Listen to what the market says

Simply pouring resources into a venture can prove counter-productive, writes Roger Trapp

The computer company Apple is garnering much praise and renewed credibility for its distinctive i-Mac machines and the latest portables. But as recently as last year the organisation shut down the operation responsible for the Newton.

The reason, according to a team of consultants from McKinsey & Co, is that it failed to attract customers in significant numbers. And the reason for that is that the initial six-year development of the product, conceived as a palm-sized alternative to traditional computers using handwriting recognition to overcome general users' antipathy to keyboards, was an almost entirely internal effort that had little direct exposure to market feedback.

The point, as James Clayton, Bradley Gambill and Douglas Harned write in the latest edition of The McKinsey Quarterly, is that such a focused effort was only possible because Apple was able to devote hundreds of millions of dollars to the project: when the operation was closed, it had soaked up more than $500m (pounds 310.4m) over 10 years.

By contrast, the development of the rival Palm Pilot began in 1992 when Jeff Hawkins, a former Intel engineer, left his programming job with GRiD Systems and raised $1m from Tandy, the electronics company that owned GRiD, and two venture capital firms. To get its first product to market, Palm built relationships with such organisations as Casio, Geoworks, Intuit and AOL.

Like the Newton, it originally failed. But, unlike Apple, Palm reacted to market feedback by making the product a cheaper complement to, rather than a replacement for, desktop personal computers. And, because it had not invested in manufacturing, it was able to shift to more sympathetic manufacturers when the original partners showed little interest in the new version.

The changes consumed an additional $5m in venture funding and stock options for employees and business partners - small beer compared with the money spent by its rival and in relation to the success the product now enjoys. With three million units sold in the first three years, the family of Palm devices is comfortably the leading player in this field.

The moral of this story is that while common sense would seem to suggest that new ventures stand a better chance if they are well-resourced this is not always the case.

"Driven by ever-increasing equity market valuations and growth challenges, many large corporations are bestirring themselves to build new enterprises that have the potential to grow much faster than their core businesses," write the McKinsey team.

"Yet, in doing so, senior managers at the parent companies often make the same well-intentioned mistake that children do with their first goldfish: overfeeding."

In fact, the McKinsey consultants suggest that while the financial and technical support that a parent corporation can give to its start-ups is the main source of competitive advantage over stand-alone new businesses when the new project is essentially an extension of the core business in familiar or strongly related markets the opposite may be true in genuinely new businesses.

"In fact, bestowing too many resources on new ventures undermines the discipline they need to grow. Excessive amounts of capital can make the managers of a new venture expand its product range too quickly, invest in too much infrastructure, and delay going to market for too long - all potentially fatal mistakes," say Mr Clayton and his colleagues.

And they point to how successful start-ups, such as the internet company Excite, bio-technology business Amgen and network management software company Tivoli all grew and prospered under the constraints of venture capital-style funding.

The McKinsey team describes how a large technology company attempted to build a business in the area of home automation - a market that is ill-defined but has huge potential.

"As enthusiasm for the project swelled, this effort to bring a single product to market ballooned into a venture aimed at developing a suite of six new products, each designed to provide a different type of functionality and targeted at a different market segment. Instead of creating a winner in a single niche as a platform for building a broader position, the company spawned a full line of mediocre losers that were shut down within two years."

Contrast that with the well-publicised example of Amazon.com. The Seattle company, which now has a market capitalisation of more than $30bn, started out by focusing on a niche - online book sales. Now it has the benefit of a detailed understanding of the market, a powerful brand and great credibility.

As large companies are increasingly urged to consider corporate venturing as a way of introducing more innovation to British industry, such lessons are well-timed. And it is worth remembering that even the most respected companies can get it wrong.

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