Broken Symmetry

Why Research Universities Should Start Offering their IP on a Subscription Basis

Over the past several years, I have heard many complaints (from graduate students and faculty on the one hand, and venture capitalists or licensing excecutives for large companies on the other) about the difficulties associated with negotiating licenses or sponsored research agreements. One might naively imagine that such agreements are routine, at least at research universities. Many have a staff of technology transfer employees whose job it is to facilitate these agreements.

But the agreements are not usually so easy to close. In fact, the agreements are so difficult that (at least in places like the Bay Area) the easiest solution for faculty or students intent on seeing their ideas comercialized is to leave the university, either temporarily or permanently, to launch a startup or consult with an established company on a new product or service.

The biggest loser is the university. Or at least that's true if you believe that there is no need to worry that greater university-industry relationships will somehow corrupt university culture. Therein lies the rub. The fact is that many people both within and without the university believe that academics should be independent from the allegedly corrupting influences of commerce.

Nevermind the hypocrisy inherent in holding that view but, at the same time, encouraging faculty to compete for federal grant money that is distributed based on political values that are directly or indirectly influenced by the same corrupting commerce. Focus on the key premise: Does an increased flow of information back and forth between university and industry hinder the growth of knowledge.

The answer to that question must be no. Facts are gathered proactively in response to practical problems. It is these facts that form the basis for academic theory. Academics can collect them on their own, and should be encouraged to do so. But there is no way that academic institutions can keep up with the scale of production of data already ongoing outside the academic system. University-industry collaborations are the future of our global economy, and the university must adapt to the new reality in which the polite fiction of academic independence can no longer be respected. Academic independence -- to the extent that it ever existed in research universities -- has been replaced with dynamic balance, detente.

Which brings us back to the original problem. Suppose the top-tier research universities, whose endowments (not coincidentally!) are often significant portions of the top-tier venture capital funds were to demand that each of those venture capital funds pay an annual subscription for (say all non-biotech or pharma) university intellectual property on a non-exclusive basis. Exclusive deals would remain subject to negotiation. The funds would go primarily to preparation and prosecution of patent applications.

Imagine the collaboration that might result from the lowered transactions costs of collaboration. The alignment of interests between the university and its industry subscribers now permits seamless communication without concern of loss of patent rights or trade secrets. Inventors have better feedback on what, if any, applications are worth filing from industry, rather than from other faculty or from tech transfer office employees alone.

The endowments see reduced expenses -- no more patent prep and pros fees -- and additional income (in whatever is leftover from the subscription fees). Inventors are more likely to stay at the University rather than leave. Only the venture capital funds and companies that aren't paying for the IP that now goes out the back door have something to complain about, and then only initially. In a new equilibrium, a portion of the University becomes a kind of Bell Labs for the economy. Renegotiated employment agreements with star inventors bring billions of capital gains to the University directly, rather than indirectly through the venture capital funds, which charge at least 20% in carried interest plus fees.

But you have to believe that it would be good for faculty and students to talk more with engineers and scientists in industry. For the time being, most people don't.

The Internet Operating System

From Tim O'Reilly:

Might an operating system of the future manage when and how data is collected about individuals, what applications can access it, and how they might use it? Might it not automatically synchronize data between devices and applications? Might it do automatic translation, and automatic format conversion between different media types? Might such an operating system do predictive analytics to collect or locally cache data that it expects an individual user or device to need? Might such an operating system do "garbage collection" not of memory pointers but of outdated data or spam? Might it not perform credit checks before issuing payments and suspend activity for those who violate terms of service?

Tim probably inadvertently sent a lot of traffic my way thanks to link through to a Google search of windows "bag of device drivers" andreessen.

Scalability is ultimately the key determinant to what Internet "operating system" will dominate. Google has the "unfair" advantage at this point. Microsoft also has a big cost disadvantage because of its need to support legacy revenue streams. Apple doesn't seem to have the capabilities now to code scalable server-side apps. iTunes is a nightmare. Cisco's products are complements to the operating system market.

Maybe there is still room for a new competitor to Google. Yahoo has more of an opportunity here than many people realize.

How do you measure innovation without reference to patents?

Or to put the question differently, how should patents be valued if not by the cost of litigation?

This is the question posed today by venerable Silicon Valley sage Tim O'Reilly:

It seems to me that there ought to be a way to measure the introduction of new products, and rank them by novelty and by widespread acceptance, in some way that reflects a more substantial measure of innovation and its impact on the economy.

