Developing long-term innovation with internal startup management

by Ted Scholten | Mar 14, 2018 | Articles, Strategy

As companies grow, they lean on standardisation and automatisation to keep control of their business. The challenge then is to remain innovative. Apart from the constant urge for the development of new products and services, larger companies more and more acquire startups to keep up with the latest developments in their markets. But acquisitions are expensive and it is hard to integrate a startup which has different roots than the acquiring company. Therefore, this article promotes internal startup management as a promising possibility to sustain corporate innovation with existing assets.

Why internal startup management fits larger companies
An internal startup is defined as: the creation of an independent company within an existing business or division of a parent company. Basically, an internal startup is an ordinary startup but initiated within an existing division or company. The development of internal startups is a much less common practise in comparison to innovation by product development or the acquisition of an innovative external startup. This is a truly missed opportunity, since large companies have all the building blocks, which startups require; skilled employees, capital support, intellectual properties (patents), contracts, office spaces and strategical support. Thus, large companies are fully tooled to build their own corporate startups. In addition, properly implementing internal startup management will keep entrepreneurial employees connected with the parent company. This is a much more attractive scenario than unhappy entrepreneurial employees leaving the company to ignite their own startup.

“Large companies are fully tooled to build their own corporate startups”

An example of an internal startup is Tripadvisor. Tripadvisor became part of Expedia in 2004. The business was eventually spun off, after a successful launch, from Expedia in December 2011. Tripadvisor disrupted the business model of traditional travel agencies via a unique way. Tripadvisor promotes services from hotels, restaurants or other recreation destinations and lets travellers advise each other what to visit on Tripadvisor’s own digital platform – an early example of user-generated content. Several suppliers of travel-accommodations such as Booking.com, Expedia and Hotels.com offer their services on Tripadvisor’s platform.

An example of a missed internal startup opportunity is Rituals. Rituals was founded by a former Unilever employee. Rituals was supported financially by Unilever in the beginning but Rituals had other strategical plans than Unilever. Therefore, Unilever chose to pull out as a supporter of Rituals. A few years later, Rituals was rewarded as fastest growing company of the Netherlands in 2016 with a revenue of €400 million and an annual growth rate of 30%.

Why internal startup management becomes more and more attractive
It is a great time for large companies to create internal startups. There are two main reasons. First of all, the product life cycle of products is becoming shorter and shorter. Therefore, effective innovation management is becoming more difficult and important at the same time. When innovations are rapidly following up on each other it is for larger companies difficult to keep up with the pace of which renewal occurs. In larger companies, the amount of people and departments involved when launching new products or services increases the time to market. Also, the organisational culture in larger companies is less rewarding risk-prone behaviour. So, it is of great value to accommodate and incubate new business ideas that do not fit in the original laid-out roadmap.

The second main reason is that the acquisition of innovation by buying external startups is becoming more and more expensive. A startup bubble of private companies is arising, which is visible in figure 1: Billion Dollar Valued Companies by Quarter from 2009 – 2016. Future expected cash-flows and their disruptive business models make startups currently an attractive investment. Investors who back startups will eventually receive a high return on their investment when the business is going public or when it is taken over by a large company. Investors also aim to inflate the startup’s valuation. Large companies, in their turn, have more money available to take-over startups since their cash positions are increased which is strengthened by the global economic recovery after the financial crisis of 2008.

“A startup bubble of private companies is arising”

The three building blocks of every startup
Basically, all startups consist of three building blocks. Every startup starts with the right person for the job. Starting a startup is challenging and requires the correct mixture of creativity, stubbornness, perseverance, confidence, knowledge and other characteristics to make a success of the startup. Therefore, choosing the right entrepreneur is the first building block of the startup.

With the right person comes the right idea. The idea for starting a business is ideally triggered by passion, an opportunity or a desire for a better service or product. The best ideas for startups solve real life problems. Usually, the startup and its business plans are constantly changing. The challenges for startups is to keep the ultimate goal in mind but to execute on a realistic timeframe.

The third building block concerns the patience to pursue a profitable startup. Long-term strategy and earnings possibilities are the spine of each internal startup. Before making any profits, startups experience a burn-rate period. A burn-rate is the rate at which a startup is spending its venture capital to finance overhead before generating positive cash flow from operations. This burn-rate depends on the desired strategy, business model and planning. But most of all, the believe in the positive outcome should outweigh the discomfort during the burn-rate period. A long burn-rate period is not necessarily a bad thing. For example, Facebook did not make any profits in its first four years of existence (from 2004 – 2008) but finished the year of 2016 with a profit of roughly 10 billion dollars.

How to prevent failure
Many startups fail (roughly 90%). The top five reasons startups fail are: no market need, running out of cash, not the right team, get outcompeted and pricing/cost issues. Basically, an internal startup is simulator to an external startup. Therefore, it is useful to look at the potential pitfalls that apply to internal startups.

Before doing so, it is a pleasant observation that an internal startup can benefit from the competencies and capabilities of its parent company. The parent company can support the internal startup with cash, man hours, specific capabilities of employees, business contacts and knowledge. Internal startups therefore have advantages but they also have unique pitfalls.

One of the pitfalls of starting an internal startup is the behaviour of the parent company itself. An internal startup must be able to make quick decisions, anticipate rapidly on trends and have the opportunity to make mistakes. However, the parent company finds itself in a different phase of the business life cycle which is characterized by a control focused management style aiming for continuity instead of innovation. The parent company sometimes focuses too much on reporting processes and find it difficult to let go of intertwined interests. Therefore, the best way to control a startup as a parent company is by not doing so. Consider the startup as an independent company.

“Therefore, the best way to control a startup as a parent company is by not doing so.”

Finding the right person to lead the startup is crucial for its success. Once an employee from the parent company has expressed its passion, enthusiasm and entrepreneurial spirit to pursue a new business idea, he or she will bring industry-specific knowledge but also company habits. These habits may have a negative impact on the internal startup’s success. The traditional way of working might not be in the internal startup’s advantage. Examples of habits which are not favoured by startups are: long daily meetings, restraints on marketing budgets, too much focus on detailed and technical aspects of new products and a long time to market principle. The best way to cope with this dilemma is by appointing the internal entrepreneurial as the responsible person of the internal startup, including a fair share in its (financial) successes. It is therefore advisable for large companies to behave as a formal investor for the internal startup and have clear agreements with the entrepreneur.

The final challenge on launching an internal startup is the reputation of the parent company. A negative reputation of the parent company possibly results in a negative effect on the internal startup. Customers will be less likely to purchase products, investors are less interested in investing and the media might not write the best press release. However, an excellent reputation of the parent company might limit the internal startup’s success too. This might happen due to stakeholders who have unrealistic expectations, the internal startup becomes overconfident or the parent company manages a more centralized policy which allows the internal startup to operate less independently. Therefore, internal startup management is applicable for large companies with both a negative or positive reputation.

To conclude, in addition to current product development programs that are in place, and the well-considered acquisition of startups, companies could find a long-term growth solution in internal startup management. Although it is a difficult process, since startups significantly differ from managing an innovative product, it is at least an interesting possibility to consider.

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