be a particularly effective inducement for innovation’ (Brunt et al., 2008). A detailed study of prize contests held by the Royal Agricultural Society of England from 1839 to 1939 revealed that the average prize award was insufficient to pay for the cost of the innovation, however inventors continued to compete in record numbers (ibid., at 17). This phenomenon is likely explained by the fact that [T]he payoff to entrants came in the form of free advertising that entry (and particularly winning) conferred on the invention, so that the monetary prizes are a substantial underestimate of the true pecuniary value of winning. This interpretation is supported by the fact that entrants seem to have been attracted to many prize competitions by the offer of medals instead of money[.] (Ibid., at 16–17, 31)

The value of medals for achievement is amply demonstrated by the military. Rear Admiral Joseph S. Mobley, director of the Navy’s awards system, observed: ‘We’re

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probably not giving out enough awards – I think it’s the most emotional and motivational tool we have’ (Shenon, 1996). The medals themselves may be of minimal physical value, but they represent a powerful crystallization of abstract national values: ‘it is easier for [a soldier] to say that he is ready to die in defense of his flag than to say that he is ready to die for an endless series of institutions and values’ (Bryan, 1943, at 351–2). Likewise, prize sponsors find that contests may serve as the best codification of their own values: Sergey Brin, co-founder of Google commented: ‘[c]ompanies today spend more on stadiums and sailboat races than we will spend on this . . . Expanding science and technology is a far better way to reflect Google’s values’ (Reiss, 2007). Beyond a positive feeling of accomplishment and civic pride, non-pecuniary prize benefits enhance an inventor’s ‘potential for follow-on grants, procurement contracts, or venture-capital support’ (National Academy of Engineering, 1999, at 7). Similar to the way that authors receive many benefits beyond royalties – such as prestige and tenure for professors (Calandrillo, 1998, at 317) – innovation prize winners significantly improve their own financial prospects for employment, future research grants (Cowen, 2007), and commercialization of their work, regardless of the size of the prize purse. Likewise, for corporations, winning a prize can lead to tremendous positive publicity. For example, winning the Golden Carrot award resulted in significant free nationwide print and television exposure for Whirlpool (Davis and Davis, 2004, at 17). The government, as the embodiment of the will of the nation and all of our civic values, has the potential to offer the most prestigious non-pecuniary benefits for a prize. This should be exploited, albeit carefully and sparingly enough to not dilute its luster. For some researchers, finding an environment to test and prove their theories has almost as much lure as publicity. For example, when video rental company Netflix created a prize contest to see if its video rating prediction system could be improved, it offered contestants access to its existing database of 1.6 billion user ratings. One result was that a vast majority of the top scholars in the field of machine learning decided to participate in the contest (Leonhardt, 2007). This attraction of scholars to large novel datasets could be used to incentivize participation in other prize contests as well. Because the government often has its own large repositories of data and access to others’ data, it may be uniquely positioned to create attractive prize contests around its datasets. When marketing a prize contest, access to data and expertise should be stressed as a key benefit to all potential entrants. Even non-winners can benefit from well-designed contests because the spillover will enhance their own R&D (Davis and Davis, 2004, at 23–4). Use the Publicity of Prizes to Recruit Experts from a Wide Range of Disciplines David Stonner, head of congressional affairs at the NSF, said that a cash prize cannot place ‘brilliant ideas in researchers’ heads’ if their focus is elsewhere, however a large prize purse may inspire other researchers to say ‘“we’re already working on this .  .  . maybe we can make a difference,” and start thinking about commercial applications’ (Epstein, 2006). Unlike grants, which ‘“push” money on people to solve problems or meet social needs, he says, prizes “pull” people to problems’ (Wessel, 2007). ‘Pulling’ new researchers and

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perspective to tackle intractable problems when ‘government bureaucracy and markets are stuck’ (ibid.) is essential because, for many problems, ‘the odds of a solver’s success increased in fields in which the solver had no formal experience’ (Kalil, 2006, at 21). Researchers observing the InnoCentive marketplace, located at http://www.innocen tive.com, which matches corporate problems with independent experts and researchers, have found that ‘having the right background is key to addressing a client’s “unsolvable problems.”’ (Travis, 2008, at 1750). For example, a chemist was able to develop a solution to a problem unsolved by pharmaceutical Johnson & Johnson in three nights due to his own background: ‘the solution was already there . . . it’s nice to see that my extensive reading of the chemical literature over 10 years finally pays off in terms of real applications and not only academic publications’ (ibid.). Likewise, a cement expert helped oil transport companies figure out how to stop oil from solidifying in barges. Jaison Morgan of the X Prize Foundation has similarly found that the novel solutions to problems are often found by individuals with deep subject matter expertise (Morgan, 2008), often ‘by applying specialized knowledge or instruments developed for another purpose’ (Dean, 2008). InnoCentive’s success, compared to in-house R&D, is that many researchers can be trained in the same discipline, and they tend to look at a problem in the same way and operate within the narrow sphere of their expertise. That uniform mindset can be an obstacle. . . . But a challenge posted on InnoCentive’s website is exposed to a wide variety of scientists likely to approach a problem from different angles (Reidy, 2006)

The idea of problem solving by outsiders fits well with the American psyche: Americans, perhaps more so than people of other nations, have great faith in the idea of the outside inventor . . . always believ[ing] that however great the facilities might be at Bell Labs or at M.I.T., there is another place, the backyard/cellar/ garage of the self-taught inventor, where sweat and commitment and zealous tinkering may lead him through one failure after another until he breaks through to an ingenious, patent-pending solutions. (Hitt, 2007)

Prize contests generate ‘pull’ through publicity. To attract experts from a wide range of disciplines, the budget for a prize contest should incorporate funds to spend promoting the prize outside its traditional area of discipline. It was widespread publicity about the Genomics X Prize (further described at http://genomics.xprize.org), for example, that inspired a team of mathematicians from MIT to enter what was thought to be a biologyfocused contest (Powers, 2008). To ensure greater participation by experts from non-traditional disciplines, prize contest organizers should develop an advisory committee that spans a wide range of disciplines and ask all members of the advisory committee to describe each particular prize challenge using the lens of their own discipline. A mathematician might not immediately see a genomics question as a math problem, for example, but perhaps a mathematician working closely with a biologist could describe it as such. Take Risks Because Even Failure Has Value The goals for a prize contest can and should be more speculative than what might be appropriate for a traditional research program (Kalil, 2006). The peer review process

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employed in traditional grant-funded research ‘tends to favor proposals that seem “safe” as opposed to “riskier” proposals that may produce surprising and potentially more innovative results’ (National Academy of Engineering, 1999). Prizes, because they reward success regardless of how it is achieved, prevent funds from being awarded to the ‘safe’ candidate, rather than the risky innovator, the grant-funding equivalent of ‘Nobody ever got fired for buying IBM equipment’. Smaller and newer research organizations are often the most innovative; however, they often have particular difficulty securing grant funding (Newell and Wilson, 2005, at 11). Creating aggressive prize goals accompanied by a sufficient reward and minimal bureaucratic obstacles, may allow these organizations to shine. Many modern measures of innovation focus on intermediate (patents) or actual output (for example, sales and number of products created) (Acs and Audretsch, 1988, 2005), however few measure the benefits from failure. Failure, if properly analyzed and publicized, can save countless years of future effort by future innovators. Prize organizers should ask all contestants to document their efforts and results in order to ensure public knowledge spillover from these failures. Even if all contestants fail to win an offered prize, there is still knowledge to be gained. This type of outcome ‘shed[s] light on the state of technology maturation . . . signal[ling] that even the best technological efforts are not quite ripe at the proffered level of monetary reward’ (Macauley, 2005). This should be of particular value, suggests Macauley, to ‘government managers when they are pursuing new technology subject to a limited federal budget’. Of course, taking risks requires the support of prize sponsors, who need to be managed carefully. The careful design of prize contests requires far more work than the issuance of grants because contest designers must specify all of the criteria for success, ensuring that they are specific enough to make clear when the prize has been won, but general enough to permit many means of achieving the goal (National Research Council, 2007, at 7). Experts must be employed to develop the specifications, a significant cost of money and resources (Powers, 2008). To the extent that third parties are employed to assist in the development of prize contest criteria, grant funding may be necessary. For example, the US Department of Transportation recently issued a planning grant to the X Prize Foundation to consider a contest for the development of alternative aviation fuels (Morgan, 2008). Government-sponsored prize contests have additional constraints. Because they generally require enabling legislation, such as the National Aeronautics and Space Administration Authorization Act of 2005 (S. 1281 at Section 314(a)); the Energy Independence and Security Act of 2007 (P.L. 110–40); and the Energy Independence and Security Act of 2007 (P.L. 110–40 at Section 654); however Congressional expectations and support for innovation prize contests need to be set carefully (Newell and Wilson, 2005, at 21). ‘[G]overnment agencies normally have only two years to spend any money appropriated by Congress – a problem if NASA [or any other agency] wants to hold a contest it thinks would take someone more than two years to win’ (Berger, 2004). In order to successfully develop prize contests, federal agencies require ‘No-Year’ budget allocations for the prize purse (Newell and Wilson, 2005, at 25; Morgan, 2008). Politics may also interfere with government sponsorship of prizes. Ideally, specific contest goals should be kept outside of Congressional hands to minimize the inappropriate political influence that has occurred repeatedly in the past. For example,

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Congressional involvement in the Synthetic Fuels Corporation, ultimately resulting in Executive Order 12346 (47 FR 5993, 3 CFR, 1982, February 8), forced the project to focus on Appalachian coal, despite Western coal being better suited (Newell and Wilson, 2005, at 24). Likewise, unwitting Congressional pressure on the Department of Defense covered up missile research that was either unnecessary or fraudulent (Lipton, 2008). One potential model for Congressional involvement can be found in the United Kingdom’s new Climate Change Bill, which ‘creates an independent expert Committee on Climate Change to advise on the level of carbon budgets and on cost-effective savings’ (British High Commission, 2008).