There is no single right answer to this question. For earlier ruminations, see Reigniting the Engine of Growth, which was cross-posted to PatentlyO (where some of the comments were very good). But the best answers will share at least this in common: Simplicity

Complex rules are too easy to game. To discourage fraud and bad behavior, rules have to be simple (not just valuation rules, by the way, this is true for any rules).

But innovation is complex. Doesn't that preclude any simple measure? Yes and no. Yes in that any measure will be an approximation. This is true for any complex phenomenon, however. That doesn't stop us from measuring temperature, humidity, barometric pressure, and then forecasting the weather. Weather forecasts are not perfect, but at certain times and in certain places they are useful. Why else would we bother? The small talk alone is not sufficient.

The ultimate answer must be that there are ways to measure innovation. Indeed, everything that for-profit organizations do is complex, even putting aside innovation. Yet we have a highly developed set of rules we follow and measurements we take in tracking the performance of these for-profit organizations. They're called accounting rules and financial statements.

Some people think that you can go even one more step removed and look at the public market price of for-profit organizations, compare that against the number of patents pending or issued, and make predictions about how a company's stock price will move in response to the number of patents. That may work in a few isolated cases, but in general public stock prices are driven up and down by too many other influences. If you stick with the financial statements, you're only increasing your signal to noise ratio

To recap what is obvious for anybody exposed to accounting but unfamiliar to the rest, financial statements include (1) a snapshot in time of the assets, liabilities, and equity of a company (this is called the balance because it has to balance assets with liabilities and equity) and (2) a time-averaged summary of revenues and expenses (this is the income statement, or just P&L for "Profits and Losses"). Actually most also include a cash-flow statement, but we can ignore that for purposes of explaining how innovation might be measured. The cash-flow statement is there so that people can figure out how much of the revenue and expenses were "accounting adjustments," which smear revenue and expenses out over time, rather than actual cash changing hands.

So how can a financial statement give you insight into how innovative a company is? The answer is that whenever a company makes an actual improvement (whether or not that improvement is patented!) in a product or process for making a product, that actual improvement will be reflected in its stream of revenues and expenses.

For example, say PayPal introduces a new feature on April 1. Before April 1, PayPal was spending $0.30 per customer to generate $0.50 in revenue per customer. After April 1, PayPal spends $0.25 per customer and generates the same $0.50 in revenue. The value of the feature is $0.05 per customer. In this example, the PayPal increased its profit margin. That's the most obvious way that innovations add value to companies, and it's the one that most people think of, but it's not the only one!

In some cases, the company may not actually have lower costs or be able to charge higher prices as the result of an innovation. Yet the company may still be more profitable as the result of the innovation. This seems to be the more common case for most incremental innovations, which in fact are the majority of those patented in my experience.

Some of you are scratching your heads, wondering: "How can a company be more profitable if it doesn't charge higher prices or pay less in costs?" The answer is turnover. Consider Company X, which sells 10 widgets a day for $100 after paying $60 to make each them. Total profit per day = 10 x ($100 - $60) = $400.

Now consider Company Y, which sells 100 widgets a day for $100 after paying $60 to make each of them. Total profit per day = 100 ($100 - $60) = $4000.

What's the difference between these companies? Turnover rate. Company Y is selling widgets for the same price at the same cost much faster than Company X. You might think this is easy to do, but in fact it is very difficult.

Now of course if Company X and Company Y have otherwise identical accounting entries, the difference in turnover rates will show up as a difference in earnings on the next financial statement. And if the differential in turnover is sustainable over many accounting periods, it will almost certainly show up as increased earnings.

The problem that readers of public financial statements have in backing out these inventory turnover rates is that many products (both old and new) are combined into a single earnings figure. Moreover, adjusting entries often washout the signal reflected in increased (or decreased!) inventory turnover rates. In practice, at least retail investors have to do a little extra research to figure out whether inventory turnover ratios are increasing or decreasing for particular products, and by how much.

So there you have it, Tim. That's my suggestion for a simple way to measure the value of innovation: Read it off the time-series of revenue and expenses. If you can convince the SEC to get public companies to report this info, we will all be indebted to you.

Not coincidentally, inventory turnover ratios are also the number one way Warren Buffett identifies for companies to raise the return on equity.

Thanks to Paul Kedrosky for the link.

Markov Tree Options Pricing?

