Managing Innovation through Corporate Venturing
New management models boost large firms in emerging markets.
New organizational models can help a firm commercialize ideas that would otherwise languish.
“Ten years on, Xerox Technology Ventures has got more than a dozen young firms established, exploiting ideas that would have either gone to waste or slipped away to make fortunes for others. Some of these new ventures have gone public, some have been sold and some are still operating as hungry little startups. The way Xerox commercializes its orphan ideas has inspired others.” The Economist (February 20, 1999)
The inability of established industry leaders to launch innovative products despite their extensive financial and human resources is a source of frequent comment and sometimes even consternation. This article considers a model that one large firm successfully used to develop innovative products and bring them to market and describes how this model addresses five areas that often hamper large firms and keep them from bringing new products to market. More specifically, it describes how Xerox established Xerox Technology Ventures (XTV), a venture fund, to commercialize internal technologies that might otherwise have languished.
The XTV model is a particularly interesting one for addressing some primary problems faced by large firms in managing innovation. The concept is to create an entrepreneurial vehicle, funded by the parent company, which mimics the traditional venture capital model. The number of companies with similar venture programs has more than tripled in the past three years. The so-called “Intrapreneurs,” or new product ventures, can have the best of both worlds by exploiting new technologies without giving up access to all corporate resources. The parent company benefits by not having to manage areas outside of its core business. And, if the new venture becomes a successful company with its own capitalization and valuation, the parent company benefits from its equity position. For example, XTV turned a $30 million venture fund into a $500 million market cap in seven years. As a major investor in these ventures, Xerox gained much more than it likely would have earned from these same products had they been developed and marketed in-house.
What are the underlying reasons large organizations must learn to manage innovation differently? Anurag Sharma provides valuable insights on this complex issue in his recent article, “Central Dilemmas in Managing Innovations in Large Firms.” He categorizes these dilemmas into five areas.
- Seeds vs. Weeds
- Experience vs. Initiative
- Internal vs. External Staffing
- Building Capabilities vs. Collaborating
- Incremental vs. Pre-emptive Launch
The XTV corporate venturing model provides an innovative organizational form to deal with each of these categories.
Seeds vs. Weeds
Sharma notes that, “the overwhelming volume of new ideas and the need to invest to carefully evaluate any one of them in itself restrains innovative activity in large firms.” Firms need processes for sifting out real opportunities from the larger group of product possibilities. Even more importantly, they need programs to nurture the selected products and bring them to market. The literature is rich with research on identifying core competence. However, senior executives’ views on the distinctive capabilities of a firm often vary. This naturally leads to differing perceptions of what a new product or technology may mean to a firm.
IBM’s struggle with the impact of PC operating systems, AT&T’s indecision about its role in the Internet, and Barnes and Noble’s challenge from Amazon exemplify the conflicts that firms face when identifying the boundaries of their strategies. All of these firms conducted extensive studies of these new markets. Yet, for a variety of reasons, they did not pursue them until long after new ventures dominated the market.
Capital budgeting processes certainly play a role in the reluctance of firms to pursue emerging markets. A company may decline a new venture when management is driven primarily by ROI concepts, due to the perceived demand for funding and technical talent. Corporate venturing, however, provides a vehicle for management to minimize investment and risk while positioning the firm to pursue new opportunities. More importantly, the parent organization may realize much higher valuations from their new ventures than they would if these same ventures were integrated in their current income statements. For example, Palm Pilot, a spin-off, is valued higher than the parent company 3Com.
Most recently, the explosion of Internet technologies has exposed a further barrier to innovation – that of core rigidity. This results from a false sense of security with the status quo that blinds corporate strategists to the impact of emerging technologies on their core competence. The failure of strategists to appreciate emerging technologies can cause them to view “seeds” as “weeds.”
A third factor that may cloud management’s objective evaluation of “seeds” is the need to apply scarce resources to current products. Innovative products often have long-term breakeven points and relatively high hurdle rates due to their inherent risk. In addition, contribution to earnings from these new products may not significantly influence the firm’s stock price or enhance its multiple. Ironically, these innovative products may command much higher valuation as stand alone companies than does the founding firm.
Only two of the eleven products launched by Xerox Technology Ventures bordered on the parent company’s core areas. These two products were finally spun-off to XTV on the basis that Xerox had spent a great deal of time and funds on them without their reaching the market, and there needed to be a new approach to bring these technologies to fruition. Xerox also felt that it would benefit by being an early adopter as a customer prior to public launch. (It is interesting to speculate how the other nine products were funded internally if they were not core.)
For example, Xerox undertook a large number of projects over a decade in the attempt to develop object-oriented document-management systems but had not shipped a product. XTV developed a business plan for a new firm, Documentum, to rapidly convert Xerox’s accumulated knowledge in this area into a marketable product. This process required Xerox to recruit an outside management team. Today, Documentum is the leading player in document management systems with a market capitalization of over $400 million. Xerox ownership is approximately 28%.
Experience vs. Initiative
Venture ideas often originate in the problems or opportunities encountered in the conduct of existing routines deep within the operating structure of firms. As a result, the initial champions of new concepts are frequently middle-level scientists and managers who are immersed in their work. These individuals may not bring new concepts to light if they are not supported in managing new ventures or taking entrepreneurial risks.
Partners and advisors at XTV provided an initial vehicle to support founders with critical management processes in accounting, control, purchasing, recruiting, marketing, and other areas such as presentation skills. This enabled founders to concentrate on moving their product to the marketplace. The new firms used the Xerox identity in their literature, providing credibility to an unknown firm.
