By Tim Vellema
In today’s world change is everywhere. For large companies (corporates) to keep up with this continuous change, investments in Research & Development are a must. However, corporates are often fixated on how they currently create customer value. Therefore, they tend to fail to adapt to new technologies or business models that force them to change the way they learned to create value. A prime example of this is Nokia, who’s market share plummeted from 45% to 5% in just a matter of 5 years after the introduction of the iPhone. One way to combat the decline of innovativeness, is to seek external sources of innovation: start-ups. To be more specific, by corporate venturing. Through corporate venturing a corporate invests in a start-up, which is often done by acquiring a minority equity stake. Corporate venturing is most often used to quickly and impactful invest in complementary technology or capabilities that solve specific problems and help the corporate to innovate. In return, the start-up receives strategic advice and funding to accelerate their growth.
Causes of a lack of innovation
At first glance, a corporate possesses all resources and capabilities to realise change through innovation: High levels of capital, many skilled employees, established positions in the market, a large network of partners, a well-established organisational structure and solid business processes. However, then why are start-ups still disrupting industries and a large source of innovation? This comes down to three main factors:
Success of a company shapes how its management ‘sees the world’. These strategic frames make that corporates find it difficult to revise their value creation towards customers. They tend to invest in resources that have led to success in the past and follow rigid organisational processes, which although efficient, might be outdated.
• Resource allocation
To realise change through innovation, commitment in terms of available employees and proper budget allocation is a prerequisite. However, the people most capable for innovation are, most often, already stretched in their day-to-day work, and therefore, not able to fully focus on the sought-after innovation. Furthermore, investing in innovation requires trade-offs in terms of employee allocation. In general, established companies prefer to allocate most of their employees to projects in which they have proven to operate efficient and effectively in the past.
• Lack of right incentives
To motivate people and encourage ownership it is important to have the right incentives in place. While start-ups operate on a “high risk, high reward” basis, corporates often have rigid managerial and structural rules. Employees are for example rewarded for the profitability of their department, which declines if investments are being made. Rewards are, therefore, often not aligned with the risk or effort of the innovators. This leads to less innovative ideas since no ownership or incentive is present to proceed. This makes that the innovation speed of a company declines as the company grows bigger and mature.
Strategic and financial objectives of Corporate Venturing
Corporate venturing can have both financial and strategic innovation objectives. Strategic innovation objectives are most often focused on learning and/or transforming.
Organisations grow into large corporates since they excel at what they do. Therefore, over the years, they develop specific skills and expertise on what made them successful in the first place. However, the evolution of their own respective industry forces corporates to keep innovating and to adapt to shifting customer needs. Of course, a corporate could internally develop the required resources and capabilities, but without prior experience on the topic, this would likely be a slower and more expensive innovation process than when acquired through a venture. If learning and adapting is the main goal of a venture, there is often a close link with current operations and the acquired resources and capabilities build on the current business model. While this approach carries low to medium risk, it will not lead to disruptive innovation.
To take it one step further, a corporate could use corporate venturing to adapt its business model. Access to the innovative minds of a start-up increases its learning and transformation capabilities, leading to valuable insights and ideas to optimise important aspects of its business model. This could even mean deviating from current core operations and adapting to trends and customer needs which safeguard the survival of the corporate for the next decades. While corporates are very much busy with current operations, start-ups are generally looking to introduce the ‘next big thing’ in the market. This way of thinking and doing business nourishes innovativeness. Although this approach carries high risk, internalising this way of thinking makes that a corporate can respond to disruptive industry developments or even, by utilising synergies to transform their business model, become the disruptor.
Although uncommon, some corporate ventures invest in start-ups for leverage. This is less common since the profits from venturing are most often not significant enough to have a noticeable impact on the corporate’s overall profit. However, with the right exit strategy, strategic and financial objectives can be combined to generate high returns.
As mentioned above, not only the corporate benefits from corporate venturing. The start-up receives strategic advice and funding to accelerate their growth. Initially, that funding is very often put into marketing to acquire new clients and market their ‘disrupting and innovating’ product or service. However, funding on its own is often not enough, and that is where synergies in favour of the start-up come into play. Through the network and sales channels of the corporate, the start-up gains access to a large pool of potential customers, which accelerates their growth.
The risks of Corporate Venturing
Research from Harvard Business School showed that alignment of goals between the start-up and corporate parent is paramount. Without the alignment, knowledge was less likely to flow from one entity to another, which limits the potential of the venture and benefit for both parties.
Furthermore, one of the main risks of working with outside parties and generating external knowledge is the ‘not invented here’ syndrome. While combining knowledge might be a great accelerator for performance and innovation, teams are sometimes reluctant to accept outside knowledge and perceive it as less valuable. This might compromise cooperation between the start-up and corporate parent and limit valuable knowledge transfer.
Lastly, it is called corporate venturing for a reason. There is risk involved in investing in start-ups and it might take a while for the investment to pay off. This also means that certain investments in companies will not succeed. However, this should not let you scare away from pursuing new investments. A clear management cycle is a prerequisite, with interim performance reviews, but a corporate parent should give a start-up sufficient time to prove its added value and review its overall performance afterwards.
How to set up your first Corporate Venture
First of all, corporate venturing is complex and should be done by people who have extensive experience. Managing the partnership, utilising synergies, and safeguarding knowledge transfer is complex and requires experienced managers to achieve the best results.
Secondly, for corporate venturing to succeed, the most important aspect is, of course, the partner company, the start-up. To invest in a start-up with the right assets and capabilities, commercial due diligence is key. Industry analysis, target selection and detailed company analyses, is therefore, something that should not be taken lightly.
And lastly, short but sweet: patience. Innovation does not happen overnight.