From friend of Broken Symmetry Harish Bhat and his student Nitesh Kumar:

This paper questions one of the fundamental assumptions made in options pricing: that the daily returns of a stock are independent and identically distributed (IID). We apply an estimation procedure to years of daily return data for all stocks in the French CAC-40 index. We find six stocks whose log returns are best modeled by a first-orderMarkov chain, not an IID sequence. We further propose the Markov tree (MT) model, a modification of the standard binomial options pricing model, that takes into account this first-orderMarkov behavior. Empirical tests reveal that, for the six stocks found earlier, the MT model’s option prices agree very closelywith market prices.

With a wink to commenters from yesterday. All models are wrong; but some are less wrong than others. See also earlier ruminations on assumptions of independence in price models.

Do Market Prices Synchronize Input and Output?

A couple of years ago I was reading Schelling's Micromotives and Macrobehavior, and was struck by his description of the phase mismatch in the marriage market. I wondered (out loud here, using sloppy terminology) whether market price signals couldn't be understood as a mechanism for ameliorating phase mismatch (or "latency"). Williamson identifies "frequency" as a category of transactions costs. But in fact it isn't frequency so much as differences in frequency (or differences in phase when buyers and sellers operate at the same frequency) that raises transaction costs.

If we think about markets as networks, then we can identify market makers as important nodes -- like train junctions or airports in transportation networks. Market makers and market prices haven't been studied much this way. But transportation networks have.

A paper by Lacasa, Cea, and Zanin is particularly suggestive in this regard. Lacasa et al. show that as the density of flow within an air transportation network increases, the network undergoes a phase transition above a certain threshold, whereby nodes of intermediate traffic density display "Brownian motion" in delay times. This "Brownian motion" ends when the traffic density increases still further, resulting in bottlenecks that, like traffic lights, effectively limit the rate of flow through the network.

Today the Physics arXiv blog calls my attention to a new paper by Fretter, Krumov, Weihe, Müller-Hannemann, and Hütt, which arrives makes similar observations about the traffic through rail and gene networks. But the newer paper takes a very interesting step forward by applying a phase synchronization analysis (related to the Kuramoto Model) to its data. Here's one of their conclusions:

We believe that a quantitative view on synchronization of arrival/departure events in the network of long-distance train connections, as presented here, can similarly serve as a starting point for a theoretical understanding, and subsequently systemic optimization, of the balance between eciency and robustness for such timetables underlying public transportation.

This work has direct relevance to scalable plans for regulation of systemic risk within our global economy.

An Obesity Epidemic in Venture Capital?

I'm glad Fred Wilson wrote this so that I don't have to:

In short, since I started investing in the web in '93/'94, I have invested in about 100 software-based web companies. And the success rate of fat companies versus lean companies is stark. I have never, not once, been successful with an investment in a company that raised a boatload of money before it found traction and product market fit with its primary product.

Fred's post is in response to a provocative piece by Ben Horowitz, The Case for the Fat Startup.

Fred does a better job than I could have taking this apart because of his superior experience. But should any entrepreneur be fooled about whether it's in their best interest to take more money from a VC? Of course folks like Ben want you to take more of their (limited partners') money.

I was going to pick apart Ben's post and show how his evidence and reasoning were incomplete. Most importantly, Ben talks about "lean" in a very loose sense that doesn't really get at what folks like Steve Blank mean by the concept. Running lean doesn't mean not spending money. Also, Ben's sample of N=1 doesn't mean anything. Anytime somebody uses a stock price chart as evidence for an argument, be skeptical.

But I hesitated because there are actually points Ben makes that I agree with. First, contrarian thinking is a good start for anybody making capital allocation decisions, including startup CEOs. So I agree with Ben's point that now might be a better time to take money than three years ago, for example. That doesn't mean it's a good idea in an absolute sense though.

I also agree with Ben's emphasis that it is the intellectual property rather than the business that most startups are building:

If you are a high-tech start-up, your value is in your intellectual property. Don’t stare at your spreadsheets so long that you get confused about that.

But a suppressed premise here is that the ultimate exit is acquisition by a larger company. If the ultimate goal were indefinite independence post-IPO, then developing IP without worrying about the IRR might still be the wrong strategy for some startups.

Fred's credibility with me again rises. It's nice to see a VC explaining to entrepreneurs how the game works from the inside. Aside from the guys at Venture Hacks, who are a kind of benchmark for this, I haven't seen that (at least not consistently) from any other VC bloggers.

