Nov 21, 2018
The Building Blocks of Corporate Innovation — Part 1 of 3
Four basic tactics for growth & change
Corporate innovation remains one of the hottest topics in Fortune 500 board rooms. According to a PwC survey, 97% of CEOs say that innovation is a top priority, but 94% are dissatisfied with their current innovation programs (source: McKinsey). For a large number of executives, the topic can be opaque and intimidating. Many wonder what innovation activities to prioritize, and who should be responsible.
As in any complex situation, breaking the problem into parts can help. In the case of corporate innovation, consider four alternative building blocks: a. build, b. partner, c. invest, or d. buy — corresponding to four corporate functions: a. research & development, b. business development, c. corporate venture capital, and d. mergers & acquisitions. There are also derivative innovation options, including corporate incubators, accelerators, licensing, and joint venture structures. These options encompass internal and external innovation.
These building blocks can be understood within a framework that evaluates two kinds of corporate commitment, or willingness to take risk:
- Operational control — this asks whether the corporation is responsible for running the innovation effort (options include full responsibility, partial responsibility, or a passive approach)
- Purchase of equity — this asks whether the corporation is acquiring ownership in an entity that it did not previously own (options include majority ownership, minority ownership, or no new ownership)
In the case of operational commitment to innovation, the corporation must decide how much control to exert — this requires knowing how active or involved to be. Full control means the corporation is responsible for everything and has final say on all decisions. Full control is the “comfort zone” for many leading organizations and is the domain of research & development (innovation born inside the corporation and fully managed) and mergers & acquisitions (innovation created outside the corporation and internalized, at which point it is also subject to full control).
While full control might be the starting point for many organizations, partial control is an option, too. This means sharing responsibility but also decision making authority, and it is the latter characteristic that makes many corporate executives nervous. Partial control presents numerous innovation options, including business development (novel commercial transactions with external companies, in which responsibilities and authority are shared, along with economic benefits), venture capital (equity investments in external startups, in which minority ownership also means limited influence on operational decisions), and even some forms of mergers & acquisitions (think of loosely integrated acquisitions that are run as wholly-owned subsidiaries with relatively independent management teams).
While partial control means sharing operational participation and influence, passive approaches are also possible. Passivity means delegating all responsibility and authority to external parties (but this does not mean “doing nothing”). A passive approach to operations can include licensing, which is a variation of business development (a commercial transaction in which products or technology is licensed to a third party that takes complete responsibility for all further commercialization, and the licensing party passively receives royalty payments). Passivity is often the second most comfortable approach for corporations. It is the murkiness of cooperating with external parties that may justifiably create trepidation for corporate executives.
Corporations must also decide how much to commit financially to new equity — this means setting a budget for what to buy. Majority ownership means controlling 50% or more of new innovation assets. Control positions are comfortable for many big companies, incorporating mergers & acquisitions and some forms of joint ventures (a nebulous innovation structure that combines characteristics of M&A, venture capital, business development, and often springs from innovations in research and development).
Just as partial control is often the least familiar option for corporations, minority ownership can be similarly uncomfortable. Minority ownership means less than 50% equity and correlates with influence but not control. Innovation options for partial ownership of new equity include corporate venture capital and its variations incubation (spin-offs of corporate R&D in which full ownership is diluted), corporate accelerators (partial ownership in externally founded startups that participate in temporary programs to develop corporate relationships), and the aforementioned joint ventures.
Corporations can also stick with what they already own, with no commitment to new equity. This means focusing on innovation approaches that don’t require any new ownership, like R&D and business development. Because financial commitment carries high perceived risk (it is easy to calculate the dollars invested in an acquisition or venture capital investment), many corporations prefer to limit the uncertainty of working with external parties.
This perceived risk often driving corporate preferences for innovation activities may be misunderstood. The familiarity of control comes at a cost, requiring the commitment of resources to manage innovation assets. On the other hand, partial control of operations implies fewer personnel devoted to managing projects. Running an R&D program and launching innovative new products internally should logically require more resources than collaborative efforts with external companies. While the upside of full control is attractive, a focus on internal innovation only may be akin to putting all of your eggs in one basket.
Similarly, acquiring external companies via M&A is typically more expensive than purchasing minority equity positions. M&A is a full commitment, whereas venture capital is a partial commitment, which leverages the financial contributions of syndicate partners. The same budget for a single acquisition might fund an entire portfolio of minority investments.
Of course, there is not one correct way to innovate. All four of these approaches offer benefits and are often used in concert by leading corporations. For example, Intel Corporation maintains an M&A team and a corporate venture capital arm, Intel Capital. Each of these related functions is led by Wendell Brooks. The company also employs business development executives based in each of the company’s main divisions, and research and development teams in each of the company’s divisions. Even a company as large as Intel prioritizes coordinating across these innovation functions to optimize decision-making.
In fact, corporations can embarrass themselves by failing to coordinate internally between the various innovation teams that may be speaking to the same external party. Professionals from these four innovation teams should cooperate as much as possible in a corporate environment.
In Part 2 of this series, we will examine the operationally focused innovation tools, building (R&D) and partnering (business development). This article will show how these approaches are similar, and also highlight how they are different, focusing on how partnering represents a lower commitment to operations and can leverage external innovation.
In Part 3, we will explore the financially focused building blocks: acquiring (M&A) and investing (corporate venture capital), again comparing and contrasting these tools. This article will explain how investing represents a lower “commitment to equity” risk profile, and show how M&A fully internalizes external innovation.
This article originally appeared on Forbes.
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Scott Lenet is President of Touchdown Ventures, a Registered Investment Adviser that provides “Venture Capital as a Service” to help corporations launch and manage their investment programs.
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