"If this is so good, why don't you trade with it yourself?"

Posted: 18th February 2011
"If this is so good, why don't you trade with it yourself?"

At the BigThink conference FarSight two weeks ago I was asked the question on Recorded Future – “if this is so good in terms of predicting the future, why don’t you trade with it yourself”. A reasonable question that people often pose regarding information innovations.

In the world of big data we have the luck of living very close to critical business problems and by having access to the very core of the data that make up such businesses you end up having very interesting business model choices to make.

At Spotfire we initially focused on pharmaceutical R&D and had a big impact on drug development. People asked “why don’t you start a early stage biotech company instead and really reap the benefits of finding targets and drug candidates”. Similar discussions emerged in helping people find new oil fields, improve semiconductor manufacturing processes, and elsewhere. The company became an analysis tools business and was sold for $195M in cash. Not a bad outcome. And still had a great impact on customers R&D pipelines, manufacturing processes, and oil exploration.

But dilemma is always there for fledgling big data start ups. Think generally about data/analytics based start ups for a bit. You have many paths to take – and let’s think about some success outcomes.

  • The Google approach – you build a very horizontal data service – like what the guys at Google did. Totally horizontal in nature and addressing billions of users.

  • The Michael Bloomberg approach – you build a vertical data service, in this case used by people in trading – addressing 100,000s of people.

  • The Renaissance Technology/DE Shaw/etc. approach – you actually engage in the vertical (trading in this case) yourself, and really only address one user (yourself).

Though 2) as well as most of the companies in 3) all are very private in nature and we don’t have access to all the data, I think we’d all be happy with an outcome similar to either one of 1), 2) or 3). The dilemma that you really face as an entrepreneur isn’t about how much money you can make (do it right and it will be very good), it’s about understanding where you personally can be successful.

There’s an argument to be made over whether your new innovation is incremental or the full tool needed to drive trading (or whatever vertical – i.e. do you have a small piece of the puzzle or whole damn thing) – but in reality even if it’s very close to the whole thing, over time it won’t be enough. A fantastic trading signal will be diluted over time.

Now assume for a second that you really think that you have the whole puzzle and want to go “make that easy money” that’s available in trading.

Building an asset management business is anything but trivial. It’s obviously not about making that one single trade (you wish!). With an information based innovation it’s highly likely it’s some sort of systematic trading approach – which likely will yield 10s, 100s, if not 1,000s of trades every day even. That means you need expensive infrastructure. You need risk controls. You need compliance. You need reporting. You need trading capital, and with that comes investors – quite different from the VC crowd you know and love.

If you’ve done classic venture capital financing you probably have one of the most “captive capital” structures that there are to be had out there. You probably agreed to that “redemption clause” that allowed VCs to potentially  pull out their money after 5 years because your lawyer told you that it has never ever been used in practice. Not much to worry about.

However – if you’ve raised money for trading that money might be gone on a monthly basis, just completely done. Very very different. The idea of “why don’t you trade on your tool/information” may not seem so simple after all.

What really matters

In the end game maybe the most important choice is “who are you”. Are you a trader? a developer? a tools guys? a data guy? That should guide you to where you can be successful. Not whether someone tells you “you could make millions in the market”.