3

ENCOURAGING ENERGY AND ENVIRONMENTAL INNOVATION

Energy Prizes Spur a National Debate Former Presidential candidate John McCain ‘proposed a $300 million federally funded prize to spur the development of a vastly improved battery for electric cars and plug-in hybrids’ (Rugani, 2008). In order to win the prize, the invention must have ‘the size, capacity, cost and power to leapfrog the commercially available plug-in hybrids or electric cars’ and ‘deliver a power source at 30 percent of the current costs’ (CNN.com, 2008). McCain determined that the prize should be valued at ‘one dollar, for every man, woman and child in the U.S. . . . for helping to break the back of our oil dependency’ (Cooper, 2008). Supporters suggested that McCain’s idea was ‘the only truly innovative proposal on energy issued by either candidate’ because ‘[i]t offers an alternative to throwing money down Washington’s R&D black hole’ (Schulz, 2008). According to editorialist Schulz, rather than ‘pick[ing] winners before the race – the conventional Washington approach – [McCain proposes] to reward the first party across the finish line’. McCain faults the approach of providing grants for research and development (R&D) as ‘throw[ing] around enough money subsidizing special interests and excusing failure’ (CNN.com, 2008). Detractors, on the other hand, noted that McCain’s prize idea failed to specify a concrete benchmark. Gerbrand Ceder, a professor of materials science and engineering at MIT, observed: ‘since plug-in hybrids are not on the market yet, there is no clear basis for estimating [what would constitute] a [30%] cost savings’, and dismissed the idea as a ‘political stunt’ (Rugani, 2008). Political historian Rick Shenkman characterizes the offering of such a prize as ‘bring[ing] a game-show ethos to American politics. It’s the Let’s Make a Deal or The Price Is Right mentality’ (Jackson, 2008). Because the performance goals of the new battery have yet to be specified, some, such as Detroit editor for MotorTrend, Todd Lassa, speculate that perhaps the prize was intended as a giveaway to General Motors or some other ‘automaker (or its battery supplier) that would have already had to make such a breakthrough in order to put plug-ins on the road in two years’ (Lassa, 2008). Others concur that the goal is likely to be met with or without the prize. Spencer Quong, senior vehicles engineer with the Union of Concerned Scientists, observes: ‘[m]ost automobile manufacturers are working with lithium-ion battery makers on this technology . . . and commercial development could

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occur in the “near future . . . maybe five years”’ (Jackson, 2008). And Alex Molinaroli, President of Power Solutions for Johnson Controls, said his firm will introduce a lithium-ion battery that is ‘half the size and twice the power’ next year (ibid.). James Barnes, a Department of Energy Program Manager, takes issue with McCain’s comparison of a $300 million prize with grant-funded research because annual grants have been limited to $50 million per year for ‘research and development for vehiclerelated energy storage’ (Rugani, 2008). Meanwhile, David Harsanyi at the Denver Post, sarcastically questioned whether the prize was high enough: ‘If $300 million is enough inducement to stimulate innovation and wean America of oil, why not offer $600 million? . . . Inventors would be twice as motivated. Isn’t that how the economy works?’ (Harsanyi, 2008). Others echo similar sentiments, but more seriously: ‘the response needs to be proportionate to the amount of carbon being emitted into the atmosphere. . . . To the average person, a $300 million prize for a better car battery sounds like a lot of money. But it’s a big pot of nothing in the face of climate change’ (Klein, 2008). McCain’s idea has also been opposed as being contrary to the free market. ‘The gain from any kind of success on this front is so obvious and so huge that there is no need to have government performing parlor tricks with taxpayer dollars’, explained Dr Donald Boudreaux, chairman of the Department of Economics at George Mason University (Harsanyi, 2008). According to Boudreaux, ‘If anyone could invent something that would save consumers in this way, there is no reason the inventor wouldn’t earn multiples of $300 million’ (ibid.). McCain’s ‘peddl[ing of] prize money’ is premised on the incorrect ‘perception that industry and scientists aren’t already working diligently on energy breakthroughs – with batteries and areas unknown – or that the market doesn’t incentivize them to do so’ (ibid.). The creation of incentive prizes for energy and environment breakthroughs are by no means limited to current Presidential candidates, as demonstrated by the $25 million Earth Challenge Prize created by Al Gore and Richard Branson. The prize will be awarded to the first to develop ‘a method that will remove at least one billion tonnes of carbon per year from the atmosphere’ (BBC News, 2007). Some $20 million of the prize money will not be paid until the method has been successfully demonstrated for at least 10 years (MSNBC, 2007). Gore and Branson hope that the governments of the United States, Britain and other countries will add to the prize money (Sullivan, 2007). There is at least one indication these wishes will be granted: both Republican and Democratic senators have recently proposed the Carbon Dioxide Capture Technology Act, Senate Bill 2744, establishing awards for researchers who can economically extract carbon dioxide from the atmosphere and sequester it (Revkin, 2009). Solar Prizes Prizes to reduce the cost of solar energy are on the drawing board. The Co-op America Foundation proposed the American Solar Advancement Prize (ASAP), ‘a high-stakes, high reward competition to develop and deploy new technologies and systems that could dramatically accelerate the reduction in solar’s costs within a decade’ (SHINE Project, 2005). The prize would be awarded to any company or team that ‘bring the price of U.S.-made solar to $2 per installed watt or less by 2010’ and offer ‘a system conversion

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efficiency of at least 12%’. Up to three winner(s) would be chosen by a panel of judges, and each would receive ‘$75 million in funding targeted to research, development, and deployment of the modules and systems, as well as a guaranteed purchase order of $100 million over a four-year period for the finished products’. To pay for the prize, ‘a small royalty on the sales would be paid by the winners to the federal Government’. The H-Prize Congress recently appropriated prizes worth $1 million to be given out every two years for achievement of specific accomplishments in the areas of hydrogen production, storage, distribution and utilization by ordering the Department of Energy to set up prize funds to incentivize new energy technology breakthroughs (Energy Independence and Security Act, 2007, at Section 654). A $4 million prize would be awarded for a working prototype of a hydrogen vehicle, and a $10 million prize would be awarded for a ‘transformational advance in hydrogen energy technology’ (Wolfe, 2007). Its legislative sponsors hope the prize ‘encourages the private sector to invest time and efforts to come up with a solution for harnessing hydrogen energy effectively and efficiently . . . as a cleaner alternative to the more traditional ways we use energy, like gas and oil’ (Johnson, 2006). Few in Congress seemed to disagree, as the House of Representatives voted 416 to 6 in favor of the prize (Epstein, 2006). Similar to the administration of the NASA Centennial Challenges, the Department of Energy will retain a third-party non-profit organization to design the prize criteria (US Department of Energy Hydrogen Program, 2008). It is expected that the administrator may seek additional sources of funding for the prize. Without additional funds, it is unclear whether the H-Prize is large enough to motivate a critical mass of researchers. The head of the Hydrogen Engineering Research Consortium at UCLA ‘pointed out that, compared to the kind of funding universities look for, $10 million isn’t much – especially compared to the $1.7 billion for hydrogen research that President Bush outlined in 2003’ (Epstein, 2006). Likewise, others caution that the prize, ‘might prove redundant’, because ‘[a] new venture meeting these objective criteria would probably have little difficulty attracting venture capital’ (Bodde, 2006). On the other hand, a former entrepreneur on the staff at Duke University’s Engineering School believes that, for academic researchers, ‘the key ingredient missing is the hunger [so the H-Prize could add] a very good fire’ to motivate them (Epstein, 2006). Professor David Bodde of Clemson University, testifying before the US House of Representatives’ Committee on Science, urged that the H-Prize also embrace directly related scientific discoveries and enabling technologies, rather than limit itself to a very narrow topic (Bodde, 2006). Such an approach might ‘broaden the pool of researchers who would find the H-Prize relevant’ and reduce an incentive to keep related discoveries secret until they could be reduced to practice for commercial sale. Prizes for Energy Efficiency The Golden Carrot Setting the stage for today’s energy prize competitions is the Golden Carrot Award, organized by the US Environmental Protection Agency and Natural Resources Defense

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Council and sponsored by a consortium of 25 utility companies (Davis and Davis, 2004, at 14; Schwartz, 2004, at 205). The utilities each committed between $150,000 and $7 million to the $30 million prize, which would be awarded to the manufacturer who could produce a refrigerator containing no ‘chlorofluorocarbon chemicals, or CFCs, used in conventional devices and that will use at least 25 percent less energy than current Government standards’ (Holusha, 1993). All but one of the 15 major US appliance manufacturers entered the competition; and Whirlpool Corporation won the award, which it used ‘to offset engineering and development costs [and ensure that] the new refrigerators will have prices similar to those of current models in markets served by the participating utilities’ (Office of Technology Assessment, 1993; Holusha, 1993). Unfortunately, Whirlpool stopped manufacturing the more efficient refrigerators ‘in 1998 after selling substantially fewer than the 250,000 units it had proposed’ (Hollomon et al., 2002). While federal efficiency standards did increase to roughly the same level as the standard set by the Golden Carrot prizewinner, ‘a Whirlpool representative reported that the similarity between . . . [Golden Carrot] efficiency levels and the new standards was a “coincidence”’ (ibid.). L Prize It is well-established that advances in lighting materials can yield significant energy savings. Both compact fluorescent bulbs and light emitting diodes (LEDs) have been shown to require less than 20 percent of the electricity required by incandescent bulbs to create the same amount of light (Taub, 2009). In order to accelerate more efficient lighting technology, the US Department of Energy has created the L Prize competition, to ‘drive innovation and market adoption’ of new lighting technologies (Bright Tomorrow Lighting Competition, n.d.). As a ‘first-past-the-post’ prize, the minimum threshold to win the $10 million L Prize reward requires creation of a mass-manufacturable replacement for the 60 watt incandescent bulb that consumes less than 10 watts and has an efficiency greater than 90 lumens per watt, according to Subtitle E, Section 655 (b)(1) and (b)(2) of the Energy Independence and Security Act of 2007 (EISA). Despite the requirement that all contestants ‘be incorporated in and maintain a primary place of business in the United States’ the first entrant in the competition is Philips, the Dutch electric giant. The L Prize also seeks to leverage the government’s purchasing power by offering not only a cash award, but also a promise to develop federal procurement guidelines that specify the government purchase of winning products (EISA, 2007, at Section 655(h)). The Progressive Automotive X Prize Prizes may prove useful when an industry is dominated by a few large players who might be inclined to bury any new technology that could take market share from their existing products. The automotive industry, where sunk platform costs are amortized over many years, is an industry where such a dynamic might be found. The Progressive Automotive X Prize (n.d.) aims to spur innovation by incentivizing industry outsiders to make a major breakthrough in the field of personal transportation through the creation of a car with a fuel efficiency equivalent to or exceeding 100 miles per gallon of gasoline (X Prize Foundation, 2008). So far, the competition appears to be succeeding: as of October 2009, despite the lack of participation by any major

