Conversation Highlights with Bill Davidow, Author of OVERconnected: the promise and threat of the internet

Bill Davidow has served the high-technology industry as executive and venture investor for over 30 years. He remains active as an advisor to Mohr Davidow Ventures, a venture capital firm.

He's an electrical engineer by training with degrees from Dartmouth, Cal Tech and Stanford.

High-tech and electrical engineering for the past 20 years has been all about, nearly all, connections. He's seen the impact from the inside out and now has written about his observations of the impact from these past 20+ years of increasing abilities we have to connect and share. 

And, he's written a fascinating book titled: OVERConnected: The Promise and Threat of the Internet.

That's what we talked about. You can listen to our conversation here.

Bill, thank you for being on the show.

Thank you for having me. I can see I have a very big challenge.

Thank you for writing a book that's bothered me. No, seriously. It's a great book. It's well-written, your conviction is compelling. You have great data. You integrate that data into excellent stories and examples you share.

You have been an investor in the tech industry for 20- 30 years. From my little part of the cornfield, tech these days is very focused on connections, collaborations and communications. Would that be correct?

It’s absolutely correct.

What the book is doing is telling people how to use those connections correctly.

I don’t have any problem with connections. I, unfortunately, don’t have a fiber-optic cable running to my home; and, I wish I did. I could never have written the book without all the information I gather on the internet. I could not work today without the connections.

But, I think it’s important that people understand that any great technology, uh, you can abuse the level of connectivity and you may be abusing it without even realizing you’re abusing it.

When in the past 20-30 years and maybe the last 10 did you see the signs that people were over using it, abusing these connections, and they were presenting serious threats to the established order, that’s not the right term, ...to how many of our institutions function and our economies and cultures work.

I tend to read a lot. For example, I love Tom Friedman’s book The World is Flat. There was a wonderful book written a number of years ago by Francis Cairncross called The Death of Distance: How the Communications Revolution Will Change Our Lives.

And I began scratching my head and I said:

"How do all these phenomena effect what is going on around us."

And in the past, I’d say the last 6 months, it has become so evident what is going on. And when I give a talk to day, I start out by saying “Egypt, Tunisia, Wikileaks, the flash crash, Iceland, the meltdown of 2008 and our economy. What do all of those things have in common?

I point out to people what they all have in common. They were all made larger and they were made more virulent and they happened faster because the internet accelerated all this.

I want people to understand how the internet acts as an accelerant in all these things. Because things happen so quickly and they come upon us so quickly we have less time to react and less time to adjust. And also things race out of control more quickly because the internet facilitates it.

As I’m prone to do, even after a couple hundred shows, when my guests start sharing great points I start scribbling. You’ve made some great points. What I’d like to do is hold that thought for just a second and instead talk about that seminal moment when you said ...I gotta write this book.

I’ve been writing this book, working on the book, for over 10 years.

And, the light really went on when I began to think about the compounding of money. If you think about the compounding of money, if you were a kid and you put money in your savings account you were paid 2% interest. That interest got fed back into your account and your money doubled in 36 years. If you could find a place that would pay you 5% interest, your money would double in 14 years because you had more money fed back into your account.

And, so when you increase the amount of positive feedback in a system things happen much more quickly. And what I realized the internet was doing was that by strengthening the connections and creating more interconnections it was creating more positive feedback in the system so things could grow more quickly.

If you were to look at over-the-counter derivatives and the notional value of those derivatives....in 2000 the notional value of those derivatives was equal to 2 trillion dollars. That’s a pretty big number and it’s equal to the output of all the countries of the world for a single year.

But, by 2007 the notional value of those derivatives had grown to 600 trillion dollars. So, that’s a compounded rate of growth of 40%.

And, none of that could have happened without the information tools of the internet that facilitated that growth. And you had to exchange a lot of paper; you had to make a lot of computations; you had to create replicating portfolios. You had to do all of this work.

As a matter of fact when Lehman Brothers went bankrupt they had 933,000 derivative contracts that they were dealing with. And they could never have kept track of that paper or created that labyrinth without the information tools of the internet.

