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"Arguing in my spare time" No. 3.21

Arnold Kling Sept. 13, 2000

Last night, I attended a panel discussion of "trends in venture capital." The panelists, all of whom were from the VC community, said in effect, "Since March, everything has changed. . . except for our basic approach."

Andrew Sachs, the president of Capital Investors, a local group of big-name angel investors, was typical. He repeated the VC mantra that "We don't try for singles or doubles. We go for grand slams."

It seems as though this is a fixed principle of venture capital investing. I cannot understand why. To me, it seems reasonably obvious that the "filling in" of the Internet frontier should have greatly reduced the opportunity for spectacular gains. Meanwhile the volume of capital pouring into the sector should only serve to increase competition. The chances of hitting a home run have fallen tremendously, while the number of low-risk, moderate-return opportunities has increased as everyone gains experience with the Net.

The venture capital strategy seems to be out of touch with the times. If I were picking a strategy in the current environment, I would be trying to hit singles and doubles.

Let's wallow in the baseball metaphor for a while. I believe that the conditions under which baseball is played have changed radically since the 1960's. Ballparks are smaller, the ball may be juiced, and umpires have truncated the strike zone.

Unlike the venture capitalists, baseball managers have responded to these environmental changes. Offenses no longer revolve around stolen bases, as they did for the Dodgers in the 60's. Walks and home runs now are the weapons of choice.

When I was a kid in St. Louis, the lynchpin of the Cardinals' offense was Lou Brock. Although he had tremendous power (today he would be a 40-homer man), what worked for him in that era could be summed up as follows: put the ball in play and cause havoc.

When Brock hit a ground ball, the infielders had to hurry to try to get him out at first. When he drove the ball to the outfield, he was a threat to take extra bases. And when he was held to a single, he menaced the defense with stolen bases. In an era where a team often won by scoring only two or three runs, Brock was extremely valuable.

Today, of course, the lynchpin of the Cardinal offense is Mark McGwire. He does not cause havoc by putting the ball in play. In fact, if you take his total plate appearances and subtract his strikeouts, home runs, and walks, he probably puts the ball in play less than just about anyone.

In the 1960's, Mark McGwire would not have been as effective. With a real strike zone, many of his walks would have been strikeouts. Forced to swing at a greater variety of pitches, he would not have hit as many balls on the nose. With the larger ballparks of that era, many of his home runs would have been caught for outs. At the risk of sounding extreme, my guess is that Mark McGwire in the 1960's would have ended up with a career somewhere in between that of Dick Stuart and Rocky Colavito.

Conversely, many of the stars of the 1960's would not have been as prominent today. Maury Wills, who had no power and was not a particularly slick fielder, would be fortunate to be considered mediocre among today's shortstops. As much as I would like to keep a halo on the great hurlers of my boyhood, I cannot imagine how Koufax, Veale, Gibson, or McDowell could have adjusted to having their best pitches called balls.

Returning to the topic of venture capital, all of the panelists said that they were now focused on investing in Internet infrastructure, including companies that focus on fiber optics. I would be impressed if I thought that this represented a well thought-out strategy to make long-term investments with proven market needs.

Instead, the shift to infrastructure appears to be motivated by the fact that the most recent successful IPO's have been in this area. The companies that have gone public are no more profitable than the now-scorned consumer Web sites.

The name of the game in VC investing is still fools selling to greater fools. It's still the Mark McGwire model. Instead, I think that the right strategy today is to play 1960's-style baseball. Put the ball in play and cause havoc.