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global automobile manufacturer except Tata, 43 teams had passed the design review and advanced to the prototyping stage of the competition (as announced at http://www. progressiveautoxprize.org/teams). John Shore, director of the competition believes that, for the contestants, the value of the publicity offered by the competition far exceeds the value of the $10 million prize purse (Glaskin, 2008). The X Prize Diaspora Captivated by the success of the X Prize competition, by 2007, more than $77 million has been allocated for prizes worth more than $100,000 each in the field of climate-change and environmental innovations, a more than tenfold increase over the $6 million offered for such prizes a decade earlier (McKinsey & Co., 2009; Venkataraman, 2009). The arrival of Jaison Morgan in Abu Dhabi may also augur an X Prize diaspora. After leading the Prize Development Department of the X Prize Foundation, Morgan was lured to the United Arab Emirates to advise on the establishment of the Zayed Future Energy Prize to reward ‘excellence in the innovation, development and implementation of sustainable energy solutions’ (Abu Dhabi, 2008). Unlike the X Prize, however, the Zayed Prize does not call for the achievement of a particular defined objective or solving a specified problem. The result is that the Zayed Prize may be more likely used to help nurture nascent innovations through additional funding, rather than spur the original creations of those innovations. More akin to the X Prize competition format is another venture advised by Morgan: the Saltire Prize, a £10 million prize offered by the government of Scotland for advances in wave and tidal energy (Saltire Prize Challenge, n.d.). The winner of the Saltire Prize must demonstrate ‘in Scottish waters a commercially viable wave or tidal energy technology that achieves a minimum electrical output of 100GWh over a continuous 2 year period using only the power of the sea’. And the design must be cost-effective, environmentally sustainable, and safe. Given Scotland’s extensive shoreline, any significant wave energy developments could be readily applied to create zero-emission power onto the grid (Macdonell, 2008). Prizes for Planning and Skill Demonstration Not all innovation incentive prize competitions require a large prize purse. The Clean Energy Prize, sponsored by the University of Michigan and DTE Energy, offers a far lower reward, only $100,000, than other competitions; however, it also places fewer burdens on its participants: who need little more than a word processor and some library research to enter. Rather than rewarding pure invention, the prize is awarded to those who can demonstrate the best ability to identify and plan to commercialize existing technology from universities (DTE Clean Energy Prize, n.d.). If the Michigan colleges and universities earn royalties or license fees on out-licensed technology and the Clean Energy Prize provides the impetus to commercialize that technology, the sponsors could reap far more than the prize reward paid out. The first competition was won by students from the University of Michigan and Michigan State University, united in an entity entitled the Algal Scientific Corp. The winning team demonstrated a plan to use algae to simultaneously treat wastewater

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and produce raw material for biofuels (Lane, 2009). The project inspired collaboration between an ecology doctoral student, engineering graduate students, and business school students (Reuters, 2009). Not to be outdone by Michiganders, the Massachusetts Institute of Technology established the MIT Clean Energy Prize in 2007 to ‘encourage innovation in the energy space, specifically with regard to clean energy’ (MIT Clean Energy Prize, n.d.). Unlike the Michigan competition, there are no geographic limits on who may participate in the MIT competition, which requires a year-long process leading to the selection of finalists in each of the five categories: Energy Efficiency and Infrastructure, Biomass, Renewables, Clean Hydrocarbons, and Transportation. A Grand Prize winner is selected from among the finalists, however all finalists receive some form of cash prize. A similar competition on the West Coast is the CleanTech Open, where competitors have raised over $130 million in venture capital based on the plans originally presented at the competition (CleanTech Open, n.d.). Both the MIT Clean Energy Prize and CleanTech Open emphasize the hands-on training and mentoring components of their competitions, as well as connections to potential venture capital investors. These business plan competitions build on the Schumpeterian perspective that singular inventions require additional effort before they are transformed into innovations (Schumpeter, 1947). These competitions aim to inspire that work by bringing inventions to the attention of a wider audience, ranging from sales and marketing professionals to financiers. In order to encourage broad recruitment of contestants, these competitions have a less-defined task/problem than the Ansari X Prize and DARPA Challenge. The lack of single objective reduces the upfront planning required by contest organizers, however it also renders judging more subjective and potentially more difficult. Other notable prize competitions in the energy field include the Freedom Prizes, designed to ‘reward and encourage the deployment of technologies, which will reduce our dependence on foreign oil’ (Freedom Prize, n.d.); the Conoco Phillips Energy Prize (n.d.), offering $300,000 in cash for innovative ideas in the areas of new energy sources, energy efficiency, and combating climate change; and the Ignite Clean Energy Business Plan Competition (n.d.).

4

FUTURE DIRECTIONS FOR PRIZES AND ENTREPRENEURS

Many nascent businesses, particularly in the science and technology field, get their start performing contract research built around their founder’s expertise. Government grants for science research, from entities like the NSF, and procurement focused on the small business community, such as the Small Business Innovation Research (SBIR) Program, have nurtured many young enterprises (Brannen and Gard, 1985). Harvard Business School Professor Josh Lerner reports that ‘[s]ome of America’s most dynamic technology companies received support through the SBIC and the Small Business Innovation Research (SBIR) programs while the companies were still privately held entities, including Apple Computer, Chiron, Compaq, and Intel’ (Lerner and Kegler, 2000). The use of incentive prize competitions is now being pushed into this arena. In June 2005, the US House of Representatives, in the Science, State, Justice, Commerce and

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Related Agencies Appropriations Act of 2006, told the NSF to develop its own prize program ‘to focus on high risk/high payoff research’ (Kintisch, 2005). This met with both excitement about the possibility of success akin to the X Prize (Mervis, 2006a), and concern about how ‘[s]ome brilliant scientists might lose out if the government curtails or drops an existing research program’ (Kintisch, 2005). The NSF was directed to seek advice from the National Academies on how to structure the prizes (House Report 109-118 accompanying Appropriations, 2006; Mervis, 2006b). The National Academies suggested that the NSF start with several small-scale prizes of between $200,000 and $2 million each to experiment with different prize contest formats (National Research Council, 2007, at 3). In order to design, structure, and implement the prize programs, the NSF was urged to establish its ‘Office of Innovation Prizes’; however, it should also consult with any agencies that may be subject matter experts on particular prize topics, such as the National Institutes of Health on medical matters (National Research Council, 2007, at 3). Benchmarks for success of the prize programs include: ● ● ● ● ●

whether a larger and more diverse number of contestants participated than traditional NSF grant competitions, whether contestants were able to raise private funds to support their competitive efforts, whether any spin-offs resulted from the competitions, whether public awareness of a particular area of science or innovation is improved, and whether the NSF’s public image is enhanced by the competitions.

In furtherance of broadening the contestant base, the NSF was advised to minimize the conditions it placed on contestants by eliminating: accounting requirements, restrictions on entrance by former NSF grantees, and laying claims to intellectual property developed for the competitions (National Research Council, 2007, at 5; Davis, 2002). Prize goals should be set carefully to ensure that they are both objectively measurable and represent a significant advance over what might be developed in the absence of such a competition (National Research Council, 2007, at 7). This emphasis on prize contests suitable for small business is likely to be particularly important in the energy industry. For example, a new agency, ARPA-E, has been created within the Department of Energy to fund advanced energy R&D under a model similar to that of DARPA (Establishing the Advanced Research Projects Agency – Energy (ARPA-E) Act, 2007; Weiss and Bonvillian, 2009). Of the lead recipients of ARPA-E’s first round of funding, 43 percent were small businesses (US Department of Energy, 2009). It is expected by many that ARPA-E will follow in the footsteps of events like the DARPA Challenge by incorporating prize contests as part of their energy innovationinducing repertoire. In sum, innovation inducement prizes offer several potential benefits. They provide an opportunity for individuals and groups to interact with government science organizations in a less bureaucratic setting, they leverage financial resources of contestants more so than grants, and they have the capacity to educate and inspire the public (National Academy of Engineering, 1999). Further, prize providers can economize on knowledge

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because they need only know the goal sought, as opposed to grant providers, who need to know who to hire (Cowen, 2007). From an economic perspective, well-designed prizes ensure alignment of interest of the researchers and the funders (Newell and Wilson, 2005). On the other hand, prizes require more upfront work by organizers to design objective goals, they limit participation to contestants who have their own resources, and they may result in duplicative effort if multiple contestants develop the same solution (Kalil, 2006, at 7). The renaissance of ex ante innovation prizes seems likely to persist, given changing patterns in American philanthropy. This renaissance can and should spread to the government sector as a complement to research grants and support of the existing intellectual property system. Careful design of government prize contests, including exploitation of the government’s unique access to data and ability to generate publicity and prestige, may further enhance their success.

REFERENCES Abu Dhabi (2008), ‘Abu Dhabi Opens Worldwide Nominations and Submissions for Zayed Future Energy Prize’, Press Release, July 6, available at: http://www.zayedfutureenergyprize.com/MEDIA-CENTRE/2008PRESS-RELEASES.aspx (accessed December 2008). Acs, Z. and D. Audretsch (1988), ‘Innovation in large and small firms’, American Economic Review, 78 (4), 678–90. Acs, Z. and D. Audretsch (2005), ‘Entrepreneurship, innovation and technological change’, Foundations and Trends in Entrepreneurship, 1 (5), 1–65. Adler, J. (2007), ‘Like a Virgin’, National Review Online, September 24. BBC News (2007), ‘Branson launches $25m climate bid’, February 9, available at: http://news.bbc.co.uk/2/hi/ science/nature/6345557.stm (accessed December 2008). Berger, B. (2004), ‘Financial Request for NASA’s Centennial Challenge Goes Back to Congress’, Space News Business Report, July 26. Bodde, D. (2006), ‘Statement on the H-Prize Act of 2006’, US House of Representatives, Committee on Science, April 27. Boyle, A (2007), ‘Glove wins $200,000 NASA prize’, MSNBC, May 3, available at: http://www.msnbc.msn. com/id/18474732/ (accessed December 2008). Brannen, K.C. and J.C. Gard (1985), ‘Grantsmanship and entrepreneurship: a partnership opportunity under the Small Business Innovation Development Act’, Journal of Small Business Management, 23 (3), 44–9. Bright Tomorrow Lighting Competition (n.d.), ‘Energy Independence and Security Act of 2007’, Subtitle E, Section 655, available at: http://www.lightingprize.org/ (accessed December 2008). British High Commission (2008), ‘Landmark UK Climate Change Bill passed’, November 20, available at: http://ukincanada.fco.gov.uk/resources/en/news/2008/November/climate-change-bill (accessed December 2008). Brunt, L., J. Lerner and T. Nicholas (2008), ‘Inducement prizes and innovation’, Centre for Economic Policy Research, Discussion Paper 6917, available at: http://people.hbs.edu/tnicholas/CEPR-DP6917.pdf (accessed December 2008). Brutscher, P.B., J. Cave and J. Grant (2009), ‘Innovation Procurement: Part of the Solution’, RAND Europe, available at: http://www.rand.org/pubs/documented_briefings/DB580/ (accessed December 2008). Bryan, R.C. (1943), ‘In defense of honors and awards’, The School Review, 51 (6), 348–52. BusinessWire (2007), ‘X PRIZE Foundation Raises $2.7 Million at Gala Hosted at Google’, March 7, available at: http://findarticles.com/p/articles/mi_m0EIN/is_2007_March_7/ai_n27289851 (accessed December 2008). Calandrillo, S. (1998), ‘An economic analysis of intellectual property rights’, Fordham Intellectual Property, Media and Entertainment Law Journal, 9, 301–60. Chernow, R. (2004), Titan: The Life of John D. Rockefeller, Sr, New York: Vintage. CleanTech Open (n.d.), available at: http://www.cleantechopen.com/app.cgi/content/home/index (accessed December 2008). CNN.com (2008), ‘McCain calls for $300 million prize for better car battery’, June 23, available at: www.cnn. com/2008/POLITICS/06/23/campaign.wrap (accessed December 2008).