The internet didn’t create the financial crisis of 2008. But, it facilitated a lot of the components. Before the internet that problem would have been much smaller.

Now, Erika Andersen wrote Being Strategic. One of her concepts in that book is the reasonable aspiration or hoped-for future. What was your reasonable aspiration or hoped-for future with writing this book?

Originally, I started out thinking if I could help 2000 policy makers understand that they are living in a different world, then maybe we’ll be able to avoid some of these problems.

Whenever you see interconnections increasing you ought to scratch your head and say:

“What is that doing?”

And also, there is a whole set of studies that academia has done with accidents. And they know that when you increase interconnections in a tightly-coupled environment the environment becomes more accident prone. And that doesn’t matter if it’s the Three-mile reactor in Pennsylvania or the chemical plant in Bhopal or the Challenger 13.

The increase in activity in an environment in which you have more accidents. I wanted to alert people to look for problems earlier. And ask questions about ‘are they going out of control?”

For example, had the regulators looked at the over-the-counter derivatives in 2002 and seen they had grown by 60-80% they would have said:

“Gee maybe we should act earlier and make this less of a problem.”

Being an engineer by education and a venture capitalist by profession, I know this next question will be easy. What metrics will you use to measure your progress towards that hoped-for future?

I guess the metric I would use is if people read the book and ultimately get back to me and say:

“I found the book useful and here’s what I did because of it.”

A number of years ago I wrote a marketing book. After 25 years it’s still in hard cover and people keep coming back to me and saying:

“Gee, I changed the way I ran my business because of that.”

I started to have conversations with policy-makers in Washington and to a degree that they come back to me and say “Gee, I found this useful and helped shape some of my thinking. ” then I’ll consider this a success.

I’m having a lot of fun and as long as people find the answers that it provides are valuable then that will be great.

Let me back up and talk about a couple of the points you mentioned and describe how they come in contact with my world.

You mentioned the discussion, among academics, that increased connections within a tightly closed system increases the probability of accidents; increased connections equal increased risk of accidents.

Now, in my little world, one paradigm I live by is that increased connections within a business means fewer accidents. Closer conversations with the customers, those making and delivering a product, and it’s the lack of connections that create accidents: bad product launches, marketing messages.

So, where am I not connecting with what you just said?

You’re talking about something I didn’t talk about in the book. It got edited out.

But I had something that people thought was too wonky. I talked about intra-hierarchical connections, those things that go on in a business, and extra-hierarchical connections, those things that go on outside the business.

And, extra-hierarchical connections are extremely important. They let you find out what’s going on with customers and things like that. Or the military uses them all the time to gather intelligence on what the opponents are doing.

But, they do something that is very, very, key. They do not let those extra-hierarchical connections penetrate the organization.

I’ll give you an example of an extra-hierarchical connection that penetrated our control structure: WikiLeaks. Or somebody puts a foreign agent inside the government.

I will give you an example of another extra-hierarchical connection which is very relevant. You have a tremendous amount of debt with China. We are a debtor nation to China. That debt is an extra-hierarchical connection that gets involved in our control structure. It’s quite possible that China will demand a higher interest rate. And then that may drive up the interest rates in our country.

You have to be very careful about the external connections that you have.

This is the key point about them.

You might ask Greece what they think about extra-hierarchical connections of that nature. Because, the austerity that is being imposed on their country is because of their dependence on foreign debt.

Now, once again, that’s not an internet-related connection. But, the internet can do quite the same things.

I’ll give you one example. The stuxnet virus that people think brought down a lot of the uranium processing in Iran. That is an extra-hierarchical connection that got into their system.

Your book talked about some of our recent financial and global crises and disasters: our financial and real estate markets, Iceland's banking collapse, the dotcom bubble...and the loss of privacy. And I read you to say that the internet and its rampant connections accelerated and/or magnified their impact.

Would that be fair to say?

I kept thinking....national and global financial disasters, rampant speculation, ponzi schemes and natural disasters. We've seen them before. The Great Depression of the 30's, The Savings and Loan Debacle of the 80's which I think the bill is coming due very soon for that bailout.