Internal vs. External Staffing
Sharma found in his study that managers of innovative projects within large firms “were severely taxed, since virtually every staff position that was created within the ventures required extensive justification in terms of technical need and economic viability.” This process naturally included presenting new opportunities to personnel from other divisions in compliance with internal HR policies.
The XTV corporate venturing model eliminated these barriers created by the corporate bureaucracy. In Documentum’s case, there were no requirements for the founders to use Xerox personnel. In fact, to insure a clean break from the corporate procedural environment, XTV insisted that the CEO of the new firm be hired from the outside. As a new firm, equity incentives could be used to attract top talent from the outside. Such incentives would not be available if the project was developed internally.
Building Capabilities vs. Collaborating
A large firm conceptually can benefit from inputs from multiple divisions to support a new product concept. However, in practice internal technology transfer can run into multiple barriers as managers try to work across organizational lines. It often is easier to develop relationships with outside firms. The financial risk of the new venture also can be shared with the alliance partners. Xerox was able to offer equity incentives to potential partners by creating a new corporate vehicle. This attracted many vendors who shared in the risks by employing their unused capacity in exchange for stock.
Partnering can expose firms to new knowledge, organizational structures, or cultural characteristics that are essential in serving an emerging market. Firms that partnered with XTV brought new perspectives and modes of operation that made the ventures more competitive. The parent company was even able to selectively adopt these insights into its existing operations.
Incremental vs. Pre-emptive Launch
The corporate resource allocation issue becomes particularly apparent in a new product launch. It is tempting to commercialize on a small scale before putting millions of dollars at risk in a large firm. However, incrementalism can trigger competitive activity, limit volume buying and production opportunities,and may also signal customers that the firm is only testing the waters.
XTV insured that each venture was backed with sufficient capital and management to hit the ground running. XTV solicited other major venture capital firms to hedge its own portfolio risk and to provide adequate capital for growth while Documentum was logging its first $100 million in sales. In contrast, internal launches are often hampered by a lack of development funds.
XTV turned a $30 million dollar fund into a $500 million dollar valuation in seven years. It provided Xerox a vehicle to recognize a significant return on its internally developed products which, otherwise, were “orphans” in the total corporate product strategy. In 1997 Xerox formed Xerox New Enterprises (XNE) as a new management paradigm within the company to manage and grow innovative businesses formed outside the corporation’s core strengths.
The number of companies with similar venturing programs has more than tripled in the past three years. Firms such as Lucent, AT&T, CMGI, and Hewlett Packard are creating separate entrepreneurial organizations in order to streamline the management of new product concepts. Some of these companies have “spun-off” specific products or technologies as stand alone companies. Examples include AT&T’s creation of Lucent Technologies, Hewlett Packard’s formation of Agilent Technologies, and 3Com’s spin-off of Palm Pilot. These spinoffs are attempts to provide major product groups with the flexibility, incentive, and management structure to meet the needs of a particular marketplace.
Large organizations appear to be unable to survive with traditional hierarchical approaches to innovation. Corporate venturing models, however, provide the flexibility and incentives needed to compete in the “new economy.”
Seeds vs weeds
The last post demonstrated the remarkable ability and unique features of aphids that allow them to rapidly boost their numbers and colonize their hosts in favorable conditions. What about weeds? What features give them the ability to rapidly colonize a potted crop or planted field? Many plants become weeds because they have the powerful trick of producing many many seeds. Seeds are dispersed by wind, insects, animals, or by their association with our nursery tools and machinery. Often, these seeds are long-lived in the soil. Consider these statistics:
Probably some unfortunate graduate students or field assistants in 1954 were given the task to count weed seed of hundreds of common weed species from about 50 plant families in North Dakota. The table above is just a sampling (Stevens 1957). In most cases a single plant, judged to be of average size and growing where competition was low, was harvested at maturity or when a maximum number of seeds could be obtained. The plants were air dried for two weeks or more, threshed and cleaned to re-move immature seeds, empty florets, etc. All of the sampling methods are described in the Stevens reference given below.
So basically left on their own, weeds have a profound ability to produce seed. Some seed are not viable, some germinate immediately, and some persist, perhaps for years, in the soil as a “seed bank”. This bank represents the holdings of weed seeds in the soil. Place a “deposit” of seed in this bank, and your “interest” is compounded in a big way. An interesting experiment with velvetleaf (Abutilon theophrasti) an important weed in soybean crops demonstrated this (Hartzler, 1996).
Velvetleaf is a prolific seed producer and seeds are long-lived. In 1990, replicated experimental plots were planted with soybean and then with one of three velvetleaf densities: 0, 0.2, and 0.4 plants per square meter. In subsequent years, the experiments were maintained in a corn-soybean rotation. Weed densities were determined at crop harvest for four years. As seen above– even with competition from the crop plants– velvetleaf density increased dramatically for years following the very sparse initial planting of the weed. There were even some velvetleaf plants seen in the untreated “0” plots, even though the plots were hand weeded to reduce seed production for 5 years prior to initiating the study.
The number of weed seeds in in the soil can range from near 0 to over 1,000,000 per square yard, and most weed seeds are between 0 and 5 years old. A small number of seed can remain viable for decades or more. With this knowledge, one of the most important principles of weed management is to “never let weeds go to seed”. Never.
Stevens O.A., 1957. Weeds, Vol. 5, No. 1 (Jan.), pp. 46-55
Hartzler R.G. 1996. Velvetleaf (Abutilon theophrasti) Population Dynamics following a Single Year’s Seed Rain