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Coase, R. (1960), ‘The problem of social cost’, Journal of Law and Economics, 3, 1–44. Conoco Phillips Energy Prize (n.d.), available at: http://www.conocophillips.com/EN/tech/energyprize/ (accessed December 2008). Cooper, M. (2008), ‘McCain Proposes a $300 Million Prize for a Next-Generation Car’, New York Times, June 24, available at: www.nytimes.com/2008/06/24/us/politics/24campaign.html?fta= (accessed December 2008). Cowen, T. (2007), ‘Authors @ Google’, available at: http://www.youtube.com/watch?v=YOjAdjWgtgY (accessed December 2008). Davidian, K. (2005a), ‘Prize Competitions and NASA’s Centennial Challenges Program’, International Lunar Conference, available at: pp.nasa.gov/documents/cc_ilc_paper_2005-09-08.pdf (accessed December 2008). Davidian, K. (2005b), ‘Prizes, Prize Culture, and NASA’s Centennial Challenges’, available at: http://com mercialspace.pbwiki.com/f/Prizes%2C+Prize+Culture%2C+and+NASA%27s+Centennial+Challenges.pdf (accessed December 2008). Davis, L.N. (2002), ‘Should We Consider Alternative Incentives for Basic Research? Patents vs. Prizes’, paper presented at the DRUID Summer Conference, Elsinore, Copenhagen, June 6–8, available at: www.druid.dk/ conferences/summer2002/Papers/DAVIS.pdf (accessed December 2008). Davis, L. and J. Davis (2004), ‘How Effective Are Prizes as Incentives to Innovation? Evidence from Three 20th Century Contests’, paper presented at the DRUID Summer Conference on Industrial Dynamics, Innovation and Development, Elsinore, Denmark, May 7, available at: http://www.keionline.org/misc-docs/ds20041343.pdf (accessed December 2008). Dean, C. (2008), ‘If You Have a Problem, Ask Everyone’, New York Times, July 22. Doughton, S. (2008), ‘Gates Foundation tackles a giant that preys on Africa’s children’, Seattle Times, February 6, available at: http://seattletimes.nwsource.com/html/malaria/2003897861_malariatanzania09. html (accessed December 2008). DTE Clean Energy Prize (n.d.), available at: http://mpowered.studentorgs.umich.edu/index.php?n=DTE. CleanEnergyPrize (accessed December 2008). Epstein, D. (2006), ‘Who wants to be a millionaire?’, Inside Higher Ed, May 16, available at: www.insidehigh ered.com/news/2006/05/16/prize (accessed December 2008). Establishing the Advanced Research Projects Agency – Energy (ARPA-E) Act (2007), H.R. 364, signed into law as part of the America COMPETES Act. Freedom Prize (n.d.), available at: http://www.freedomprize.org/ (accessed December 2008). Glaskin, M. (2008), ‘Interview: Driving towards the 100-mpg car’, New Scientist, July 23. Hanson, R. (1998), ‘Patterns of Patronage: Why Grants Won Over Prizes in Science’, available at: http:// hanson.gmu.edu/whygrant.pdf (accessed December 2008). Harsanyi, D. (2008), ‘McCain’s magic-battery idea is low-watt economics’, The Denver Post, June 24, available at: http://www.denverpost.com/harsanyi/ci_9677242 (accessed December 2008). Heaton, G.R., C. Hill and P. Windham (2008), ‘Addressing Global Climate Change: Grassroots Initiatives and Technology Diffusion in the U.S.’, Report and Presentation to the SEPP Program at Tokyo University, Technology Policy International. Hitt, J. (2007), ‘The Amateur Future of Space Travel’, New York Times Magazine, July 1. Hoffman, C. (2007), ‘The right stuff: forget cyberspace. Geeks are about to conquer outer space. And the $10 million X Prize is just the beginning’, Wired Magazine, November, available at: http://www.wired.com/ wired/archive/11.07/space_pr.html (accessed December 2008). Hollomon, B., M. Ledbetter, L. Sandahl and T. Shoemaker (2002), ‘Seven Years Since SERP: Successes and Setbacks in Technology Procurement’, Pacific Northwest National Laboratory, available at: eere.pnl.gov/ femp/publications/SevenYearsSinceSERP.pdf (accessed December 2008). Holusha, J. (1993), ‘COMPANY NEWS; Whirlpool Takes Top Prize In Redesigning Refrigerator’, New York Times, June 30. Ignite Clean Energy Business Plan Competition (n.d.), available at: http://www.ignitecleanenergy.com/ (accessed December 2008). InnoCentive.com (n.d.), available at: http://www.innocentive.com (accessed December 2008). Jackson, D. (2008), ‘McCain’s $300M lure for new, “green” car battery sparks buzz’, USA Today, June 24, available at: http://www.usatoday.com/money/autos/environment/2008-06-23-mcain-car-battery_N.htm (accessed December 2008). Johnson, B.A. (2006), ‘Competition Urges Innovation in Harnessing Hydrogen Energy’, PC Magazine, May 12, available at: http://inglis.house.gov/sections/news/pdf_news_coverage/PC_Mag_05_12_06.pdf (accessed December 2008). Kalil, T. (2006), ‘Prizes for Technological Innovation’, The Hamilton Project, Brookings Institute, Washington, DC. KEI Research Note (2008), ‘Selected Innovation Prizes and Reward Programs’, available at: http://www. keionline.org/misc-docs/research_notes/kei_rn_2008_1.pdf (accessed December 2008). Kintisch, E. (2005), ‘Agencies hope to cash in on the allure of competition’, Science, 309 (5744), 2153–4.

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Klein, E. (2008), ‘A Better Battery? Or a Better Candidate?’, The American Prospect, June 24, available at: http://www.prospect.org/csnc/blogs/ezraklein_archive?month=06&year=2008&base_name=a_better_ battery_or_a_better_candidate (accessed December 2008). Krass, P. (2003), Carnegie, Hoboken, NJ: Wiley. Kremer, M. (1998), ‘Patent buyouts: mechanisms for encouraging innovation’, Quantitative Journal of Economics, 113, 1137–67. Krohmal, B. (2007), ‘Prominent Innovation Prizes and Reward Programs’, KEI Research Note 2007:1, available at: http://www.keionline.org/index.php?option=com_content&task=view&id=29 (accessed December 2008). Lane, A. (2009), ‘University of Michigan team wins Clean Energy Prize’, Crain’s Detroit Business, March 23. Lassa, T. (2008), ‘McCain’s $300-million battery prize comes with a catch’, MotorTrend Blog, June 23, available at: http://blogs.motortrend.com/6259250/technology/mccains-300-million-battery-prize-comes-with-acatch/index.html (accessed December 2008). Leonhardt, D. (2007), ‘You Want Innovation? Offer a Prize’, New York Times, January 31. Lerner, J. and C. Kegler (2000), ‘Evaluating the Small Business Innovation Research Program: A Literature Review’, The Small Business Innovation Research Program: An Assessment of the Department of Defense Fast Track Initiative, Board on Science, Technology, and Economic Policy, National Research Council. Lipton, E. (2008), ‘Insider’s Projects Drained Missile-Defense Millions’, New York Times, October 21. Macauley, M.K. (2005), ‘Advantages and disadvantages of prizes in a portfolio of financial incentives for space activities’, Space Policy, 21 (2), 121–8. Macdonell, H. (2008), ‘Green Scotland “can power whole of UK”’, The Scotsman, April 3. Masters, W. (2005), ‘Paying for prosperity: how and why to invest in agricultural R&D for Africa’, Journal of International Affairs, 58 (2), available at: http://www.agecon.purdue.edu/staff/masters/MastersPayingForProsperity_JIA2005.pdf (accessed December 2008). Masters, W.A. and B. Delbeq (2008), ‘Accelerating innovation with prize rewards: history and typology of technology prizes and a new contest design for innovation in African agriculture’, Purdue University Working Paper, West Lafayette, IN. McKinsey and Co. (2009), ‘“And the winner is .  .  .”: Capturing the Promise of Philanthropic Prizes’, March 3, available at: http://www.mckinsey.com/clientservice/socialsector/And_the_winner_is.pdf (accessed December 2008). Mervis, J. (2006a), ‘Legislator Wants NSF to Offer $1 Billion Energy Prize’, Science, 311 (5766), 1363. Mervis, J. (2006b), ‘House Panel Tells NSF to Keep Eye on the Prize’, Science, 312 (5871). MIT Clean Energy Prize (n.d.), available at: http://www.mitcep.org/about-us/ (accessed December 2008). Morgan, J. (2008), Author’s Conversation with Senior Director of Prize Development at the X Prize Foundation, November 5. MSNBC (2007), ‘$25 million climate prize offered by Branson’, February 9, available at: http://www.msnbc. msn.com/id/17063453/ (accessed December 2008). National Academy of Engineering (1999), ‘Concerning Federally Sponsored Inducement Prizes in Engineering and Science’, Steering Committee for the Workshop to Assess the Potential for Promoting Technological Advance through Government-Sponsored Prizes and Contests, available at: http://www.nap.edu/catalog. php?record_id=9724 (accessed December 2008). National Research Council (2007), ‘Innovation Inducement Prizes at the National Science Foundation’, Committee on the Design of an NSF Innovation Prize, available at: http://www.nap.edu/catalog/11816.html (accessed December 2008). Newell, R. and N. Wilson (2005), ‘Technology prizes for climate change mitigation’, Resources for the Future Discussion Paper, 05-33, Washington, DC. Nordhaus, W.D. (2004), ‘Schumpeterian profits in the American economy: theory and measurement’, NBER Working Paper W10433, Cambridge, MA, available at: http://ssrn.com/abstract=532992 (accessed December 2008). Office of Technology Assessment, US Congress (1993), ‘Energy Efficiency: Challenges and Opportunities for Electric Utilities’, OTA-E-561. Olsen, S. (2007), ‘Q&A: Space entrepreneur shoots for the moon’, CNET News.com, October 1, available at: http://news.cnet.com/QA-Space-entrepreneur-shoots-for-the-moon/2009-11397_3-6210751.html (accessed December 2008). Omidyar Network (n.d.), ‘Network Portfolio’, available at: http://www.omidyar.net/portfolio.php?fi=1 (accessed December 2008). Platt, K.H. (2007), ‘New X-Prize Announced: $30 Million for Moon Rovers’, National Geographic News, September 14, available at: http://news.nationalgeographic.com/news/2007/09/070914-lunar-xprize.html (accessed December 2008). Powers, K. (2008), Author’s Interview with former Executive Vice President of X Prize Foundation, October 30.