They all share the same drivers: Greed, a willful suspension of disbelief, a sense of entitlement or that somehow this business model is different.

All those things have happened in the past. And, I’m not going to argue that the 2008 financial crisis wouldn’t have happened; it might have happened in 2010. The argument is it would have been smaller and less virulent.

My favorite example is the Tulip Mania in Holland in the 17th century. They tried to export that bubble. They drove up the prices of tulip bulbs until a tulip bulb cost an equivalent of $20,000 at that time. And they tried to move that to the UK. But, they couldn’t export it.

Or the South Sea bubble which was once again a British financial crisis and it didn’t get exported.

All the internet is doing is increasing the probability that these things will get exported and will be larger.

I had a banker from Lehman tell me that none of this could have happened without the internet. And what they meant was not that the financial crisis could have happened, but gee it wouldn’t have been that big.

And what the internet does is it has the ability to magnify these things and make them much faster. All the argument in the book is just be careful. Things are going to race out of control more quickly because you have all of these wonderful tools.

As an example is I have a Facebook page and you have a Facebook page. But the idea that over 600 million people could have a page...over night is just amazing.

I was reading a book, an excellent book, titled Virtually You. It was talking about the psychological consequences and impacts this is having on people. If the book is right, it has a number of negative consequences. Well, in the old days, when you might have had 1 million users you would have time to think about that and modify your behavior. Suddenly that gets to 500 million users and it’s a totally different situation.

I can remember when we first started using email. I used to argue with people that you should charge for email. I used to get people very irritated with me. My point was we charge for junkmail, we charge for regular mail, we charge for telephone conversations, we charge for federal express. Why should this form of communication be free? Why, if it is free, isn’t it going to be abused? I think 3rd-class mail is abused. My mail box is full of stuff still today that I don’t want to get. My argument still today is if you were going to make email free you were just going to get spam and things like this.

Well, everyone said you don’t have to worry about that. You can construct filters and do this and do that. But, it’s very difficult to deal with a problem once it gets entrenched. And I don’t think the filters work very well.

It’s easy for me to blast my image in front of people. Their time is very expensive. But, my time to do this is very easy. It’s very cheap for me to do this.

One of the things that all of this over-connectivity does is it enables people to externalize costs. When you increase connections you increase the chances that costs will be externalized.

An example of this is if you build a coal-fired plant in the midwest, you get acid-rain on the east coast. What you’ve done is externalized the costs of that pollution. It’s the people on the east coast who pay for the pollution that is generated in the midwest.

In California, our air quality is effected by what’s going on in Beijing. In the central valley we are paying a price for the lack of pollution controls in China.

As things get more and more connected and connections span much greater and greater distances it is much easier to externalize costs and pass the costs on to somebody else. In the financial crisis, a lot of the costs were externalized and passed on to the tax payer. The internet made the financial crisis larger and so it increased the externalized costs to a group of people.

In much the same way, the internet makes it much easier to move production to companies that don’t have good environmental laws. You can hear about that from unions, from politicians. We are in effect, in many cases, independent of how irresponsible corporations are going to act. The people in these foreign countries are paying the costs of environmental pollution and we’re getting the products with cheaper costs.

These things tend to happen and connections make it possible.

One thing I had in mind, you talked about the example of the coal-fired plant. I grew up in North Carolina and the Great Smoky Mountain National Park suffers from acid rain from the coal-fred plant in a neighboring state.

I’m thinking the increased connections would help people understand doing x in that state and generating y in that state. And possibly there would be a more comprehensive conversation that would include accountability for actions across state borders.

I absolutely think that is one of the very positive things. The transparency that the internet provides is wonderful in helping to control that type of problem and creating awareness. There are so many positive things about the internet. And all I’m trying warn people about is that there can be negative consequences that we should be alert to.

Overall, in the final chapters of the book, I have a section titled “everything is a connection”. I want people to understand that there are other types of connections that can have the same effect that you have to be careful about. One of the most important inter-connections that we are making today, and is not internet-related, is that we frequently connect high-risk systems with low-risk systems.

