The delicate art of growth
Inside Business: Large companies need clear objectives when they go down the capital venture route or they may well get lost, writes Roger Trapp
Sunday 23 August 1998
McKinsey & Co, the international management consultancy, says in a study it achieved an internal rate of return of about 90 per cent over five years, but had little success in improving the position of the Macintosh.
Furthermore, Paul Brody and David Ehrlich, the authors, point out that these returns, "though attractive, had minimal impact on the company's overall performance" as will be clear to anybody in the least bit familiar with the company's chequered past.
The point made by Mr Brody, a former McKinsey consultant now working as a specialist in high technology markets with i2 Technologies, and Mr Ehrlich, a consultant in the firm's Kuala Lumpur office, is that a venture programme is just one instrument for implementing a company's business mission. Claiming that the Apple programme's managers later admitted that the strategic potential of their investments had not been realised, they say that the primary objective "should clearly reflect the company's overall strategy".
In the latest issue of The McKinsey Quarterly, they set out how their experience suggests that only four objectives can legitimately claim to do this. The first of these is improving the capture of value from strategic assets. This is most appropriate for companies that are able to exploit traditional assets such as world-class manufacturing skills, extensive distribution networks or strong brands, but lack enough good product ideas to capture the full value.
Merck, the pharmaceutical company, and 3M, the industrial company, have pursued venture programmes for such a reason.
Second, is improving the capture of value from good ideas. This is most suited to companies that are good at generating ideas but struggle to bring many of them to market. Organisations with extensive technical skills but a lack of enterprise suffer from such problems, with Xerox PARC perhaps the most-often-quoted example.
The third objective is responding more competitively in a rapidly evolving industry. Organisations that are battling with energetic upstarts can find themselves aiming in this direction, and a venture programme can provide a platform for boosting successful product innovation, with strategic bets used as a defence mechanism to keep competitors from gaining access to key evolving technologies. The article "Can big companies become successful venture capitalists?" says that Cisco Systems, the fast-growing producer of internet-related products, has pursued this route to gain control of important technologies.
The final objective is supporting demand for core products. This, say Mr Brody and Mr Ehrlich, applies when the demand for a company's core products is affected by the evolution of a separate industry niche, and a well-structured venture programme can be useful in shaping the direction of such an evolution. They point to how both Intel and Adobe Systems have used venture programmes to support technologies that drive demand for their core products.
The objectives and the clear thinking needed to pursue them form a key part of the article's argument that successful venture capital investment is a lot harder than it sometimes looks. With management gurus and consultants urging the boards of large companies to follow the example of the fast- growing companies that are driving the economies of many of the world's leading industrial nations and become more enterprising, executives must feel under pressure to start venture capital funds.
One of the problems is that, while venture capitalists' successes gain publicity, the failures tend not to be noticed. As Messrs Brody and Ehrlich note, venture capitalists are specialists who tend to have a simple goal: "Take a pile of money and make it bigger." Such a steady focus on financial returns makes decision-making easier. But when larger companies go down this route, there is a tendency to confuse this with the desire to gain access to innovation or markets, to retain entrepreneurial talent and to achieve greater growth for core products.
They say that the fact that Adobe Systems, for example, has been so successful with the $40m venture fund launched in 1994 that it has recently set up another demonstrates that big companies can apply the venture capital model effectively. But more often the results are disappointing.
Among the reasons are difficulty in establishing the systems, capabilities and cultures that make good venture capital firms successful, corporate managers' lack of freedom to fund innovative projects or cancel those that will not live up to promise and the fact that managers are typically equipped with the skills for managing mature businesses rather than nurturing start-ups. But at the route of the problem, suggests the McKinsey article, is a lack of understanding of the characteristics of the venture capital model and the need to tailor a programme to an organisation's own circumstances without losing sight of the essentials.
Above all, an organisation needs to be absolutely clear about its reason for launching the programme, which, of course, brings you back to the four key objectives and Apple.
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