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Progressive Auto X Prize (n.d.), available at: http://www.progressiveautoxprize.org/teams (accessed December 2008). Reidy, C. (2006), ‘100,000 heads are better than one: companies are using online scientific talent to augment their in-house research and development staff in finding solutions to vexing problems’, The Boston Globe, August 21. Reiss, S. (2007), ‘Google Offers $20 million X Prize to Put Robot on Moon’, Wired Magazine, 5.10, September 13. Reuters (2009), ‘Team Algal Scientific Wins Inaugural Clean Energy Prize’, March 23, available at: http://www. reuters.com/article/pressRelease/idUS184952+23-Mar-2009+PRN20090323 (accessed December 2008). Revkin, A.C. (2009), ‘Dot Earth: Senators Propose Prizes for Capturing CO2’, New York Times, November 12. Rugani, L. (2008), ‘John McCain, Battery Booster: The senator’s proposed $300 million prize for an electriccar battery prompts excitement, skepticism’, Technology Review, June 25, available at: www.technologyre view.com/Energy/21006/ (accessed December 2008). Saar, J. (2006), ‘Prizes: The Neglected Incentive’, European Inter-University Association on Society, Science and Technology Working Paper, available at: http://innovationprizecentral.com/pdfs/prizes_the_neglected_ innovation_incentive.pdf (accessed December 2008). Saltire Prize Challenge (n.d.), available at: http://www.scotland.gov.uk/Topics/Business-Industry/Energy/ Action/leading/saltire-prize (accessed December 2008). Schroeder, A. (2004), ‘The Application and Administration of Inducement Prizes in Technology’, Independence Institute, IP-11-2004, available at: www.i2i.org/articles/IP_11_2004.pdf (accessed December 2008). Schulz, M. (2008), ‘Recharging McCain’s Battery Prize: It’s the most innovative proposal of the campaign, so why won’t he talk about it?’, National Review Online, October 16, available at: http://article.nationalreview. com/?q=MWZiZGRlZjUzNzBhNjYyMWZmMGMwNTA1ZmM5OTRkNDQ (accessed December 2008). Schumpeter, J. (1947), ‘The creative response in economic history’, Journal of Economic History, 7(2), 149–59. Schwartz, J. (2005), ‘Thrillionaires: The New Space Capitalists’, New York Times, June 14. Schwartz, P. (2004), Inevitable Surprises, New York: Gotham. Science (1939), ‘The Rockefeller Foundation’, New Series 89(2310), April 7, p. 319. Science, State, Justice, Commerce and Related Agencies Appropriations Act (2006), Public Law 109-108. Scotchmer, S. (2004), Innovation and Incentives, Cambridge, MA: MIT Press. Shenon, P. (1996), ‘The Nation; What’s a Medal Worth Today?’, New York Times, May 26. SHINE Project (2005), ‘The Solar High-Impact National Energy (SHINE) Project: A Call to Action for U.S. Energy Security and Independence’, Solar Catalyst Project, February, available at: http://www.cleanedge. com/reports/reports-shine.php (accessed December 2008). Silva, A. (2008), ‘Proposal for an Energy Independent Home X Prize competition’, available at: http://www. youtube.com/watch?v=abYYsVCxZ0Y (accessed December 2008). Sobel, D. (2005), Longitude: The True Story of a Lone Genius Who Solved the Greatest Scientific Problem of His Time, New York: Walker & Co. Sullivan, K. (2007), ‘$25 Million Offered In Climate Challenge’, Washington Post, February 10, p. A13. Taub, E.A. (2009), ‘LED Bulbs Save Substantial Energy, a Study Finds’, New York Times, November 29. Travis, J. (2008), ‘Science by the Masses’, Science, 319, March 28, 1750. US Department of Energy (2009), ‘Energy Research Projects Win $151 Million in Funding: ARPA-E selects 37 projects that could fundamentally change the way we use and produce energy’, October 26, available at: http://smallbusiness.doe.gov/business/625.htm (accessed December 2008). US Department of Energy Hydrogen Program (2008), ‘Administering Organization Announced to Support DOE in Implementing H-Prize’, September 23, available at: http://www.hydrogen.energy.gov/news_hprize_ foundation.html (accessed December 2008). Venkataraman, B. (2009), ‘Green, Inc.: Using Prizes to Drive Energy Innovation’, New York Times, November 5, available at: http://greeninc.blogs.nytimes.com/2009/11/05/using-prizes-to-drive-energy-innovation/ (accessed December 2008). Watts, S. (2006), The People’s Tycoon: Henry Ford and the American Century, New York: Vintage. Weiss, C. and W.B. Bonvillian (2009), ‘Stimulating a revolution in sustainable energy technology’, Environment, 51 (4), July–August, 10–21. Wessel, D. (2007), ‘Prizes for Solutions to Problems Play Valuable Role in Innovation’, The Wall Street Journal, January 25. Whitaker, N. (2008), Author’s telephone conversation with DARPA Urban Challenge Program Manager, November 6. Wolfe, K.A. (2007), ‘House Passes “H-Prize” Bill for Energy Research’, CQ.com, June 6, available at: http:// public.cq.com/docs/cqt/news110-000002525938.html (accessed December 2008). X Prize Foundation (2008), ‘X PRIZE Foundation & Progressive Insurance Join Forces to Officially Announce

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the $10 Million Progressive Automotive X PRIZE, March 20, available at: http://www.progressiveautox prize.org/press-release/x-prize-foundation-progressive-insurance-join-forces-to-officially-announce-the-1 (accessed December 2008). X Prize Foundation (n.d.), available at: http://www.xprize.org/about/the-x-prize-heritage (accessed December 2008).

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Index

actions 44–5 adaptive expectations 276, 278 additionality 340 Afuah, A. 233 agency innovation actors and mechanisms of creative destruction 284–9 path creation 278–9 agglomeration economies 88, 99–100 agricultural R&D 354 Ahuja, G. 173 Akeena Solar 234 Algal Scientific Corporation 363–4 Allen, P. 350 Alliance to Save Energy 41 alliances, strategic see strategic alliances aluminium recovery and recycling 29 American Solar Advancement Prize (ASAP) 360–61 Amit, R. 147, 148, 233–4 Annex I countries 335, 340 Anttonen, M. 294 Apaclara 29–30 applied research 354–5 ARPA-E 365 Arthur, B. 276, 277, 280 asset management 158–9, 162 assignment contracts 334, 337 attitudes, business angels’ 205–7 attractiveness of industries 205, 206 energy industry 205–7 automotive industry 259, 362–3 see also electric vehicles balancing risks 93 Ballard Power Systems 29, 30–31, 258, 259 Barnes, J. 360 baseline 340, 341 basic research 354–5 battery competition 359–60 beliefs 44–5, 46 Bell, A.G. 197 Bell, J. 330 Bell, M. 332 Bergek, A. 53 betweenness centrality 258 bilateral CDM projects 340–41

biofuels 49–50 Finland 292, 293 Bio-fuels 29 biogas 9, 58, 68–77 market in Germany 68 TENIRS 69–77 biotechnology 217 Bitterfeld-Wolfen 97–8 blocking mechanisms 53 Bodde, G. 361 Boehnke, J. 229 born-again global ventures 330 born global ventures 113, 329, 330 Boschma, R.A. 87 Boudreaux, D. 360 boundary spanning 279 Bower, J.L. 173 Brachert, M. 95, 96 brand image 266–7 Branson, R. 360 Brazil 341, 343 breakthrough technology 2, 3 Brin, S. 356 Brockhoff, K. 61 Brook, M. 29 Buchorn, A. 281 build–own–operate rooftop PV models commercial building owner 155, 168, 169–71 commercial buildings 154, 168, 169–71 generic business model 156, 157, 160, 162 building materials 49, 50 Bürer, M.J. 54 business angels 10, 197–213, 215 in Germany 10, 197, 200–209, 211 attitude towards energy investments 205–7 deal flow and investment behaviour 201–5 demographic characteristics 201, 202 energy investment behaviour 207–9 value added for energy entrepreneurs 198–200 business models and financial performance of renewable energy firms 11, 229–46 gestalt theme 233–5, 237–44 location in the value chain 231–3, 237–44 operational construct 147–8

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for photovoltaics (PV) 10, 145–71 identifying generic business models 150–63 value constellations resulting from deconstruction of the value chain 148–50 business plans competitions 363–4 investment propositions for business angels 201–3 business/professional services 47, 48, 49–50 Calyxo 98 Canada 29, 30–31, 255 capital, access to 126 see also finance; human capital; social capital capital requirements energy entrepreneurship 208, 210–11 prize contests 352–3 capitalism, and innovation 282 car dependence 294–5 carbon extraction and sequestration 360 Carter, S. 220 case study methodology 70, 77 Cavusgil, S. 330 Ceder, G. 359 centrality of a network 257–9 certification 50, 51 certified emission reductions (CERs) 326, 340, 341, 343 chain reactions 53 change 328 disruptive, exogenous 46 initiators of 84–5 locus of 84–5 Chatman, J.A. 176 chemical products 49 Chernobyl accident 90, 291 Chesbrough, H.W. 172, 174, 175, 231 China 101, 214, 226 CDM and international technology transfer 12, 326–7, 341, 342–4, 345 Law on Renewable Energy Resources 107 solar industry 9, 104–20 explaining the rise of solar producers in China 114–16 rise of 107–11 Christensen, C.M. 173–4 Christie, C. 321 Chrysalix Energy 181, 258, 259 churn (customer switching of energy supplier) 263–4, 266, 268–9 City Solar 98

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civic society innovation actors and mechanisms of creative destruction 284, 287–8, 296 Finland’s oil dependence 294, 295 see also social movements Clark, K.B. 173 clean development mechanism (CDM) 12, 326–7, 329, 338, 340–45 China 12, 326–7, 341, 342–4, 345 clean energy 339 venture capital investments in clean energy technologies 177–90 Clean Energy Council 309 Clean Energy Prize 363–4 cleaner technologies and processes 24, 25 CleanTech Open 364 Cliburn, J.K. 146 climate change 328–9 international policy 12, 335–40 Kyoto Protocol 121, 134–5, 290, 291, 326, 335–8, 340 policy makers’ and entrepreneurs’ responses to 305–6 prize contests for technologies to reduce 354 and technology transfer 335–45 CDM 340–45 closeness centrality 258 clusters/clustering 7, 86–7 German PV industry 95–100 coalitions 53 code definition 238 see also keywords codified knowledge acquisition 59, 61, 63–4, 66–7 TENIRS 72, 74, 75–7 collaboration, interfirm 42–3 commercial sector, photovoltaics in 153, 154, 166–8 commercialization 61, 65–7 TENIRS 72–7 commitment 9, 44–6 common technology platforms 125 communities of practice 123 community-driven technology transfer 332 competencies core see core competencies required in the PV sector 152–3, 170–71 competition under increasing returns 280 components 252 Conference of the Parties (COP) 335 configurations 233 for value constellations resulting from deconstructing the value chain 148–50 Conoco Phillips Energy Prize 364

