Guest Post: Making Money on Making Public Goods

(Ed. note: This is a guest post by Yury Lifshits. Yury is a Research Scientist at Yahoo who has done extensive research into market models. We're thrilled to republish this piece on the changing nature of public goods, which was originally published on his blog).

There is a new trend in the tech industry: making money on public goods. Until recently, public goods were viewed as an area of philanthropy. Now entrepreneurs, investors and corporate leaders see the business opportunity there. This essay gives a basic tour around the market of public goods. We cover the definition, core business models and future areas of growth.

What is a public good?

One can classify goods by the following two criteria: rivalry and excludability. A good is rival if its usage by one consumer reduces availability to others. In contrast, non-rival good can be used by every consumer in parallel. If a producer manages access for every user individually, the good is called excludable. Non-excludable goods are available for everyone interested. Thus, we get four groups of goods:

• Private good (rival and excludable): iPhone, Toyota Prius.
• Common-pool good (rival and non-excludable): Customer support, water in a river, conference rooms in an office building.
• Club good (non-rival and excludable): Cable television, Windows 7.
• Public good (non-rival and non-excludable): National defense, roads (excepting toll roads), GPS Satellites, Wikipedia.

In this essay we use the term public goods more broadly than in classic economics settings. Namely, we consider voluntarily non-excluded goods and nonrival-before-congestion goods to be public. Public goods are produced in a number of areas: city infrastructure, education, law enforcement, peace, safety/security, energy, environment, health, food safety, social security, employment, transportation, tourism, mass communications, and financial systems. In this essay we will have a look at the concept of public goods enterprise (PGE) - an organization that produces non-rival non-excludable goods at profit.

Comparing public goods to other concepts

Let us recall the definitions of several related concepts. Non-profit is an organization that does not distribute profit to its shareholders (all money are reinvested in operations and development). Charitable organization is a non-profit that serves some charitable purpose, in many cases helping those who can not help themselves. Charitable organizations are eligible for certain tax benefits. Social enterprise is entrepreneurial organization (i.e. typically for-profit) that is committed to make a certain change of philantropic nature. Emergent venture is a subclass of social enterprise that is characterized by tech-based approach, focus on enrichment needs, business sustainability and small-to-medium scale.

How does this compare to public good enterprise? Well, PGE can be both for-profit and non-profit, as it only characterized by its product and not by the profit spending mode. PGE can produce both charitable goods (e.g. documentary about food safety) and luxury products (GPS sattelities). Public goods market is the overall ecosystem of supply and demand of non-rival non-excludable products. Non-profits, charities, social enterprises, emergent ventures as well as for-profit corporations can all be players in this market. We use the name public good enterprise (PGE) to describe any entrepreneurial entity on public goods market. The key common challenge for PGEs is to find means to produce freely available goods.

Public goods have several prejudices associated with them. The first one is that selling public goods to governments (and to foundations) is hard and corruption is typically involved. Of course, there is certain truth to that. However, some governments are genuinely looking for vendors of public goods. Some foundations make it simple to pitch them. We get better marketplaces to sell public goods. And corrupt governmental suppliers are still looking for subcontractors. At second, public goods are associated with charity and non-profit. It is not encouraged to make a fortune on saving African kids from AIDS. However, public goods is a much broader category than just survival needs of poor people. Think about city fireworks or a web-based fine payment system. One should think about a public good as a regular product with an indirect business model. Finally, sponsor-based business model does not reached mainstream status in technology sector. On the other hand, sponsorships and donations pay for fine arts, performing arts, museums, education, environment protection and event industry. Public goods need sponsors. So the tech industry will eventually embrace sponsor-driven products.

Business models

To produce public goods an enterprise needs to raise startup and R&D funding and then to find a sustainable source of operating revenue. There is a number of options for startup funding. To begin with, there are generic VC firms as well as VC firms with specific focus on public goods (Omidyar Network, Good Capital, Unreasonable Institute). Secondly, one can bootstrap from foundation/governmental grants. Then, there are special loan programs, like the one that was received by Tesla. Finally, public good enterprise can receive significant non-monetary investment in terms of volunteer help, media support, free facilities, technology and data donations.

Non-rivalry and non-excludability of public goods leads to so called "free rider problem". Everyone looks for others to fund the creation of public goods. As a result, public goods are underproduced. There are three primary ways to approach this problem and establish operating income for PGE:

• Pledge-based mechanisms. In this case, the producer of public goods sells directly to future users. A producer can set a threshold and ask for commitments. If the total amount of commitments exceeds the threshold, the production of public good is started. Kickstarter enables fundrising campaigns of this type.
• Pooled money. Another approach is to pool money from a community members to a single source. Then this proxy organization decides how to spend the pooled money for producing public goods. Governments, non-profit foundations, industry associations, chambers of commerce and home owner associations are typical examples of this approach.
• Complementary products. A producer of public goods can also fund its operations through selling additional products. For example, World Wildlife Fund (WWF) is selling the rights to use its panda logo for commercial purposes (e.g. on credit cards) in order to rise funds for nature conservation programs. Selling name rights is another common scheme (e.g. Sloane Business School). Mozilla funds the development of Firefox browser by auctioning the default choice of search engine. Finally, public goods can follow freemium (PBWorks, gitHub) or ad-supported (Google Search) business models.

