Comment from Paul Asel, managing partner, NGP Capital
Industry incumbents are at a crossroads. We envision a connected world in which everyone and everything transmits a signal. Industries previously untouched by technology are undergoing digital transformation. McKinsey has said the internet impacted 15% of gross domestic product, the internet of things will transform the other 85%. Increasingly incumbents must disrupt themselves or risk being disrupted.
Much as Google and Facebook championed the internet era, the connected world is spawning a new class of data first companies. These data first companies are redefining industries through new business models enabled by the confluence of cloud, mobile, sensors, 5G and intelligence. Early winners include Tesla in automobiles, Uber in transportation, Teladoc in healthcare, Airbnb in hotels, Doordash in restaurants and Root in insurance. Yet the transformation process is just beginning as new technologies permeate a broadening array of industries.
Companies are tapping corporate venture programmes to help navigate industry change. Corporate investment has grown fourfold since 2010 with more than 2,100 firms globally participating in 14% of venture deals in 2020. Corporate venture is a mainstay among leading technology firms. Qualcomm Ventures celebrated its 20th anniversary last year and Sapphire Ventures and Intel Capital enter their 25th and 30th years, respectively, this year.
Corporate venture requires clear objectives, engaged sponsors, aligned incentives and a capable team to fulfil its promise. Based on our interviews with over 50 firms across 15 industries, corporate venture applies best in highly contested industries undergoing rapid technology change. It flourishes in open innovation cultures among companies generating sufficient operating cash flow to sustain inorganic growth strategies. Corporate venture languishes, however, when it lacks executive support, when investment activity is ad hoc or subscale, or when the investment mandate is unclear. Poorly constructed programmes occur too frequently as the median corporate venture lifespan is short-lived. Josh Lerner estimated the median lifespan of CVC as about a year in his 2013 Harvard Business Review article though this figure is based on a 1990s study.
Nascent corporate venture programmes confront myriad structural challenges from the outset: competition for corporate resources breed internecine rivalries; “not invented here” mindsets resist partner engagement, and corporate leadership and strategy changes threaten sustained corporate venture commitments. Venture leaders must manage these inherent challenges by delivering immediate and ongoing strategic value to bridge the gap between venture investing lifecycles and corporate patience cycles.
Yet established programmes have shown that corporate venture can provide both strong financial returns and strategic benefits while leveraging their research and development (R&D) budgets with the $217bn invested annually in VC. Corporate investments create low-cost options in startups that can accelerate time to market while delivering high returns in startups in which the corporate sponsor has strategic interest. Studies, such as Lerner’s, show that venture programmes enhance corporate innovation while startups backed by corporate venture have higher success and growth rates than other venture funded startups.
Corporate investment is a flexible tool offering many strategic benefits, according to a recent survey by Global Corporate Venturing. Investment maintains optionality in dynamic situations where companies seek influence without control. Venture offers a window on innovation to help defend strategic interests and explore new market opportunities. Investment reinforces alliances increasing the likelihood of partnering success. Corporate venture can be a cost-effective form of outsourced R&D to accelerate time to market and fill technology gaps. Some firms deploy venture as a try-before-buy prelude to potential acquisitions. Venture investments can help companies improve operational efficiency and expand market demand for company products and services.
Corporate venture is also well suited for ecosystem building. Data first companies demand robust partner and developer ecosystems to broaden user engagement, tap new data repositories and extend product offerings to new markets.
Our research has found that companies with open hardware and software systems are more likely to adopt corporate venturing to help build ecosystems that nurture their platforms. Intel Capital launched in 1991 shortly before the “Intel Inside” campaign promoting its chips as a hardware platform for the consumer electronics industry. SAP started SAP Ventures (now Sapphire) in 1996 coinciding with the launch of mySAP.com as the bulwark for its new Internet strategy. Nokia started Nokia Ventures (now NGP Capital) in 1999 to build a developer ecosystem forming around its mobile Internet strategy. Qualcomm launched Qualcomm Ventures in 2000 to promote CDMA as the 3G wireless standard. Salesforce started Salesforce Ventures in 2009 to broaden adoption of its customer relationship management (CRM) platform.
Vertically integrated companies with closed ecosystems like Apple, Netflix and Tesla prefer to build or buy rather than invest. But firms long sceptical of corporate venture capital have started investing as their business models evolved into ecosystem plays. Amazon eschewed corporate venturing for twenty years but formed the Alexa Fund in 2015 to promote its Alexa voice platform and later AWS as primary infrastructure. Microsoft launched M12 Ventures in 2016 to promote its Azure platform after limited corporate venture initiatives for over 40 years.