I’ll give you an example. GM retirement plan that they had to scrap as a result of bankruptcy connected a high-risk system, your retirement, with GM, a low-risk system. You look at it, GM has been around for 100 years and it will never fail. But the obligations to that pension system played a big role in causing the crisis of GM.

So, when you inter-connect things you have to be very careful. All the time, we’re connecting high-risk systems with low-risk systems. We think that the low-risk situation will save us with the high-risk situation. That is getting us in trouble with systems like Medicare and Social Security, today. We tend to think that the other guy can pick up the bill.

Alvin Toffler in his book Revolutionary Wealth, I think, described, or foretold, the collapse of some of social and governing institutions. He described their collapse arising from their inability to embrace change. You reference some of this in your book when you discuss the lack of controls and the connection of high-risk and low-risk change models.

What is the relationship with overconnectedness and our current institutions’ inability to manage change?

Awright. I got a good example. May 6th we had the flash crash. The Dow Jones dropped almost 1000 points in a single day. And it was followed by what I call the rocket recovery. It gained back almost 650 points of the 1000 point decline.

And if you look at what happened there, and here is an example of over-connectivity at work. In 2005, we began to see the emergence of those alternative trading systems. Think of them as electronic trading systems. The NYSE in 2005 was trading, doing about 80% of the volume in stocks. And they had circuit breakers; they had market-makers. And they tended to make the market orderly. By 2010, the electronic exchanges and all these alternative trading systems were doing about 75% of the volume in the listed NYSE stocks. That’s one very rapid change.

And then along comes high-frequency trading. People can use computers and put them on the exchange floor and track very small trades, very very quickly, and make a few pennies on the trade. And if they make millions of trades that adds up to lots of money.

So, these two things happened. By the year 2010, almost 2/3’s of the trading of stocks was done by electronic trading systems.

And that happens to be a tightly connected system in which regulators...nobody, the regulation just didn’t come up.

Then along comes May 6th. People are worried about the Greek debt. And Waddell Reid goes in and sells $4 billion of S&P futures short. That shouldn’t have created a problem. But, what it did was, in that emotional environment was it triggered a selling panic. All the buyers left the market. And suddenly you had the price of the stock cratering.

Now, some really crazy things happened. A Proctor and Gamble stock which was trading at $62 a share falls to $56 a share. The NYSE says “Hey, that’s hit a circuit-breaker. Let’s take a timeout and think about this”.

But, the electronic systems find alternative exchanges that are happy to trade the stock at $40 a share. And by the end of the day, the stock has popped back up to $60 a share.

Or you have Accenture, which was trading at $40 a share that day and there were no buyers in the market. All of these electronic systems were forced to have something called the “stub-quote”. And the “stub-quote” happened to be a penny a share. And here’s Accenture that drops from $40 a share to $.01 a share and pops back up to $39.00 a share.

So, all of these things are happening in this new environment where the regulators haven’t been able to track or keep up with things.

I define “overconnectivity” as change that happens at such high rates because of these overconnections or dense arrays of interconnections that the rest of the environment can’t keep up.

The flash crash was a perfect example of what went on in that environment.

Great examples, great details. Is there any pulling back? Can we pull slow this pace of change down with series of brakes, or walls, if you will? Let the institutions catch up?

I think you can do that.

I am not a big fan of regulation. But, I don’t know what you do about if people are going to abuse it.

For an example, there was a time I was talking to a banker, just this weekend, and she said:

“I use to work for the B of A and we would never make a real estate loan for anybody where the payments on the house, plus the insurance plus the taxes turned out to be greater than 30% of the person’s monthly income”

Now. You’re not going to have a real estate bubble under those circumstances.

But, those were the banks’ rules. The banks were doing a great job of regulating themselves and that environment.

Suddenly you have all these tools and people say:

“Well, you can throw the rules out the window.”

If businesses and institutions aren’t going to act responsibly then...I don’t think you have another choice.

And it’s great to talk about self-regulation, but if it’s not going to happen.

My favorite whipping boy is Over-the-Counter derivatives. They played a part in the 2008 financial crisis. With $30 trillion of Over the Counter derivatives, if there had been a problem it would have been no big deal. But with $600 trillion, it was.