UPDATE: Ben replies to Fred's comments here. Read Ben's reply for yourself. His reply did more to convince me that Fred has the right side of this one. Ben's reply basically reduces to pointing out that achieving product/market fit is difficult and uncertain (okay, but how does having more VC money early make it less difficult and uncertain?), and that his N=1 sample is still representative of the population. The latter point is ridiculous. Even if he hadn't raised a bunch of money already (making the earlier stage VCs allies in raising more money), Marc had brand name at that point from Netscape that almost nobody has. It didn't matter that Marc was at Ning. Ben's failure to acknowledge this is disappointing.

What is organizational economics?

Teppo Felin at orgtheory points out a new issue of the Journal of Institutional Economics:

The most recent issue of the Journal of Institutional Economics has an excellent exchange of ideas on organizational economics. The issue begins with an essay by Richard Posner: “From the new institutional economics to organization economics: with applications to corporate governance, goverment agencies, and legal institutions.”

...

Even cooler than the essay itself: more than a dozen scholars were asked to write essays in response to the above, and they also raise a host of new issues: Who are actors and entities, what are markets? What is the role of intrinsic versus extrinsic motivation? Do theories readily apply across various contexts — e.g., across different types of organizations? Where is mainstream economics versus more heterodox approaches? Etc. The responders include Elinor Ostrom, Bruno Frey, John Roberts, etc. And, Posner then in turn responds to these comments.

Worth checking out.

Books which have influenced me most

With encouragement from Tyler Cowen, here's my list. "Influential" to me means it has changed the way I understand the world. In some cases, that happened fast. In others, slowly as I reread. In some cases, both.

To elaborate on something Tyler eluded to -- in preparing this list my awareness of how much it was people rather than books that influenced me was heightened.

I'm also grouping a few in one because their length was physically limited by technology in a way that makes the group comparable in length to only a portion of others on the list.

1. Galatians (what does it mean to be free?), 1 John (what is love?), Job (why evil? why not nihilism?), 1 Samuel (for the stories about David).
2. Feynman Lectures, especially the lecture from volume II on principal of least action.
3. Conceptual Physics by Hewitt, which I studied over the summer in seventh grade and credit as much as any book for my interest in physics.
4. Problematics of Jurisprudence by Posner, which I read the summer before law school. Posner sets the bar for intellectual courage.
5. The Common Law by Holmes, which led me to understand law as a complex adaptive system long before I had heard the terms.
6. The Intelligent Investor by Benjamin Graham, Zwieg edition, which gave me the theory I needed to understand corporate finance after I had learned how to prepare and read financial statements.
7. Buffett's letters to his shareholders as collected by Cunningham, which together with Charlie Munger's almanack (honorable mention) took my understanding of Graham's theory to a point where I could connect it up with mathematical principles I learned studying physics.
8. Waddell & Bodek on the Rebirth of American Industry, which awakened me to the way in which accounting rules are responsible for commercial culture.
9. The Happiness Hypothesis by Haidt, which gave me a reason to start reading psychology and sociology literature for the first time.
10. Creativity by Csikszentmihalyi, which gave me the last few puzzle pieces I needed to connect up the many domains of knowledge I have studied formally and informally (physics, law, economics, psychology, sociology) into an integrated whole.

Renaissance Returns

From the WSJ:

Mr. Simons made his reputation on his signature fund, called Medallion, which has posted average returns of about 45% a year, after fees, since its inception in 1988. Since 1995, it has had only one money-losing quarter, slipping 0.5% in the first quarter of 1999, according to documents reviewed by The Wall Street Journal.

Wow. That's quite a benchmark.

For those readers wondering what speech recognition might have to do with market prices, click on the "Fourier Analysis" category link at right.

Eric Smith and Duncan Foley on the Parallels between Economics and Thermodynamics

Available here:

The most important point of this paper (more important than the establishment of formal parallels between thermodynamics and utility economics) is that economics, because it does not recognize an equation of state or define prices intrinsically in terms of equilibrium, lacks the close relation between measurement and theory physical thermodynamics enjoys.

There's plenty more where that came from at Eric Smith's page.

