4impact
17/4/2024

The Four Variable Problem

What 4impact capital believes in.

Three people walk into a bar: an Environmentalist, a Socialist, and a Capitalist. All seats are taken except this one table in a corner of the room. They all sit down at that table and very soon start fighting about climate justice, incentives, the economy and politics. They start blaming each other for their misery. Other patrons of the bar notice the disturbance and shoot them annoyed glances, hoping it would stop. The commotion goes on for a while until the shouting and violent gesticulation suddenly stops.

The three of them get up, shake hands, and walk out of the bar in good spirits and unison.

Getting bogged down in accusations around individual responsibility is not constructive. While being conscientious around an individual’s impacts on the world is commendable, individual actions are limited and everyone will continue to live their lives taking a toll on the planet – this is normal!

It is crucial to approach our environmental and social challenges from a systemic perspective. We can do this by understanding and addressing the root causes of unsustainable behavior.

We believe that:

1. Unsustainable behavior causes damage to society and the planet and is the result of poor decision making.

  1. Ignoring the hidden costs of what we do has caused clear damage to society and our planet. For instance, even the transition to a low-carbon economy comes with hidden costs estimated to be around €40 billion in the EU until 2050.
  2. Our actions in the economic system are based on cost-benefit analyses that severely underestimate the costs of environmental degradation, leading to lower long-term returns on our actions. This is poor decision making.
  3. Examples of poor decision making include the obvious, such as procuring textiles from suppliers with environmentally harmful practices for lack of insight into alternatives. And the less obvious, operating industrial machinery with the same settings in different conditions leading to energy and materials losses. On the people side, we continue to see hiring based on personal biases, causing organisational attrition and loss of productivity. Humans are frequently and critically overwhelmed by complexity.

2. Humans can reliably manage up to four variables in problem solving and decision making.

  1. We make bad decisions not because we are bad people, but because humans are not good at complex decision making. Scientific studies suggest that humans can reliably manage up to four variables in problem solving - not more than that.
  2. Complexity and uncertainty are the bane of human decision making. This is why in public markets, index funds consistently outperform managed funds. Private markets on the other hand require exclusive access to the right opportunities, as well as good judgment and execution.

3. The shift toward a sustainable future is more complex than four variables.

  1. Humans run institutions and humans are ultimately responsible for achieving the transition to a sustainable future. Can we deal with the challenges of the future adequately?
  2. We present two examples of how decision makers can use the right information to improve outcomes for planet and people:
    1. a. Can we pick the right suppliers from a complex web of parties? Smart software solutions like Circularise and Green Story are two of our portfolio companies that help procurement managers make the right calls. Dealing with commercial, strategic, logistical, and impact requirements simultaneously complicates making the best decisions in the absence of data-driven solutions.
    2. b. It may not always be a product or supplier that requires diligent ‘choosing’. Hiring the right people is just as important to organisations for striking the right course. Our portfolio company Equalture takes the bias out of those decisions to get both skills and culture fit right. Quan then improves organizational culture, increases wellbeing and retention to allow organizations to execute on their ambitions without disruption. SkillsCV broadens the labor pool by unlocking the transferable skills of traditionally blue-collar workers. Smart software cuts through the complexity and delivers immediate impact on human decision making and behavior.

4. Unsustainable behavior cannot be fixed with better hardware.

  1. As the above examples show, it is not for lack of the right hardware that we make bad decisions. In some cases, ‘better’ hardware may even lead to worse environmental outcomes. In the United States, the fuel efficiency of car engines has doubled since 1970! Yet, total emissions from cars have increased by 50% and the total miles driven has increased by 140%. Humans can have a bias for abusing efficiency gains of new technologies at the cost of resource depletion (Jevon’s Paradox), whether it relates to cars, space travel, or sugary drinks.
  2. We have great hardware in place that is underutilized due to bad design and operating decisions. Think of renewable energy sources that are not being used due to a timing mismatch with demand, electric vehicles whose energy storage capacities are almost entirely ignored, water leaks in pipelines that remain unmonitored, or high-speed rail infrastructure that is not built due to political paralysis. All of this is due to bad information, leading to bad decisions.

6. Digital technologies are critical for informing good decision making at scale.

  1. Humans can only deal with four variables. Software can handle billions at the same time.
  2. Software has strong leverage because of low capital expenditure: there is no speed limit to the impact that can be achieved with software. Every country, organisation, and person runs on a computer. There is potential for global scale! Hardware is most often de-accelerated by its capital expenditure needs and cannot meet our demands of urgency.
  3. Software has strong leverage because of low barriers to implementation; plug and play! Information permeates all dimensions of space with the speed of light, endowing the world with integral e-health, e-government, digital banking, and educational and social services. Digital technologies contribute to 70% of SDGs. 
  4. Network effects resulting from the above three points are a powerful mix for meaningful change!
  5. Software can uncover hidden patterns that humans are unable to detect. 
  6. Digital technologies capture the bigger picture with more and better data to inform the individuals and organizations molding our world through their decisions.
    1. a. Improved decisions that are enabled through smart software include allocating capital to the highest-quality carbon removal technologies, how to run existing machinery using less resources, how to operate buildings more efficiently, detecting leaks in critical infrastructure, or identifying opportunities for efficient energy storage.
  7. All of the above combined lead to the highest impact per dollar spent when utilizing digital technologies for good! This massive potential of scale is also reflected in the track record of software venture investments.

6. Digital technologies have generated the highest venture returns in history to its investors.

  1. 28 of the 33 highest-returning venture deals of all time are digital tech or software startups (excl. Chinese data).
  2. Software startups learn and pivot the quickest. In a fast-moving world, this is critical.
  3. More specifically, digital technologies were the only vertical from the Cleantech 1.0 boom that returned significant money to investors. Unfortunately, materials science and hardware verticals did not return any money at all.

7. Sustainability is becoming the driving force of our political, societal, and economic thinking.

  1. Europe is a hotbed of environmental regulation and these shape how powerful organizations in the real economy decide and act.
  2. European society is becoming more informed and more passionate about sustainability. This scope will broaden as more people are impacted by the effects of climate change.

8. Digitisation will continue to grow and shape our lives.

  1. More people are being connected to the internet than ever before, at a rate greater than ever before.
  2. More digital infrastructure is connecting countries, organizations, and computers with one another, at a rate greater than ever before.
  3. This creates a wealth of data that must be used for good – and not for exploitative purposes!

9. The intersection between digitization and sustainability creates the biggest financial and impact opportunity of this decade.

  1. It’s as simple as putting 2 and 2 together. 2 + 2 = 4.

10. 4impact capital invests where the megatrends of digitisation & sustainability converge delivering strong financial and impact returns.

  1. Join us. The three people from that bar and many more already have.