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Index conservation/efficiency/reuse green businesses 48, 49 construction and installation 152–3 construction and installation service provider PV business model 156–7, 160, 162 construction sector 49, 50 consultancy arrangements 334, 337 consumer demand 40 content analysis 237–8, 239, 241–2, 243 context 125–6, 133–5 conventional internationalization theory 104, 105, 111–12 conversion efficiency of solar cells 107, 110 cooperative research and development agreements (CRADAs) 334 Coordinated Action on Ocean Energy 129 coordination effects 276, 277–8 core competencies generic business models for PV 156–7, 159, 161–2 utilities 158–9, 161–2 corporate customers (b2b) 263 corporate sustainability 2 corporate venture capital (CVC) 6–7, 215 organizational culture and survival of a CVC fund 10, 172–93 conceptual model 178–9 CVC fund survival rates 187–90 measuring and managing success 179, 186–7 parent firm organizational culture 179–84 risk and organizational decision making 179, 184–6 success factors and challenges 175 Corzine, J. 314, 315 cost of fuel cells 251–2 profiles and solar power in China 108 set-up/fixed 276, 277 Cowen, T. 351 creative construction 3–4 creative destruction 12, 274–5, 282–4, 296–7 in energy systems 283–4 innovation actors and mechanisms of 284–9 theory of 282–3 Crick, D. 123 CSG Solar 98 Customer On-Site Renewable Energy (CORE) rebate program 306, 308–13, 317–18 customer service 158–9, 162, 267 customer touchpoints 266 customers and EERE businesses 40, 42–3, 43–4, 45 loyalty in the energy market 11, 265–9

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problems of creating value recognized by 26–7 DaimlerChrysler 258, 259 DARPA Challenge 354 database segmentation 271–2 datasets, access to 356 David, P. 276–7 Davidian, K. 351–2 Day, G.S. 173 Dean, T.J. 23 Dechezleprêtre, A. 341–2 decision making, organizational 179, 184–6 deconstruction of an industry value chain 145–6, 148–50 degree centrality 257–8 Delmas, M. 54, 55 Deloitte 228 demand 40 supply–demand discrepancies 28 demonstration projects 128, 133 Denmark 5, 222–3, 225, 281 desalination of seawater 29–30, 31 destabilization 297 Deutsche Bank 338, 339 developing countries 15 and firm internationalization 112 Diamandis, P. 350 diesel cars 293 Dimitratos, P. 331 direct methanol fuel cell (DMFC) 251 dispersal 86 disruptive innovation 173–4, 234 distributed networks of actors 278–9, 281 distribution alliances 254, 255–6 Doranova, A. 342 downstream 151–2, 231–2 downstream business models 231–2, 237–44 drinks cartons 29 due diligence 179, 184–5, 186 Duke Energy Carolinas 160 Dunham, D. 175 Dunning, J.H. 111–12 durability 251–2 Dushnitsky, G. 174 dynamic capabilities 114, 116 Earth Challenge Prize 360 economic development 2 economic knowledge 4 economies of scale 145 educational background 201 efficiency-driven business models 230, 234–5, 237–44 Eisenhardt, K. 54

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‘Electric Cars – Now!’ 294 electric vehicles 223, 224, 294 McCain battery prize 359–60 electronics 223 elementary business models 154–6, 165–71 embeddedness 278–9 emerging industries 6 business models for renewable energy firms 235, 242, 243 incumbent firms and new entrants 54–5 market construction 54 emissions trading scheme (ETS) 326, 338 employment in EERE businesses 41, 42, 44 in green businesses 49 Endesa 159–60 Energy Alley 44 energy control 152–3 energy efficiency 14, 220–21, 339 prizes for 361–3 energy efficiency and renewable energy (EERE) businesses 38–57 challenges from non-EERE companies 40–41 early 1990s study 41–3 late 1990s study 43–6 see also green businesses Energy Mentalities 269–72 energy market research see market research energy prices 40 customer loyalty 265, 266–7 oil prices 219, 222, 289, 291 and venture capital investment in greentech 219, 221–2, 227 energy systems evolution 11–12, 274–301 creative destruction 283–4 innovation actors and mechanisms of 284–9 oil dependence in Finland 289–95 path creation 279–81, 289–91, 292–5 path dependence 277–8, 279, 289–91, 292, 294–5 engineering 49, 50 entrepreneurial learning 9, 58–80 biogas market 68–75 commercialization stage 65–7, 72–5 technology development stage 62–5, 70–72 theoretical framework 60–61 entrepreneurial opportunities see opportunities entrepreneurial spirit 183–4 entrepreneurs/founding teams 122–3, 128–9 entrepreneurship and entrepreneurial opportunity 84–5 institutions, public policy and 4–5 knowledge, creative construction and 3–4

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research landscape 2–8 small firms, large firms and 2–3 EnVal 29 environmental resource management 339 environmental services 339 environmental turbulence 58–9 environmental ventures 8, 21–37 evidence on impediments to environmental enterprise 23–31 equilibrium economics 28, 34 EquiMar 134 established firms see incumbent firms established industries 235, 242, 243, 244 ethanol 224 European CVC funds 177–90 European Union (EU) 327 ‘20 20 by 2020’ initiative 274 Climate Energy Package 293 opening of energy markets 262 Renewable Energy Directive 121, 135 Second Strategic Energy Review 274 European Wave Energy Symposium 129 European Wave and Tidal Energy Conference 129 evolutionary perspective 23, 33, 34–5 exit strategies for business angels 204–5 expectations, adaptive 276, 278 experience 201, 202 expertise business angels’ 198–9 incentive prizes and range of 356–7 explicit knowledge 59, 60, 61, 332 see also codified knowledge acquisition external innovation barriers 61, 62–3, 64, 65–6, 66–7 TENIRS 72, 74, 75–7 external stakeholders 55 externalities 22, 33–4 failure, value of 357–9 Facebook 219 feed-in tariffs 134, 314, 315 Germany 91, 92–3 finance 5–7, 10–11, 126 business angels see business angels difficulties for environmental ventures 25–6 New Jersey PV 310–11 utilities solar loan program 316–19, 320 venture capital see venture capital financial crisis 203 financial performance, business models and 11, 229–46 Finland oil dependence 289–95 path creation in transport systems 292–5

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Index path dependence in traffic systems 292, 294–5 total energy consumption 289, 290, 291 Finnish Oil and Gas Federation 291 Fiordaliso, J. 313, 317 firm internationalization see internationalization First Solar 218–19, 234 fixed costs 276, 277 Fobox 134 Fonseca, L.A. de 158 foreign direct investment (FDI) 333, 336 CDM 340–41 China 343–4 theories of 111–16 Fortum 294 forward osmosis 30 fossil fuels 121, 214, 305 see also greenhouse gas emissions Fox, J. 308, 309, 313 franchising 333–4, 337 Freedom Prizes 364 Frenken, K. 87 fuel cell technologies 11, 249–61 Ballard Power 29, 30–31, 258, 259 network approach 254–60 supply chain 252–3 FuelCell Energy 258, 259 Garud, R. 222–3, 279, 281 Gates, B. and M. 351 Gdf Suez 160 Gdf Suez ESS 161 Geels, F.W. 297 General Motors (GM) 258, 259 generic business models for PV 156–7 best suited for utilities 157–63 Genomics X Prize 357 geography new geography of innovation 7–8 spatial structures see spatial structures Germany 104, 106, 115, 255 biogas market 68 business angels 10, 197, 200–209, 211 energy market 265, 266 feed-in law 90, 91, 92–3 PV industry 9, 83, 88–101 1,000 roof programme 90 100,000 roof programme 92 evolution of spatial structure 93–100 social movements and the evolution of a legal supporting scheme 88–92 renewable energy legislation 68, 338 Geroski, P. 163 gestalt themes 233–5, 237–44

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GfK Energy Mentalities 269–72 Global Environmental Facility (GEF) 344 globalization 7–8 Golden Carrot Award 361–2 Gompers, P. 175 Good Energies 115 Google 219 Gordon, G.G. 176 Gore, A. 221, 222, 360 governance structures 254 government agency budgets 358 government-driven technology transfer 332 governments action and clustering 85–6, 87 PV industry in Germany 90–91, 91–3 and EERE businesses 40, 42–3, 45, 54 involvement in funding allocation decisions 214–15 lobbying 33 national innovation systems 125, 133–4, 137 policy see policy prize competitions sponsored by 353–5, 358–60, 361–3, 364–5, 366 subsidies see subsidies Grady, E. 38 grant funding for research 355, 358 green businesses 39–40, 47–55 jumpstarting 52–5 survey in Minnesota 47–52 see also energy efficiency and renewable energy (EERE) businesses green technologies (greentech) 10–11, 214–28 greenhouse gas emissions 293, 326, 335–8 CDM see clean development mechanism ground-mounted PV systems 153, 154, 166–8 GROWIAN large wind turbine 5 H-Prize 361 Hanson, R. 355 Harsanyi, D. 360 hedonism–puritanism scale 270–71 Henderson, R.M. 173 high-tech clusters 7 High-Tech Gründerfonds 211 ‘historical accidents’ 84, 86 Hockerts, K. 54–5 holding period for business angel investments 204, 205 Hornych, C. 95, 96 human capital 126, 198–9 hybrid structures 124, 131–3 hydrogen 249–50 see also fuel cell technologies Hydrogenics Corporation 258, 259

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Hyflux 29, 31 HyWind project 131 Ignite Clean Energy Business Plan Competition 364 imitation 334 implicit knowledge see tacit knowledge in-front-of-the-meter programs 319, 320 incentive prizes 12–13, 350–70 encouraging energy and environmental innovation 359–64 future directions 364–6 resurgent interest in 350–52 theory of prizes 352–9 increasing returns 276 active management of 280–81 competition under 280 incumbent firms 2–3, 14 and emergence of spatial structures 97–100 and innovation 173–4 innovation actors and mechanisms of creative destruction 285–6, 286–7 and new entrants in emerging fields 54–5 see also large firms India 214, 226, 341, 343 inducement mechanisms 53 industrial dynamics 87–8 industry areas of investment by venture capital 217–18 attractiveness 205–7 CVC parent firm view of industry development 179, 181–2 sectors and fuel cell network 256 transitions 13 value chain see value chain informant bias 77 information asymmetries 22, 26–7 inadequacies and business angel investment in the energy sector 209–10 positive spinning of 45–6 information technology (IT) 283 venture capital investment 217, 218–19 initiators of change 84–5 InnoCentive marketplace 357 innovation 22, 328 actors and mechanisms of creative destruction 284–9 barriers 61 external 61, 62–3, 64, 65–6, 66–7, 72, 74, 75–7 internal 61, 62, 63–4, 64–5, 66, 67, 72, 74, 75–7 disruptive 173–4, 234

