Technology and innovation are disrupting traditional ways of doing business and delivering services to industry, challenging established business models and firms. Examples of this abound — from Uber Freight, Freighthub and Flexport challenging traditional freight forwarders with their supposedly all-digital operations, to virtual power plant operators like Limejump or Next Kraftwerke delivering faster grid services than traditional energy utilities.
In response to this digital transformation, corporates have poured money into mergers and acquisitions (M&A) and venture capital. In 2018, 212 corporate venture capital (CVC) firms invested in over 1,000 deals in the USA, according to Pitchbook, with a total deal value of USD 60bn. This was more than double the amount invested in the year prior. Globally, 264 new CVCs invested in 2018, 35% higher than the year prior.
This is not the first time this has happened. Yet too often corporates have invested, only to fail or retreat. According to a 2002 article in the Harvard Business Review, “quarterly corporate venture-capital investments in start-ups rose from $468 million at the end of 1998 to $6.2 billion at the beginning of 2000 and then tumbled to $848 million in the third quarter of 2001.” Not only is CVC investing prone to huge cycles, it often does not achieve the objectives of financial or strategic gain that may have been set.
Will this time be any different?
A 2016 paper in the Journal of Business Venturing Insights by Anokhin et. al, studied the investments of 163 corporates over 4 years. It found that a) the vast majority of investments made by corporates in startups were emergent (i.e. for learning) or passive, and that b) such deals were detrimental to strategic goals of a corporate investor. Corporates were most likely to be successful investing in deals that were either “driving” — i.e. directly supportive of corporate strategy — or “enabling”, i.e. complementary to current business, yet rarely were they involved in such deal making.
Partnering with experts that apply a tested and robust methodology can help corporates to put strategic ventures on the path of success. We work frequently and closely with corporates — both with their venture capital arms and with specific business or corporate strategy units to identify and develop new investment and business opportunities. Analysing hundreds of investments confirms: just allocating capital is not enough. Rather, three strategic markers distinguish and enable effective corporate innovation:
- Is the investment made off a corporate balance sheet? The first marker of likely success is whether the CVC activity is independent or not. Many corporates tend to invest off a balance sheet, with the CVC unit beholden to strategic priorities and corporate governance. This sets the CVC initiative up for failure — unable to make bold bets and constantly playing second fiddle to the host. This is what differentiates companies such as Bosch or Statkraft, that hire and establish a fully independent VC arm, from others, which invest off the corporate balance sheet.
- Is the goal to “learn” or to build new business? Many CVC funds are established to “learn” about what is going on in the broader universe of the industry. Yet, as objectives go, this is decidedly vague and does not provide a clear pathway to success. While learning about change is certainly a desirable objective, it should be seen as an outcome of investing, rather than the reason for it. Bosch Ventures as an example, invests well ahead of areas that may be relevant directly to Bosch. Learning is a by-product of that activity and of the operational model which involves frequent knowledge exchange between Bosch and Bosch Ventures.
- Does the spectrum of acceptable investments reach beyond what exists and disrupts a company’s own existing profit centers? Many corporates use the traditional VC approach to investing in what is, rather than what could be. A particular reason for this may be the fear of disrupting oneself. Another is likely inability for blue ocean thinking within a corporate context. Nonetheless, such an approach is imperative because if companies do not disrupt themselves, someone else will. This may explain why Statkraft Ventures, the CVC arm of a leading European energy utility, invested early into Limejump, a virtual power plant (VPP) startup. The corporate had undertaken in-depth work to understand the benefits of this new business model and choose to invest into and build out a company for that specific purpose — eventually selling it to Shell. Simultaneously, the learnings it received likely helped the company scale up its own VPP into one of the world’s largest.
Our own approach within our principal investment platform — Industrial Innovation Partners — (IIP) addresses these three key strategic areas.
- The objective of building new successful businesses remains paramount with each investment — whether that is within or outside of a corporate context. Learning is an outcome of our cooperative operating model.
- IIP operates outside of a corporate framework yet with close links to industrial partners, be they co-investors, clients or our own investors.
- IIP invests actively and with a clear direction, identifying specific areas of opportunity and looking to find, partner with and grow new businesses.
The approach mimics how a corporate may initiate a new business case and provides all the support that the business unit (BU) may have, but with the flexibility and versatility of operating outside the corporate sphere and influence. During this process, the corporate partners receive valuable insights, including on the state of the selected sector we cover with them. This includes working to help companies understand the return of investment (ROI) and develop new internal business cases in fields such as predictive maintenance, smart and distributed energy services, and logistics and warehousing. Simultaneously, the deal-flow provides additional opportunities to these same companies to partner with or acquire.
While this approach is not new and has been attempted in various forms before, its execution remains a challenge. Companies with innovative models have previously aimed at finding this balance between corporate strength and entrepreneurial spirit — the most obvious of those was Frost Data Capital, a GE initiative that rose and fell with the fortunes of GE. Others that have attempted this include Cisco with its Spin-In model that encouraged employees at Cisco to leave to setup new businesses as startups backed by Cisco and an option to be “re-acquired” at the right point in time.
The irony of the current corporate approach to innovation is that it positions corporates as being “behind the curve”. Yet, they know their customers and the industries in which they operate better than any new entrant — small or large. The challenge has been a tendency amongst them to straitjacket their innovation arms into learning mode, while preventing new business arms from taking bold new bets that may challenge their existing businesses. When corporates are able to invert the thinking and build their approaches anew, they can once again be ahead of the curve, translating their industry knowledge into new business opportunities, while newer entrants might struggle to catch up with gaining customers and industry expertise.