How to tell when you are on to a winner

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The Independent Online
New ventures can produce enormous shareholder value - just look at Direct Line, which made millions for the Royal Bank of Scotland, its parent group, before the competition followed suit and ate away at margins. But they can also bring heartache, as the up-and-down story of Mercury, the Cable & Wireless subsidiary, has shown in its attempts to become a serious rival to BT.

With mature markets continuing to slow growth, investors and large corporations are increasingly looking for opportunities. But can they make sure that their ventures follow Direct Line rather than Mercury?

Research by PIMS Associates, a consultancy that specialises in benchmarking, suggests that they can. Drawing on the experience of 200 start-up businesses in consumer and industrial markets in America, continental Europe and Britain, it says that ventures are often stifled in their infancy by banks and parent companies that do not have an understanding of what it calls "start-up dynamics".

It is well known that as many as 80 per cent of businesses fail in the early years, but PIMS maintains that most ventures that become long-term successes do not break even until year four or five, which is some way after most backers lose patience.

This is all very well. But how do you justify sticking with one business this long and not another? PIMS says there are several indicators.

The most important of these is rate-of-market penetration. "The quicker the sales grow and competitive position strengthens, the more margins improve, leading to the maturity position where market share is a key determinant of profitability," it says.

But growth in market share is itself dependent on other factors. In particular, high quality of the product relative to the market is essential to the success of any launch. Conversely, contrary to many people's perception, discounts do not generally work. Prices should be on a par with those charged by competitors. In addition, it is vital to make a marketing impact. Investment in aggressive marketing can deliver four times the expected market share at year four, says PIMS. Orange, the mobile phones operator, is cited as an example to substantiate this claim.

Another factor, which backers may find hard to bear, is that it is not usually enough to provide just one tranche of funding. "Second-wave innovation" is necessary if the entrant is to continue growing and stay ahead of the competition, which will often be seeking to use its extra might to catch up.

But perhaps the most important factor, in terms of the effect it has on management style, is the size of the originators' ambition. "A lot take a tip-toe approach, which minimises the risk but also minimises the potential," says John Hillier, who carried out the research with Tony Clayton, a fellow PIMS consultant. They recommend setting tough goals, since aiming low often results in a miss.

The problem with this, of course, is that it is not always easy for large organisations to find sufficiently entrepreneurial managers within large organisations. "By nature, they are risk-averse," adds Mr Hillier, noting that this may be one of the biggest challenges for corporations.