Corporate venture has a more complex mandate than traditional venture firms, which focus solely on financial returns. Corporate venture serves both a fiduciary and strategic mandate. Our interviews produced a wide range of responses on how corporate sponsors balance this dual mandate. Some place primacy on financial returns, others on strategic benefits. Most seek to balance financial and strategic mandates finding that these objectives can be mutually reinforcing.
Both fiduciary and strategic mandates have challenges within a corporate setting. Financial performance is only ascertainable over five to 10 years, well beyond the typical corporate patience cycle. Venture returns are unreliable in the short term, as they follow a J-curve where losses are realised before gains.
Strategic mandates pose further challenges for corporate venture. Strategic value is hard to define and defies objective measurement. In dynamic markets with evolving strategic initiatives, perceived relevance in long-lived assets often differ at entry and exit. Tying investments too closely to strategic initiatives may undermine the broader purview needed to spot disruptive startups that pose as future threats and opportunities to the corporate sponsor’s core business.
Long-lived corporate venture programmes deliver both financial returns and strategic benefits. Several factors augur for focusing first on financial returns. Companies must do well (perform well financially) to do good (fulfil a strategic purpose): startups that evolve with the market are more likely to deliver financial returns and remain strategically relevant. Furthermore, mature corporate venture programmes that are consistently cashflow-positive are more likely to survive corporate leadership changes, strategy shifts and cyclical downturns than those that require annual cash infusions.
Corporate venture programmes with clear investment objectives aligned with their sponsor’s business live longer and perform better financially, according to Paul Gompers and Lerner, writing for the National Bureau of Economic Research in 2000. Strategic alignment better leverages corporate insight and positions the programme as a preferred partner in a competitive venture market.
Strategic mandates span one or more of three dimensions: investing to build the core business, the corporate ecosystem or explore new markets. the task of the investor differs substantially, depending on the strategic mandate. The value proposition is strongest when supporting the core business, and strategic value is more readily discernible within the core business and ecosystem than in future markets.
One recommended strategy when launching a corporate venture programme is to focus on one or two business units for early wins with potential champions. Citibank and Citi Ventures, Microsoft and M12 and Amazon and Alexa Fund used this approach to overcome initial scepticism and create demand pull from other business units.
Venture programmes annually engage thousands of startups, hundreds of venture firms and scores of corporate partners. Insights that identify early latent opportunities or threats could be more valuable than any single investment outcome.
Knowledge transfer from startups to corporations does not happen automatically and cannot be left to chance. Investors are potential matchmakers, as startups alone lack resources to navigate corporate menageries. Bosch and Swisscom assign business unit liaisons with their venture programmes to facilitate partnerships and reinforce mutual accountability.
Many venture programmes delineate separate roles for hunters and gatherers recognising that stalking new investments and harvesting strategic value are different skill sets. A separate business development function connects startups with company business units to facilitate partnerships and mutual insight. Marketing also plays a key role engaging both external communities and corporate sponsors to raise awareness of venture activity and insight.
Venture investing and corporate management are different disciplines. Companies recognise sales executives are coin-operated and compensate them accordingly. Thoughtful companies similarly design incentives consistent with venture industry practice.
Incentives aligned with capital gains are only expensive if investments succeed. The truly expensive incentive schemes are those that diminish investment performance. Research shows that venture programmes attract and retain talent better (see the article Dennis Park, Rama Velamuri and I wrote for the Journal of Private Equity in 2015) and have stronger performance when incentives align with investment success, as Gary Dushnitsky and Zur Shapira found in Strategic Management Journal in 2009. Recognising this, Cleveland Clinic, Google, Nokia, Prudential, SAP and many others have adopted incentive structures consistent with venture industry practice.
Corporate venture, like venture investing, offers much opportunity but requires thoughtful design and execution. Programme success requires clear objectives and incentives that align financial and strategic interests. Investors must engage effectively with startups, the venture community and corporate executives to harvest insights and investment returns.
Yet a successful corporate venture programme may be just what is needed to navigate well in a connected world where digital transformation is required and disruption is the norm.
Asel is managing partner of NGP Capital. He has realised more than 20 successful investments, including five initial public offerings and four exits of more than $1bn, of which UCWeb and Ganji are two of the largest technology acquisitions in China.
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