Disruption, disruption, disruption…. It’s a ubiquitous topic, but one that’s impossible to ignore. Companies are constantly being challenged by new entrants offering new products, new platforms, new experiences that could revolutionise their sector – or not. It’s a constant challenge trying to work out where to place bets in a rapidly changing world. One possible way forward is the corporate venture fund. It’s certainly not a new concept, but it’s found new life in the disruptive era as companies look for ways to cast a wide net across new talent and technologies. A great concept in principle, but companies need to ensure that they able to reap the innovative benefits– and that’s not always easy.
There’s been some debate recently about the nature of disruptive innovation. Is the same product offered on a new platform – such as Uber – ‘disruptive’ or an ‘improvement’ on the previous service? Does an innovation need to create an entirely new market to be disruptive? Does it matter? It’s probably true that not all innovation is disruptive; but that’s rather a moot point for companies who are losing business to an online rival, a new platform or a new product delivery system. The issue for them isn’t so much what they can classify an activity as ‘disruptive’, but what can they do to meet new challenges that are multiplying across numerous sectors.
And it seems that finding the right approach to meet these challenges is a growing issue for many companies. In a recent global survey conducted by Forrester Research, more than half corporate respondents expected the majority of their revenues to be digital-dependent by 2020; however, more than one in four don’t believe their company has the necessary skills and talent to execute this transformation. We’ve spoken before about how companies are using M&A to meet the disruptive challenge. But, success obviously isn’t achieved by simply buying up ‘online’ assets. Boards need to look deeper into where the value now sits in the supply chain and perhaps rethink long-held assumptions about the deal process and integration.
They also need to think about timing. Purchasing fully-fledged ‘disruptive’ assets is normally an expensive business. By the time a company with a potentially disruptive idea or technology is ‘proven’, potential buyers are queuing around the block with a knock-on impact on price. But, buying earlier in process can mean purchasing smaller start-ups, which is alien territory for many companies. It’s not just the size of the business, but also the experience of management and staff and the overall maturity of the organisation that will be unfamiliar. There will be less data and surety and a greater risk. The business will probably still need careful nurturing to develop. In this sense the corporate acquirer is acting more like a venture capital fund. So why not create one with the appropriate structure and expertise that enables them to lay multiple bets?
Corporate venture capital (CVC) isn’t new, but it has come into its own in recent years as a means for companies to invest in early stage companies. Last year deal activity increased five-fold compared with 2012. There’s by no means a standard model in this expanding market. There are just about as many ways to establish and run a CVC as there are CVCs, who vary in funding models, the amount of hands on involvement from the parent company and the access they provide to their own facilities and expertise. There is also significant variation in financial expectation. As the British Venture Capital Association (BVCA) notes, CVCs will generally sit on a financial-strategic continuum with some funds – whilst not setting out to make a loss – prioritising strategic benefits over return on investment.
The advantage of CVCs over traditional R&D is the ability to gain access to ideas and products that have at least been developed and partially tested in the market. This can make it quicker and possibly cheaper route to innovation and – depending on the model used – allow the business to spread its net wide and gain access to a variety of new technologies, markets, products and talent via a larger number of smaller investments. In return, the portfolio business could gain access to the parent company’s capital, expertise and connections and – again depending on the model used – their manufacturing and distribution networks and branding. This model also allows the business to develop outside of the parent organisation, which can help preserve an innovative culture and perhaps retain staff that wouldn’t want to work for a larger corporation.
The CVC model is continually involving and adapting to new paradigms. As the model adapts, we expect to see parent companies apply the same portfolio review principles to their venture funds as they have to their own businesses. It doesn’t make sense for companies to keep and invest in businesses indefinitely if they no longer fit within their own evolving strategy – even if they are profitable. Many of the problems with CVCs in the past have been caused by rigidity in structure and strategy. CVCs today are more likely to be better flexibly aligned with their parent companies. As the Economist, notes: “the new generation of venture units looks better integrated with their parents: instead of chasing the next Facebook (or drone), they tend to invest in industries related to the firm’s main business.
Success still takes considerable effort. Alignment and cross-fertilisation aren’t automatic. The parent business needs to have an operating structure and culture that will allow them to absorb new ideas and technologies. Meanwhile, it’s vital that CVCs don’t work within a silo and become too insular. There needs to be a clear and frequently reviewed mandate covering the fund’s objectives to ensure investments remain on track with the parent company. Even then, it’s important to remember that the CVC isn’t a silver bullet that will resolve all of a company’s disruptive problems. It should enable the company to be more outward looking, but it’s still up to the company to make the most of any new developments and make any deep structural changes necessary to move with the market.
And CVCs aren’t for everyone. It can be hard sometimes to structure a deal that both parties can agree on within a CVC set up, especially if the investing company wants to have more visibility or control over the acquired company. Some companies start with CVCs and end up bringing them in house, investing directly so they can have more day-to-today involvement in management – and to learn more directly from the acquired company and its management. Disruption takes many forms and so will companies’ responses.