Mammalian Cells Can Feel their Physical Surroundings

From Berkeley:

Observations have indicated that mammalian cells are sensitive to the physical aspects of their environment, such as the texture or geometry of the surrounding tissue. However, evidence that physical forces impact freely-moving signaling molecules (as opposed to focal adhesion molecules) in the membranes of cells has been lacking because the cell membrane is an environment that has always been difficult to characterize and manipulate. Groves and his research group have found a way to overcome this obstacle with the development of unique synthetic membranes constructed out of lipids and assembled onto a substrate of solid silica that enables them to directly control cellular signaling activities.

The nominal goal for the research is fighting cancer. The potential therapeutic and other consequences are much broader. I can hardly grasp the picture of a web of chemical and mechanical feedback loops that constitute animal architecture.

Is there a European Union? The United States used to be compared with European States.

Tyler Cowen today observes:

Say that Portugal, Italy, and Greece were more like Germany, economically speaking that is. Toss in Albania to make the contrast starker. They would have higher productivity and higher output. They would export more. But with their higher wealth, they would import more too. That includes more imports from Germany, most likely. German *net exports* might well decline, as Germans buy more olive oil and high-powered computer software from Albania. But German exports need not decline *on net* (over a longer run of continuing global growth they certainly will not decline) and that should prove good enough for the German model to sustain itself.

This raises the interesting question of whether Greece ever really became part of the European Union. Or indeed whether there is a European Union at all. I don't mean in the technical sense of course.

Here's another quote from Chernow's biography of Alexander Hamilton:

Governor Clinton argued that the United States covered so vast a territory and possessed such a variety of peoples "that no general free government can suit" all the states. In rebuttal, Hamilton outlined his vision of American nationalism, showing that a true nation, with a unified culture, had been fused from the diverse groups and regions of the original colonies. In all essential matters, "from New Hampshire to Georgia, the people of America are as uniform in their interests and manners as those of any established in Europe." A national interest and a national culture now existed beyond state concerns. This was an assertion pregnant with significance, for if Americans had already constituted a new political culture, they needed a new order to certify that reality. And the Constitution bodied forth that order.

After all, that is why we call it our "constitution." There's lots going on here so let me break it down a little:

• Hamilton in the New York Convention and through the Federalist lays the foundation for "the national interest and national culture" by communicating his vision of it to the individuals who make of the citizens of the confederated states;
• The act of ratification was just what Chernow calls it -- a certification of a constitution that had already been constituted through the aggregation of individual commitments necessary to state ratification;
• The United States is compared by Hamilton with individual European states whereas at present an analogy to the European Union seems more apt;
• The European Union seems never to have had any conflicts that might foster a sense of identify as part of the European Community... until the present financial crisis?
• Even the "the national interest and national culture" were insufficient to head off the conflict among the United States caused by what Gouverneur Morris called "the curse of heaven."

Lots of interesting things happening in the world today.

Where to find the mind: Identifying the scale of cognitive dynamics

from Luke Conlin, Ayush Gupta, and David Hammer:

There are ongoing divisions in the learning sciences between perspectives that treat cognition as occurring within individual minds and those that treat it as irreducibly distributed or situated in material and social contexts. We contend that accounts of individual minds as complex systems are theoretically continuous with distributed and situated cognition. On this view, the difference is a matter of the scale of the dynamics of interest, and the choice of scale can be informed by data. In this paper, we propose heuristics for empirically determining the scale of the relevant cognitive dynamics. We illustrate these heuristics in two contrasting cases, one in which the evidence supports attributing cognition to a group of students and one in which the evidence supports attributing cognition to an individual.

What would Gene Fama say?

Since the last post happened to relate to Buffett's purchase of Burlington Northern, I couldn't help mentioning an investment opportunity that's had my attention of late:

A train ferry is a ship designed to carry railway vehicles. Typically, one level of the ship is fitted with railway tracks, and the vessel has a door at the front and/or rear to give access to the wharves. In the United States, train ferries are referred to as "car ferries". The wharf (sometimes called a "slip") has a ramp, linkspan or "apron", balanced by weights, that connects the railway proper to the ship, allowing for the water level to rise and fall with the tides. For an example of a specialized slip to receive railcars see ferry slip.

While railway vehicles can be and are shipped on the decks or in the holds of ordinary ships, purpose-built train ferries are much quicker to load and unload, especially as several vehicles can be loaded or unloaded at once. A train ferry that is a barge is called a car float.

Burlington Northern might or might not own a few of these. But given the investment Buffett is putting into railways, one can't help wondering why some rail ferry owners are selling at a discount.