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four-stage model of the innovation process 61 incumbent firms and 173–4 market failure, market dynamics and 8, 21–37 national innovation systems 125, 133–4, 137 new geography of 7–8 organizational culture and 175–6 CVC parent firm view of innovation 179–81 solar power industry 107 innovation-driven business models 229, 230, 234–5, 237–44 inside view 184 institutions 4–5, 296–7 clustering and 87, 99–100 fragmentation 52 and international new ventures 125 supporting institutions for green businesses 52–3, 54, 55 insulation 49, 50 integrated business models 148, 232–3 financial performance and renewable energy firms 237–44 photovoltaic energy 154, 165–8 interconnection standards 311 interfirm collaboration 42–3 interfirm relationships see networks; partnerships; strategic alliances Intergovernmental Panel on Climate Change (IPCC) 332, 335, 338 internal innovation barriers 61, 62, 63–4, 64–5, 66, 67 TENIRS 72, 74, 75–7 international agreements 126, 134–5 see also Kyoto Protocol international climate change policy 12, 335–40 see also clean development mechanism (CDM); Kyoto Protocol international conferences 129 International Energy Agency (IEA) 338 international entrepreneurship 327–9 offshore renewable energy industry 9, 121–41 and technology transfer 12, 326–49 typology of new ventures 329, 330–31 international industrial organizations 129 international new ventures (INVs) 9, 122–6, 329, 330 entrepreneurs/founders 122–3, 128–9 nurturing context 125–6, 133–5 offshore renewable energy industry 127–38 venture level 124–5, 130–33

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Index international orientation 122–3 International Renewable Energy Agency (IRENA) 338 international standards 125, 134, 137 international start-ups 330 international ventures 331 internationalization Chinese solar power firms 110–11, 114–16 factors explaining 131 theories of 111–16 internet 217 and churn 268 investment bubble 225–6 investment behaviour of business angels 201–5 energy investment 207–9 investment decisions 179, 184, 185–6 investment propositions 201–3 investment tax credit (ITC) 315, 316 iterative processes 32, 67 Jacobsson, S. 53 Japan 104, 106, 255, 259 Jehn, K.A. 176 Johnson, J. 330 joint implementation (JI) 326, 338 joint ventures (JVs) 254, 255–6, 334, 336 Jones, M. 123 Kahneman, D. 184, 185 Kammen, D.M. 180 Karnøe, P. 222–3, 279, 281 keywords 238, 239, 241–2 Khosla, V. 224 Kiel University Institute of Agricultural Engineering 70–71 Kleiner Perkins Caufield and Byers (KPCB) 219–20, 222, 224 Klepper, S. 38 Knight, G. 330 knowledge business angels’ 198–9 economic 4 explicit 59, 60, 61, 332 tacit 59, 60, 61, 332 knowledge acquisition 59, 60–61, 62–4, 65–7 TENIRS 72, 74, 75–7 knowledge integration 59, 60–61, 64–5, 67 TENIRS 72, 74–5, 75–7 knowledge spillover theory of entrepreneurship (KSTE) 3–4 Korea, South 259 Kuemmerle, W. 331 Kyoto Protocol 121, 134–5, 290, 291, 326, 335–8, 340 CDM see clean development mechanism

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L Prize 362 Lampel, J. 281 Lampert, C.M. 173 large firms 2–3, 14 former monopolies in the energy market 264 innovation and mechanisms of creative destruction 284, 285–6, 296 Finland’s oil dependence 293–4, 295 see also incumbent firms large project development specialist 155, 168, 169–71 large project facility construction and installation specialist 155–6, 168, 169–71 Lassa, T. 359 latecomer theories of internationalization 104, 105, 112–13 LLL theory 113–14, 116, 117 and the rise of Chinese solar producers 114–16, 117 layer player model 149, 155–6, 165–8 learning, entrepreneurial see entrepreneurial learning learning effects 276, 277 Lee, B. 55 legitimation 72–3 Lenox, M. 54, 174 Lerner, J. 175, 364 Levinthal, D.A. 173, 186 Lewis, M. 151–2 licensing 333, 336–7 lifestyle typologies 11, 269–72 lighting technology 362 linkage, leverage and learning (LLL) theory 113–14, 116, 117 Lindbergh, C. 350 liquid manure composition measurement 69, 71 lobbying government 33 local content requirement 344 local investment 7 localization stage 86, 94–5, 96, 100 location on the value chain 231–3, 237–44 locus of change 84–5 loss aversion 185–6 Lovallo, D. 184, 185 low-involvement market 263, 265–9 loyalty, customer 11, 265–9 Lum, O. 31 management/managers 136–7 management fees 216 manufacturing capacity 109 manufacturing/products green businesses 47, 48, 49–50 March, J.G. 186

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Marcus, A. 53 Marine Institute of Ireland Development and Evaluation Protocol 130 market dynamics 8, 21–37 opportunities arising from entrepreneurial responses to 33–5 market failures 8, 21–37 and path dependence 276–7 as a source of opportunity 22–3 that impact on the appropriation of returns 27–8 market maker model 149, 150, 165–8 market-oriented economists 214–15 market pull 286 market research 11, 262–73 challenges of energy market research 263–5 customer loyalty 265–9 marketing efficiency in a highly fragmented market 269–72 market segmentation see segmentation, market marketing 13–14 communications 272 markets construction in emerging fields 54 creation of a market for PV electricity in New Jersey 12, 305–25 growth 223 market mechanisms for technology transfer 332, 333–4 Markides, C. 163 Maskus, K. 333 materialism–postmaterialism scale 270–71 materials 252 Mathews, J.A. 113–14 McCain, J. 354, 359–60 McDougall, P. 122, 330 McEvily, B. 53 McGreevey, J. 308, 309 McMullen, J.S. 23 means–ends calculus 22, 31 reconfiguring 32 measurement of CVC success 179, 186–7 medals 355–6 medium-size project development specialist 155, 168, 169–71 medium-size project facility construction and installation specialist 155, 168, 169–71 mergers and acquisitions 254, 255–6 Mexico 343 micro-multinational firms 331 Miller, D. 233 Minnesota 41–52 green businesses in 2009 47–52 surveys of EERE businesses 41–6 MIT Clean Energy Prize 364

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Mitchell, K. 52 mobile phones 283 mobility dependence 294–5 mobility of personnel 334–5, 338 Mobley, J.S. 355–6 Molinaroli, A. 360 molten carbonate fuel cell (MCFC) 251 momentum, generating 279 monetary prizes 355–6 monitoring 199 Montes-Sancho, M. 54 Montreal Protocol 340 Morgan, J. 357, 363 motivation for international expansion 124 multilateral CDM projects 340–41 multinational corporations (MNCs) 121 partnerships with offshore renewable energy companies 132, 137 western MNCs 104 multi-stage prize contests 353 NASA Astronaut Glove competition 352 National Academy of Engineering 355 national innovation systems 125, 133–4, 137 National Science Foundation (NSF) 365 natural gas 290, 291 near-infrared-spectroscopy (NIRS) technology 69 see also TENIRS negative feedback 53 Nemet, G. 180 neoclassical economics 33, 34 Neste Oil 293 net metering 311 Netflix 223, 356 networks 253–4, 296–7 business angels’ 199–200 fuel cell industry 11, 254–60 prolonged gestation and 45, 53 new economic spaces 217 new firms 3 offshore renewable energy industry 127–8, 135–6 small new firms as innovation actors in energy systems 284, 285–6, 287, 294, 295, 296 New Jersey 12, 305–25 Board of Public Utilities (BPU) 307, 308, 309, 311, 313, 314–15, 316–17, 318, 319 CORE rebate program 306, 308–13, 317–18 Electric Discount and Energy Competition Act (EDECA) 1999 307 Energy Master Plan 307, 314 Office of Clean Energy (OCE) 309, 312, 313, 316

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Index solar policy transition 2006–2008 313–16 solar RPS policy 308–14, 316, 317 sustaining markets for PV electricity 319–21 utility loan programs 316–19, 320 utility restructuring 1999–2002 307–8 new products, marketing 14 Newell, R. 354 niches 53 non-financial support from business angels 199, 204, 210 non-market mechanisms for technology transfer 332, 334–5 ‘North–South divide’ 329 Norway 134 Novozymes 344 nuclear power 290, 291 opposition in Germany 89, 90 Nuvera 258 OECD 328 offshore renewable energy industry 9, 121–41 oil dependence in Finland 289–95 global consumption 289 prices 219, 222, 289, 291 wastes 29 Omidyar, P. 351 operations and maintenance 152–3 opportunities arising from entrepreneurial responses to market dynamics 33–5 entrepreneurial opportunities and the formation of PV clusters 9, 83–103 environmental ventures 8, 22–31 how opportunities are realized 28–31 exploitation of 327, 328 sources of 84–5 market failures as 22–3 WLOs 83, 86–7, 94–7 OPT 134 orchestrator model 149, 155, 165–8 organizational culture and innovation 175–6 and survival of a CVC fund 10, 172–93 parent firm organizational culture 179–84 organizational decision making 179, 184–6 organizational mindset 179, 182–4 Orteig Prize 350 outside view 184–5 Oviatt, B. 122, 330 OWEC Tower 130–31 ownership, location and internationalization (OLI) paradigm 105, 111–12, 116 ownership-specific advantages 111–12, 116

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Pacific Gas and Electric (PG&E) 161, 316, 320 in-front-of-the-meter program 319 solar loan program 317–18, 319 parent firm’s organizational culture 179–84 partnerships internationalization through 124, 131–3, 136, 137 venture capital 216 see also strategic alliances patents 135 technology transfer via reading patent applications 334 path creation 12, 274–5, 278–81, 288, 296–7 and creative destruction 282–3 in energy systems 279–81 Finland’s oil dependence 289–91, 292–5 path dependence 12, 274–5, 275–8, 288, 296–7 and creative destruction 282–3 in energy systems 277–8, 279 Finland’s oil dependence 289–91, 292, 294–5 theory 275–7 venture capital 220 ‘patient capital’ 316–19 peat 290, 291 Pelamis Wave 135 penalty payments 307, 316 performance, business models and 11, 229–46 personal knowledge acquisition 59, 61, 62–3, 65–6 TENIRS 72, 74, 75–7 personnel, movement of 334–5, 338 philanthropy 350–51 Philips 362 phosphoric acid electrolyte fuel cell (PAFC) 251 photovoltaic (PV) energy business models 10, 145–71 elementary models 154–6, 165–71 generic models 156–7 generic models best suited for utilities 157–63 China 9, 107–11, 114–18 creation of the market for PV electricity in New Jersey 12, 305–25 Germany 9, 83, 88–101 global industry 105–7 industry value chain 151–4 see also solar energy Pichel, K. 176 planning, prizes for 363–4 plug-in hybrids 359 Plug Power 218, 258, 259

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policy, public 4–5 innovation actors and mechanisms of creative destruction 284, 286–7, 296 Finland’s oil dependence 293, 295 international climate change policy 12, 335–40 see also clean development mechanism (CDM); Kyoto Protocol and INVs 125, 137 market creation for PV electricity in New Jersey 12, 305–25 and market failure 34 research possibilities 14 venture capital and greentech investment 224–5 policy coalitions 281 politics 358–9 polymer electrolyte membrane fuel cell (PEMFC) 251 portable power generation 253 Porter, M.E. 40, 147 Portugal 133–4 positive feedback 53, 276, 277–8 postmaterialism–materialism scale 270–71 Power and Sun 29, 30 prestige 355–6 price risks 93 prices, energy see energy prices private customers (b2c) 263 private sector-driven technology transfer 332 prizes, incentive see incentive prizes probe and learn 67 problem definition 353–5 products/manufacturing green businesses 47, 48, 49–50 professional/business services 47, 48, 49–50 professional venture capital see venture capital profit equation 147–8, 154, 167 Progressive Automotive X Prize 362–3 Project Design Documents 341 project development 152–3 prolonged gestation 9, 38–57 EERE businesses in Minnesota 41–6 green businesses in Minnesota 47–52 take-off from 52–5 protectionism 117 Proton Energy Systems 258 prototype testing 73, 128 public policy see policy public transport 293 publicity 356–7 pulp and paper companies 293–4 puritanism–hedonism scale 270–71 PV Crystalox 98

