Your Executive Newsletter with Sun Wu.
Five Proven Ways to Bring in External Innovation to Your Company
Friday, August 9th, 2019
If you work for an established company you know the feeling that rapid innovation only seems to happen outside your organization’s walls.

Because of their focus on profitability, established companies are usually bad at acting on trends or investing in areas with unknown chances of success.

Startups, on the other hand, are nimble in nature and have the ability to pivot and switch directions quickly as they craft their way to profits, which gives them huge advantages for the exploration of new market opportunities while keeping costs at a minimum.

It is through startups that many innovations originate and make it to market.

Their lack of bureaucracy and extreme focus make small companies innovation powerhouses that change markets around the world.

It is startups, not large corporations, that usually redefine industries and change the ways of doing business.

But that doesn’t mean that established organizations can’t tap into the stream of creativity and energy of startups.

There are, in fact, five effective ways in which large corporations can work with startups and invest just enough to cap their losses and reap any upside if these startups turn out to be a success.

Let’s go through these five alternatives one by one.

Outside-in Innovation Programs
The idea of an "outside-in" innovation program is to invite startups to pitch you ideas of how to use their innovations to create value for your organization or your customers.

You then select the ideas that you believe have the most potential and work with the startup to create a proof of concept that demonstrates their application in your business.

This is probably the most basic approach that we’re discussing in this article but it is so powerful yet inexpensive that there’s no good reason not to at least explore this alternative.

You can take this approach and work with more than one startup, and even have them compete for your business if you find a few with competing solutions.

Inside-out Innovation Programs
In a way, an inside-out innovation program is the reverse of the outside-in approach, but in this case, you find startups that could use your products and services to build theirs.

So, rather than receiving creative ideas from startups to use their products with yours, this time it is you who has to come up with ideas of how startups can use your products, and create a support ecosystem that helps them towards the integration.

Think of Paypal, the online payment platform, which for a long time has provided startups with a variety of tools to help them integrate PayPal as their core payment gateway.

By getting your product embedded into a startup’s solution, you can prove how effective the product is for similar companies, at the same time that you lock-in captive demand.

Strategic Alliances
At its most basic level, a strategic alliance is a collaboration agreement between at least two companies to pursue a common set of goals and it is usually a cost-effective alternative to an acquisition or a merger.

A common case of a strategic alliance is two firms forming a partnership to tackle a particular market segment with a combined offer that incorporates the complementary capabilities of each partner.

For example, when you play a song on Spotify, you get access to the song’s lyrics and the meaning behind those lyrics through Genius, a company that specializes in this area, which partnered up with Spotify to expand Spotify’s user experience.

One reason to consider a strategic alliance instead of a merger is that an alliance can achieve most of the same goals without the commitment and complexity of the real thing, making it a good alternative to see how the companies work together before making bigger commitments.

The obvious downside of a strategic alliance is that we have to share the profits that the collaboration produces, and the fact that managing the combined effort as two separate companies may turn out to be more difficult.

But in the cases that work, a strategic alliance is a great alternative to an acquisition and in some cases may be the best way to test one BEFORE making an irreversible commitment.

Corporate Venture Capital
A CVC program is an in-house effort that allows you to seek (and be pitched by) startup companies with relevant technologies or business models in your business space, in need of seed, growth or expansion capital

CB Insights reported that during 2017 CVC groups provided over $30 billion of funding across 1,791 deals globally, a 19 percent increase with respect to the previous year.

Well-known corporations with an in-house CVC arm include Dell Technologies, Intel, Salesforce, Citigroup, Cisco, Comcast, and GE, all of which have been very active over the last few years.

The way in which most CVC deals work is through direct acquisition of new shares of the target company.

These shares are usually issued in big chunks or investment rounds by the startup that’s seeking capital, and the corporation provides funds to the company in exchange for a portion of the shares, making the corporation a shareholder of the target.

With this, your company becomes a shareholder in the entrepreneurial company as a way to keep a close watch on its developments and progress.

If well structured, a CVC plan should be a win-win for both sides: the startup gets access to funds and markets, while the corporation gets to expand its product portfolio with cutting-edge developments without the risks and costs of an in-house innovation effort.

One benefit of playing the role of an investor, instead of developing the solution in-house, is that you can distribute money across a number of companies, some of which may be competitors.

For example, through its Vision Fund, Japanese tech company SoftBank Group has made important investments in both Lyft and Uber, two companies that are fighting fiercely for leadership in the ride-sharing market.

Independently of who wins the ride-sharing space there is one sure winner: SoftBank.

Acquisitions are by definition very simple: a company buys another company and makes it part of itself. Like a startup too much? Then buy it right out.

The general rule you look for in any acquisition is that the value the target will produce for the buyer over the foreseeable future must exceed the cost paid for it.

This may sound like common sense, but we all know that’s not always the case. In fact, most times it is actually very hard to even try to measure that.

The first challenge with any acquisition is that the buyer must value strategic factors in addition to a plain financial evaluation. So the price each potential buyer puts on a target will be different, because it depends on how that bidder evaluates things like contracts with key customers, exclusivity agreements and intellectual property.

The second challenge is that the buyer’s strategic interests change over time.

When Cisco Systems (NASDAQ: CSCO) bought Pure Digital, the company that made the popular Flip video cameras in 2009 for $590 million, it did so with the intention of expanding its product offering and showing the market that it was making the right moves in the consumer electronics space.

But success in the consumer market turned out to be harder than Cisco expected and two years later in 2011 it decided to close the business and stop selling the Flip products to "refocus on their network-centric platform strategy". Nice way of sugarcoating a half a billion dollar mistake.

A common downside with acquisition is that as the acquirer you will, in many cases, overpay for the target.

That kinda sucks, but you just have to accept it as the cost of making the deal happen.

The reality is that unless you’re the only buyer and the seller is desperately trying to get out of a business, it would very difficult to get a "fair" valuation, especially with public companies since basically anyone can make an offer once an acquisition attempt is announced.

We see acquisitions happening these days at 80 percent or even 100 percent goodwill (overpayment), but as we said earlier, the details are not in the face numbers but in the strategic value that the target creates for the buyer.

In the News this Week
It was announced this week that Barneys New York filed for Chapter 11 bankruptcy protection and will close 15 of its 22 stores.

Locations that will be shuttered include Barneys New York locations in Chicago, Las Vegas and Seattle, five small concept stores and seven Barneys Warehouse stores, the company statement said.

Barneys just became another corpse in the retail apocalypse of the last several years which has taken down iconic names such as Toys R Us and SEARS and that keeps threatening all other survivors.

Other names in line to the slaughterhouse include Family Dollar, Shopko, Gap, Kmart, J.C. Penney, and Victoria’s Secret.

So what’s the future of retail?

Hard to tell, let’s see when the dust settles.

On another tune, this week we published a great interview with Peter Thiel by Dave Rubin where Thiel talks about Trump, Gawker and why he moved out of Silicon Valley.

Here’s the full interview if you want to check it out.

We keep making changes to this newsletter and to the content on our website. Let me know what you think so far about the direction we’re taking.
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