So, why did the financial institutions become involved in $600 trillion worth of notational transactions? Well, because they could make lot of money doing it. They were out to make money. They got away with externalizing the costs.

Now, you sit here and say what can you do about it? It turns out there is no way you can build a phenomenally large, tightly-connected system, that isn’t accident prone. You can have all the regulations you want. But that system is going to be accident prone.

And the argument is always the same from people:

“Regulation is going to be destructive.”

And, I absolutely agree that there’s a lot of downside. But the only way you can make that system safe is to make it a lot smaller. You can do that in a number of ways. But it would require world financial regulation in order for it to work.

For example, if there were a tax on all derivative transactions. Or, there were margin requirements for derivatives similar to the ones you have for commodities you would not have $600 trillion in derivatives floating around.

Even a BA in Art can understand this, even the margin requirements.

My estimate is that if you would put the margin requirements in and you would put exchanges in place where the exchanges can act if the counter-party failed. ...This is my guess. It would have required $5 trillion in capital to be set aside to support the $600 trillion in OTC derivatives. That’s a guess.

But if people had to set aside $5 trillion to support $600 trillion OTC derivative market, there wouldn’t be $600 trillion in OTC derivatives.

It just seems so obvious and straight-forward. But, the word that keeps coming up, flashing on my little screen here is “GREED”.

You know, I think Gordon Gecko said “Greed is good.”

Yeah, but that was a movie.

I think you know greed does play a role in economic development. It has the ability to go to excess. As long as your greed isn’t hurting anyone else that can be a very private issue. But, when your greed hurts 200 million middle-class people then that’s a problem.

I remember my father’s favorite stories of Jay Gould. Someone came up to him, and he certainly was greed man...he was one of the robber barons, and someone said to him:

“I’m going to kill you”.

And Jay Gould said:

“Why.”

And the man said:

“You have $100 million and I have nothing.”

And Jay Gould said:

“Well, my $100 million is equivalent to $5 for every man, woman and child in the United States. Here’s $5 and go out and collect $5 from everybody else.”

Let’s talk about net neutrality. I think there’s been proposed a two-tier system by the FCC. Would it, a two-tier system, slow down or serve as a breaking system?

I’ve become very confused about what network neutrality really means. But, some of the thoughts about charging different rates for different services might slow down the rate at which somebody like NetFlix can move to stream digital information or movies to people’s homes. It has the potential to slow down some of these things.

But, I don’t think that’s going to have much effect on the phenomena I’m talking about. The phenomena I’m talking about has to do with the social dislocations that occur from major changes in connectivity and our ability to cope with them.

And, some of them are absolutely great. I love getting my news on my iPad. But I worry that investigative reporting is going to go away. I love shopping on Amazon. But, I also know that the local bookstore had a culture role to fill in our society.

Those types of disruptions are going to go on. I don’t hink network neutrality is going to effect whether they happen or not.

As I read your book, I kept thinking about one of my favorite topics which we touched on briefly at the beginning and that topic is employee engagement. I’m going to ask it again because I think it’s important.
Employees are way out in front of corporate management and policies with technology to connect. What are some examples of companies who have become overconnected or connected too fast for their leadership to lead it?

I’ve never really thought about that problem. I think in general corporations have figured out pretty good ways to use those tools inside a corporation. On the other hand, I could give you a very big corporation and call it Egypt or Tunisia. It certainly, the internet played a very important role in its collapse.

If the corporation had numerous disaffected employees then having all this internal communication could create problems.

I am unaware of the internet causing big problems in corporations. It’s caused some embarrassments. Whistle-blowers have come on the scene. Bosses have been pilloried by unhappy employees and things like that. I don’t think there have been big tragedies caused by that.

You touched on this with your point that the citizens of Egypt were not able to make meaningful employment for themselves. The objective was as key as the ability to share divergent political views. There’s a big movement on social media to be a curator of content. We’d serve as publishers or routers for news.