The opportunity

It is likely that demand for public goods will grow over the next few years. We see the increase in foundation money (e.g. "Giving Pledge" movement), developing countries become richer, corporations embrace the concept of corporate social responsibility, citizens of socialist and authoritarian countries (Sweden, North Korea) are giving their governments large shares of GDP to be spent in public interest. A for-profit enterprise has a lot of advantages in this market. It can invest in technology and people and attract large venture capital. Working on public goods means working on big problems: jobs, education, environment, health, transportation.

There are two emerging clusters of web-based public goods. The first one is marketplaces. CharityNavigator connects donors and charities, Kiva connects lenders and entrepreneurs, Kickstarter connects artists and supporters, CatchAFire connects volunteers and charitable projects, Alter Eco connects farmers with fair trade buyers, Spot.Us is crowdfunding platform for investigative journalism. The second area is knowledge publishing. KhanAcademy and SupercoolSchool publish lessons, Ushahidi aggregates crisis reports, Wikipedia organizes encyclopedic knowledge, TED shares big ideas, OpenCongress makes law-making two-directional process and Ashoka profiles best social entrepreneurs. Other areas not far behind: mobile applications, e-government, payment and financial systems, social networks and communication systems.

Predictions for the market of public goods

• Better markets for public goods. The biggest barrier for producing public goods is the cost and complexity of sales to governments and foundations. Ideally, selling/buying public goods should be as easy as 1-click experience at Amazon. Existing procurement systems have a lot of room for improvement. We need specialized modern marketplaces for selling technology solutions to local governments, large public organizations (schools, hospitals), industry associations. DonorsChoose and Kickstarter are promising examples in this direction. We need a centralized market for corporate sponsorships. The public history of past spending would be very useful to identify sponsors of future products. Finally, a system to track demand ("wishlists") for public goods should be created.
• Sponsor networks. Like in advertising-supported media, the task of fundraising/selling to governments and the task of making public goods tend to be separated. Naturally, we will have sponsor networks, affiliate networks, large foundations and large governmental contractors who are good at collecting money. In turn, these entities will transfer most of the money to the layer of producers. While the first layer is under "be non profit" pressure and is subject to corruption, the second layer can focus on the actual creation of goods.
• Metrics and measurements. The easier it is to measure the public benefit, the easier it is to sell it. We need more metrics and quality control solutions in the areas of education, environment, and health.
• Improved venture funding. Some venture and seed funding is already available to public goods enterprises. Hopefully, we will see more such sources in the future.
• Increased spending for public goods. Another important direction is to allocate government/corporate/foundation budgets for funding creation public goods. In particular, we need more transparency and centralization around corporate social responsibility programs. Right now, raising corporate sponsorship requires a lot of legwork and personal connections. Another opportunity is to connect public goods spending to new tech clusters (Skolkovo, Chile, Boulder). Channeling technology demand to these places will bootstrap the ecosystem, attract talent and venture capital.
• Low cost public goods. Because selling to governments and foundations is hard, and because there is no liquid market for public goods, the prices are very high. Thus, an important direction for innovation is to deliver the most standard public goods at the lowest price possible (as Walmart and EasyJet do in case of private goods).
• Connected community. One of the reasons why Silicon Valley is not contributing much to public goods is the long distance to Washington DC. Public goods industry will succeed if we connect tech cluster, government/foundation cluster and user cluster (education/environment/health needs). Silicon Valley entrepreneurs should travel to places were public goods are in highest demand. We need conferences, education programs, role models, best practices, directory of existing activities and players. It would be great to have a tradeshow where tech industry showcases available products to governments and foundations.
• Private goods companies to enter public goods sector. Private goods companies like Apple, HP and Sony accumulate enormous talent and technology assets. When they work on public goods (e.g. Apple iTunes U or Google PowerMeter) they consider it to be a philanthropy rather than business. As a result, these teams are underfunded and the projects are underdeveloped. Once we have a more efficient market for public goods, the contribution from these companies can reach the next level.

Takeaway lessons

1. Public goods is a great opportunity for the tech industry. As the market for private goods gets more competitive every day and large corporations seize the control over most profitable areas, it is time to shift technology ventures to the market of public goods. There are huge opportunities in the areas of healthcare, education technology, environment protection, governmental data, employment marketplaces, and financial systems.
2. The nature of public goods dictates the choice of business model. If your product belongs to the category of public goods then your revenue sources are direct sponsorships, governments, foundations and complimentary products. At the times, ad-supported business model was driving most of innovations in the web industry. Now it is time for sponsor-driven technology. Public goods are private goods. While a good is public with respect to end-users, it is still a private good for sponsors, foundations and governments. It is especially true for local public goods (knowledge translations, tourism marketing campaigns). Therefore, the regular business practices can be used. Customer development just becomes sponsor development.
3. The progress in public goods technology is tied to improvements of the marketplace. Once we will have a unified market for selling/buying public goods and widely accepted impact metrics, the speed of innovation increases dramatically.

Thanks to Preston McAfee, Michael Schwarz, Bjoern Lasse Herrmann, Ivan Davtchev for reading drafts of this. Contact me at @yurylifshits or yury@yury.name.

Photo credit: jurvetson

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