Jun 17, 2019
The Building Blocks of Corporate Innovation — Part 2 of 3
Building internally vs. external partnering
In Predicting the Turn, Dave Knox describes the “emerging disconnect between the world’s largest spenders on Research & Development (R&D) and those companies that are considered by their peers to be the most innovative.” Only five companies that were in the top ten for R&D expense — Amazon, Google, Microsoft, Samsung, and Toyota — were also named by their peers as being in the top ten most innovative, in a Global Innovation 1000 study by a division of PwC. As demonstrated by this study, being perceived as innovative requires more than just R&D spending.
In the first article of this series, we examined four basic building blocks of corporate innovation: 1. build, 2. partner, 3. invest, and 4. buy — corresponding to four specific corporate functions: 1. research & development, 2. business development, 3. corporate venture capital, and 4. mergers & acquisitions. These were presented in a framework contemplating a corporation’s commitment and control, encompassing options for internal and external innovation.
In Part 2, we compare the operationally focused innovation tools, 1. building (R&D) and 2. partnering (business development). This article discusses how partnering can represent a lower operational commitment by leveraging external innovation. While partial commitment implies less responsibility and fewer required resources, it also means less control or influence on outcomes. Neither of these innovation approaches requires an investment in new equity.
1. Research & Development
“Building,” or research and development, typically involves internal development of new businesses, including incubated concepts that can later be spun out as stand-alone companies. In this model, the corporation controls everything and the effort represents a full commitment. R&D allows the corporation to leverage its unique technology, team, and business advantages while relying exclusively on internal capital and resources.
The National Science Foundation (“NSF”) defines R&D as planned, creative work aimed at discovering new knowledge or devising new applications of available knowledge. This includes (1) basic research: acquiring new knowledge or understanding without specific immediate commercial applications or uses, (2) applied research: solving a specific problem or meeting a specific commercial objective, and (3) development: systematic use of research and practical experience resulting in additional knowledge directed to producing new or improved goods, services, or processes.
The NSF reports that businesses spent $375 billion on research and development in the United States in 2016. According to Knox, non-defense R&D totals about $80 billion per year. By comparison, venture capital funding currently amounts to approximately $70 billion per year, predominantly funded by non-corporate sources.
Corporate incubators create new businesses from scratch, and thus are similar to core research & development. In fact, many incubated concepts may begin as internal R&D with no intention of being spun out as a stand-alone concept. If you are trying to distinguish incubators from accelerators, remember that the new business is born in an incubator, like a baby. Once the incubated business is spun out, however, it is no longer fully controlled by the corporation. The “parent” company may potentially invest in the spin-out or receive founders shares in the new equity that is created. Operational control will typically shift to the spin-out’s management team, often resulting in partial operational control or a passive relationship. In these ways, incubation can become more like corporate venture capital.
Notable examples of corporate incubation include McDonald’s spin-out of Redbox, Amazon’s introduction of the Kindle and Echo through its Lab126 incubator subsidiary, and the development of Java by Sun Microsystems, which is owned by Oracle.
Research & development efforts are typically led by technical teams, although these priorities are sometimes driven by senior executives and strategic priorities. R&D should be used when the corporation has distinct advantages that can be leveraged, especially with regard to technical expertise. When organic growth is sufficient, or when the internal team needs to be energized or challenged to compete, building internally can be a good choice. Because it may be politically difficult to support internally competitive R&D projects, building can also present concentration risks, akin to putting all of one’s eggs in the same basket. R&D is a good tool when corporate leadership is sure about technologies, team capabilities, markets, and how these will all unfold. When the future is less certain, partnering may present advantages.
2. Business Development
“Partnering,” or business development, typically involves commercial transactions or corporate acceleration. In this model, the corporation does not control everything and the effort represents only a partial operational commitment. Partnering allows the corporation to leverage the external capital and resources of other ecosystem participants, including startups, venture capital syndication, and other large corporations that might be suitable partners. For each individual R&D project, the corporation may have the capital and human resources to pursue multiple business development deals, creating a portfolio of new business options.
As with R&D, the core form of business development does not require the creation of new entities or the purchase of new equity. Business development deals are commercial transactions between two parties, usually attempting some combination of a) joint product development or shared R&D, b) supply chain collaboration, c) distribution agreements, d) co-marketing, or even simply e) a strategic vendor relationship. Licensing, for example, is a form of business development in which R&D is commercialized by an external party.
Accelerators are a form of business development in which corporations work with external innovators, usually startups. These startups are born externally, and enter the “orbit” of the corporation to accelerate growth. The startup is not fully controlled by the corporation, although the corporation may potentially receive equity in the startup as a result of the accelerator program, creating an opportunity to develop influence or partial control. Many accelerator programs seek to establish commercial agreements between the corporate sponsor and participating startups, with mixed success. The recent trend toward “venture studios” represents a hybrid of incubation (because the corporations select and co-create the new business ideas) and acceleration (because the corporation is collaborating with an external party, like TechStars, R/GA, or IDEO CoLab).
What makes external partnerships succeed? I spoke with Michael Himmelfarb of InnovationEQ, a firm that works with incumbent corporations to maximize the value of innovation programs. Himmelfarb shared the results of a study on corporate engagements with startups for commercial transactions.
InnovationEQ’s study included over 100 senior executives directly involved in a corporate-startup engagement (including partnerships, investments, pilots, or other collaborations). 29% of the respondents were from large companies, 45% from startups, and 26% were advisors or investors.
The survey found that among a list of potential success factors, three correlated with success of the commercial effort: 1) alignment on goals and KPIs, 2) leadership and resource commitment, and 3) open communication between the parties. Big companies were also asked to define which success factors they thought were most important to the success of the partnership. Those that rated themselves as “not proficient” at any of the self-selected factors had successful engagements only 7% of the time. If they were good at one or two, their success rates quadrupled to 28%. If they performed well at three or more of the factors they rated most highly, their success rate jumped to over 70%.
Business development efforts are typically led by strategy teams or dedicated business development professionals who can navigate politics and deliver the necessary alignment, executive commitment, and communication described by Himmelfarb. When organic growth is insufficient, or when senior leadership seeks to prepare for disruption, partnering externally can be a good choice. Partnering can also avoid the concentration risks of R&D projects. Business development can be a good tool when corporate leadership is unsure about new technologies, internal team capabilities, changing markets, and an uncertain future.
In summary, building is a high-risk, high-reward model and can be a good choice when the corporation is sure; while partnering may present advantages when the future is unclear and the corporation needs to prepare for multiple scenarios by distributing resources, leveraging external innovators, and building a portfolio of potential new business opportunities.
In Part 3 of this series, we will explore the financially focused building blocks of corporate innovation: acquiring (M&A) and investing (corporate venture capital), comparing and contrasting these tools. This article will explain how investing may represent a lower “commitment to equity” risk profile, and how M&A presents advantages by fully internalizing 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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