Shervin Pishevar is the founder of the OpenMesh Project, Social Gaming Network and an active angel investor. He authored a great post in Tech Crunch called Humans are the Routers. And the openmesh project is a project to create a new line of communications technologies that governments would find hard to block: Ad hoc wireless mesh networks.

Now what? Now we're each a router....The connections aren't becoming fewer.

In that post, he described a dinner party he had recently with Secretary of State Clinton. He told her Secretary Clinton, the last bastion of dictatorship is the router.

On the other hand the last bastion of institutional control would be the router.

I think it’s great that we have all of these information sources. But, in writing this book, I worked with a great writer: Katy Hacker. Every time I wrote a sentence she would challenge me and ask for the facts and ask for the references. And, she was a former NY Times reporter. And what I worry about is where everyone becomes the router...that there’s a tremendous amount of fact-checking that people do. And I was talking with her about foreign exchange transactions, there were $3 trillion in foreign exchange transactions...And then today people say $4 trillion.

Well, when you try and verify that number you will be surprised at how hard it is to get a solid number. And everybody believes it. It’s at best what I would call a squishy fact.

And there’s another squishy fact or opinion out there that 90% of the trades are speculative. Once again, when you try to get a handle on that number it becomes extremely difficult.

And, what I wonder is if everyone is the router then these posts that take on tremendous credibility because they are in print. It becomes very easy to make people believe all these things.

I’m becoming a bigger and bigger fan of responsible investigative reporting. And, I think it’s great that there are knowledgeable people out there that you can tap into. But, I worry about all the unreliable routers we’re going to find in the system.

That’s a very clear answer. Thank you. It really drove home the point.

We’ve reached the imagination moment in the show. Being a venture capitalist you have been exposed to imaginative enterprises, so this may be the best part of the show.

Let's imagine President Obama calls you right after we finish. He says

David, I'm sorry I missed you at the dinner out in Silicon Valley a few weeks ago. Mark and Steve are so pushy, I had to give them those seats next to me. But look, I got elected from the power of connections. But now in power, I'm a little ambivalent. Still, we're a fractured country. How do we realize the promise of the internet in being connected and avoid the dangers of being overconnected. What are three things our country can do and come on up to DC and I'll take you to dinner next time your in DC.

I’m afraid President Obama wouldn’t like my answers. One of the thing I would point out to him is that the internet enables you to arbitrage everything. And of course that’s an exaggeration.

But a slight difference in wages and you can arbitrage it. A slight difference in policy and you can arbitrage it or taxes and you can arbitrage it. I don’t like the financial regulation in the US and I’ll go operate where they don’t have those regulations. I don’t like the labor laws in Iowa, I’ll go elsewhere.

I would say to President Obama that:

Suddenly we’ve gotten into a world where we have to be competitive in everything we do. We cannot tolerate any inefficiencies whether it’s in government or business or education. We can’t afford to run a grade-school system and then have the high-school act as a backup. And connectivity is forcing us into an extremely competitive world where we’re all having to do our best every single day. And I don’t think the US has faced up to that today.

Leaders are readers. Jim Rohn says that; I just quote him. You're a leader, have been a leader for decades. You’ve mentioned a few books here already. What are you reading, for fun or work?

Well, I just got through all the Dragon Tattoo books. I enjoyed reading those.

I just got through reading the Master Switch: TheRise and Fall of Information Empires by Tim Wu which is an excellent book.

I’m reading a book titled Virtually You, right now.

I enjoy plowing through all these things and do my best to stay informed. I guess I’m going to just keep reading.

Where are you speaking?

I mostly talk in Silicon Valley. The best way to encourage people to read my book is to talk with people like you. I write op-eds. The Christian Science Monitor posted one that said the growth industry in the coming age will be the construction industry. I explained how wherever you’ve changed interconnections dramatically we end up rebuilding the infrastructure of society. That led to construction booms.

I love doing things like that and hopefully some of the ideas will be accepted.

We gotta go. I hate doing this. I so loved this conversation. But I know you’re busy and it’s early in the morning where you are. your book woke me up and I hope it’s waking a lot of people up. I hope our readers buy your book and become aware of some of the risks from all of these connections.

Thank you, Bill!