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Q-Cells 97–8, 106, 115 Quong, S. 359–60 QWERTY keyboard 276 RCS lifestyle map 270–71 recovery and recycling 24, 25 refrigerators, efficient 362 regulatory environment 85–6 Reisman, A. 333 renewable energy 48, 49, 145, 262, 293 annual growth rate 105 business models and financial performance of renewable energy firms 11, 229–46 China, the CDM and local content requirement for equipment 344 framework in Germany 88–90 need for international diffusion of technology 121–2 offshore renewable energy industry 9, 121–41 prize contests and 354 venture capital and 6 see also under its individual forms renewable energy certificates (RECs) 307, 308 solar RECs 306, 311, 313, 314–16, 317, 318–19 Renewable Energy Corporation (REC) 106 Renewable Energy Task Force 309 renewable and low carbon energy market opportunities stationary 24, 25 transport 24, 25 renewable portfolio standard (RPS) 306, 307, 308 solar RPS 308–14, 316, 317 research applied and basic 354–5 avenues for energy entrepreneurship research 13–16 subsidies 355, 358 research communities 123 research and development (R&D) alliances 254, 255–6, 259–60 cutbacks in energy R&D spending 180 funding problems 26 residential sector PV 153, 154, 166–8 resource constraints 124 Revelle, R. 305 revenue models 147, 229 risk business angels’ approach to managing 198 and organizational decision making 179, 184–6

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Index reduced for renewable energy producers in Germany 93 risk taking and incentive prizes 357–9 Robertson, C. 146 Rockefeller Foundation 351, 353 RPS Transition Working Group 314 Russo, M. 55 Rutan, B. 350 sales 41, 42, 44 Saltire Prize 363 Santos, F. 54 scale-up problems 27 Schein, E.H. 176 Schneider, M. 342 Schoemaker, P.J.H. 173 Schumpeter, J. 2, 217, 274, 275, 282, 285 Schweizer, L. 148–50 Scotland 363 Scott, A.J. 86 seawater desalination 29–30, 31 security of supply 265, 267–8 segmentation, market market research 11, 263, 265, 269–72 New Jersey PV market 310 Sequoia Capital 220 serendipity 32 Seres, S. 341 service provider to the owner of a large PV facility 155, 168, 169–71 set-up costs 276, 277 Sharma, A. 173 Sharp 106 Shenkman, R. 359 shifting centre 86 Shore, J. 363 Siegel, R. 175 silicon-based PV technology 106 see also photovoltaic (PV) energy Silicon Valley 218, 219 Sine, W. 55 Singapore 29, 31 skill demonstration, prizes for 363–4 Small Business Innovation Research (SBIR) Program 364 small facility construction and installation specialist 155, 168, 169–71 small firms 2–3, 4 incentive prizes 364–5 new small firms as innovation actors in energy systems 284, 285–6, 287, 294, 295, 296 small project development specialist 155, 168, 169–71 social capital 199–200

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social movements 55 government action and entrepreneurial opportunity 85–6 innovation actors and mechanisms of creative destruction 284, 287–8 and renewable energy in Germany 88–90 see also civic society social network analysis 11, 256–9 Societal Benefits Charge (SBC) 307–8, 309 software 221, 354 solar energy 145 business models 11, 234, 235–43 Chinese challenger firms 9, 104–20 global industry 105–7 incentive prizes 360–61 photovoltaics see photovoltaic (PV) energy Power and Sun solar home systems 29, 30 Swiss solar cell technology 29, 30 solar loan programs 316–19, 320 solar RECs (SRECs) 306, 311, 313, 314–16, 317, 318–19 solar RPS policy 308–14, 316, 317 Solarfun 108–11, 114–16, 117 Solarworld 115 Solibro 98 solid oxide fuel cell (SOFC) 251 Sovello 97–8 space travel 350–51 Spain 100–101 spatial structures 9, 83–103 determinants of the evolution of spatial structures in new industries 87–8 entrepreneurial opportunities and 84–8 evolution and the German PV industry 93–100 spin-offs 334, 338 and clustering 88, 95–7, 100 offshore renewable energy industry 127–8, 136 Sri Lanka 29, 30 St1 294 standardization 125, 134, 137 start-ups see new firms stationary power generation 253 StatoilHydro 131 Stern, N. 338 Stonner, D. 356 Stora Enso 294 Storper, M. 86–7, 88 strategic alliances 253–4 fuel cell industry 11, 254–60 TENIRS 73, 74 see also partnerships strategic benefits 174 strategic flexibility 32

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subsidiaries 110, 111 subsidies research 355, 358 venture capital, greentech and 224–5 Suess, H. 305 Sunfilm 98 Sunpower 107 Suntech 108–11, 114–16, 117 suppliers alliances with 254, 255–6, 260 EERE businesses 43–4, 45 supply chain, fuel cell 252–3 supply–demand discrepancies 28 supranational agreements 126, 134–5 see also Kyoto Protocol survival motivation of INVs 124 sustainability-related products 14 switching of energy supplier 263–4, 266, 268–9 Switzerland 29, 30 Sykes, H.B. 175 syndication 211 system integrators 252–3, 258, 259 system operations 158–9, 162 systems 53 energy systems see energy systems evolution interaction between 278 tacit knowledge 59, 60, 61, 332 see also personal knowledge acquisition take-off 38 moving from prolonged gestation to 52–5 Teamwork Technology 130 technological diversification 95–7, 100 technological dramas 281 technological strategies 117 technology development entrepreneurial learning 61, 62–5 TENIRS 70–72, 75–7 technology diffusion 332 technology push 286 technology transfer 12, 326–49 climate change and 335–45 CDM 340–45 international 329–33 mechanisms for 333–5 telecommunications market 263 TENIRS 69–77 commercialization 72–7 company background and technology 69–70 technology development 70–72, 75–7 Teppo, T. 218 thin-film PV technology 98–9, 106, 107 Third World Multinational Corporation (TWMNC) literature 113 tidal energy 121–2, 132, 135

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time business angels’ investment of 204, 210 horizons and prize contests 352–3 Tobin’s q 230, 236–7, 238–42, 243, 244 Toffel, M. 55 tradable certificates see renewable energy certificates (RECs) trade, international 333, 336 training and education 99–100 transition to cleaner energy 13 transport coordination effects 278 electric vehicles see electric vehicles Finland’s oil dependence 292–5 fuel cell technologies 250–51, 253 triangulation 126–7 Trina Solar 108–11, 114–16, 117 turnkey projects international technology transfer 334, 337 PV provider for commercial building owner 155, 168, 169–71 generic business model 156, 157, 159–60, 162 for home owners 155, 168, 169–71 Twin Cities 47–52 Twitter 219 uncertainty 58–9 unilateral CDM projects 340–41, 343–4 United Kingdom (UK) 355 Climate Change Bill 359 Department of Trade and Industry (DTI) 24 environmental enterprises, opportunities and obstacles 23–8 environmental innovators and realization of opportunities 29–30 offshore renewable energy 133–4 reduction in fuel duty on biodiesel 29 United Nations Framework Convention on Climate Change (UNFCCC) 335, 339, 343, 344 United States of America (USA) 5, 7, 8, 104, 106 approach to entering the wind turbine industry 222–3 Carbon Dioxide Capture Technology Act 360 Department of Energy 11, 258–9, 361, 362 ARPA-E 365 energy R&D spending 180 incentive prizes 12, 350–70 National Academy of Engineering 355 National Science Foundation 365 New Jersey PV electricity market 12, 305–25

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Index organizations in the fuel cell network 255, 258–9 policy, venture capital and greentech investment 224–5 SBIR Program 364 TARP bill 319 values in the national character 351–2 University of New South Wales 115 UPM 294 Uppsala model of firm internationalization 105, 112 upstream 151, 231–2 upstream business models 231–2, 237–44 used-drinks cartons 29 user feedback 72–3 user innovations 284, 287–8 users, in the supply chain 252, 253 utilities core competencies 158–9, 161–2 electric utilities, CVC funds’ survival and organizational culture 172–93 generic PV business models best suited for 157–63 New Jersey 321 ‘patient capital’ and solar policy 316–19, 320 restructuring 307–8 and PV energy 145–6 structure 158–9 utility scale PV business models builder and operator 154, 168, 169–71 power builder orchestrator and producer 155, 168, 169–71 power producer generic model 157, 161, 162 value, problem of creating customerrecognized 26–7 value added, business angels’ 198–200 value-added service provider model 156, 157, 160, 162 value chain deconstruction of 145–6, 148–50 location of business model in 231–3, 237–44 photovoltaic energy 151–4 renewable energy industry 231 value constellation 147–8, 154, 165 identifying in a context of deconstruction 148–50 value proposition 147–8, 154, 166–7 values 351–2 VDI Business Angels Panel 197, 200–209 venture capital (VC) 5–7, 197, 259 corporate see corporate venture capital (CVC)

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investment in the green technology sector 10–11, 214–28 government subsidies and 224–5 greentech vs traditional VC-financed industries 217–19 historical parallels 222–3 investment bubbles 225–6 pattern of investing 219–22 life cycle and the operation of the typical VC firm 215–16 new geography of innovation 7–8 and take-off of green businesses 54 vertical integration 95–7, 100, 232–3 Vestas 234, 344 virtual operator and energy controller 156, 168, 169–71 virtual power plant 157, 161, 162 volume risks 93 Walker, R. 86–7, 88 waste materials, conversion into a source of value 28–31 water green businesses and water processing 48, 49 Hydrochem 29, 31 seawater desalination 29–30, 31 waste water treatment 24, 25 wave energy 121–2, 128–9, 130, 132, 134, 135 WaveNet 129 Weill, P. 236 Welch, A. 52 welfare economics 27–8, 33 western MNCs 104 Whirlpool Corporation 356, 362 Wilson, N. 354 wind energy 55 business models 11, 234, 235–43 Denmark 222–3, 225, 281 offshore 121–2, 130–31 US approach to entering the wind turbine industry 222–3 Wind Turbine Owners’ Association 281 windows of locational opportunity (WLOs) 83, 86–7, 94–7 Winka, M. 313, 314 wood-based biofuels 293–4 wood fuel 290, 291 word count 238, 239 World Climate Conference 1979 335 Wüstenhagen, R. 54–5, 218 X Prize 350–51, 357 diaspora 363 Progressive Automotive X Prize 362–3

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Yin, R.K. 70 York, J. 54 YouTube 219

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Zayed Future Energy Prize 363 Zott, C. 147, 148, 233–4

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