The anatomy of a corporate venturing program: Factors influencing success

THE ANATOMY OF A CORPORATEVENTURING

PROGRAM: FACTORS INFLUENCING SUCCESS HOLLISTER B. SYKES

The author proposes a classification framework for factors that affect corporate venture success. Then, a database of 37 new venture investments by Exxon, including 18 venture capital investments, is analyzedfor insight into the relative affect of these factors on venture technical and financial success. This article presents a statistical analysis of those factors which were quant@ed. As a group the venture capital investments were financially far more successful for Exxon than the internal1.v initiated ventures. This striking difference stimulated the retrospective analysis reported here. The author was in a position to observe the program over its entire life span and had first-hand knowledge of each venture’s technology, markets, and personnel. Because of the mix of venture capital and internal investments, the author was also in a position to compare the two modes of investment. Factors affecting venture success are broadly classified as extrinsic and intrinsic. Extrinsic or environmental factors are those determined by the form of investment sponsorship (e.g., corporate or venture capital) and the characteristics of the investment sponsor. Extrinsic factors are segregated into two categories: structural and procedural. These factors are defined as the degree of difference between the corporate and venture environment in each category. The four structural factors (technology, market, organization, and people) are summed up as the overall degree of structural congruence. The author postulates that the degree of congruence is directly related to venture success within the corporation. To take the corporation into new markets some incongruence is required. Too much incongruence probably pushes the risk of failure too high. The corporation’s procedures for management of this incongruence will determine the degree to which it can successfully diversify its business, The four procedural factors (control, selection of venture managers, incentive compensation,

EXECUTIVE SUMMARY

Address correspondence to: Hollister B. Sykes, 29 Princeton Road, Cranford, NJ 07016. Parts of this study arc reported in the May-June 1986 issue of the Harvard Business Review. The author gratefully acknowledges the encouragement and support from the Director and staff at the New York University Center for Entrepreneurial Studies. Journal of Business Venturing 1, 275-293 (1986) 0 1986 Elsevier Science Publishing Co., Inc., 52 Vanderbilt Ave., New York, NY 10017

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H.B. SYKES

andJinancing) are dealt with as dtfferences between the corporate environment and an independent venture environment. Major differences in procedural factors usually exist between corporate and venture capital sponsored ventures. They probably explain to some extent the relative greater financial success of the Exxon venture capital investments as a group. However. the statistical analysis results indicate that the identtfied intrinsic factors are more important in explaining relative venture success. intrinsic factors are those inherent to the venture itself, and are subdivided into two categories: product related (market and technical risk levels) and managerial (relative experience levels). Each of the 37 Exxon ventures was rated for success and for the intrinsic factors using a simple ordinal range of 3 to 6 values. The product related risk factors showed a significant inverse correlation with financial success. The level of venture managers’ prior experience in the venture’s target market area and their level ofprior general managerial experience showed an even greater correlation withJinancia1 success. The sample correlation coefJicient between the financial success rating SF and the sum of the ratings for prior marketing and managerial experience (XS + XM) was 0.809 with a standard error of only 0.105. Selection of the influential extrinsic and intrinsicfactors is largely within the control of corporate management. An approach to selection of these factors similar to that used by private venture capital fund managers should greatly improve the overall success of internal corporate ventures.

INTRODUCTION Corporate venturing (CV) has produced remarkable successes in creating new revenue and profit growth. An outstanding example is the evolution of the Xerox Corporation from Haloid as a result of the tenacious development of the xerography process by Chester Carlson, Battelle, and the Haloid Corporation (Dessaur 1971). Yet there still appear to be more “failures” of such efforts than successes, especially for those firms that dare to enter entirely new markets. Much experience has been accumulated and written about corporate venturing activities. A large body of general principles, often contradictory, has been derived from case studies or distilled from the observations of those who have participated in corporate venturing activities. Some accounts carry the conviction that success is achievable if only the corporation will foster the proper entrepreneurial environment to enable new ideas to be sponsored and developed. In fact such an entrepreneurial environment was created at Exxon Enterprises, an affiliate of Exxon Corporation, in the 1970s. Between 1970 and 1980,37 new high technology ventures were initiated-18 venture capital and 19 internal investments. However, the program had mixed success-a number of the ventures were technically successful, a few were financially successful, but none provided Exxon with a large, successful diversification business. The program was essentially terminated in 198 1, and over the next few years most of the ventures were sold or liquidated. The author was primarily responsible for the initiation of the Exxon new ventures program and for its management except for a short period when part of the program was under another manager. Consequently, the author was in a position to observe the program over its entire life span and had first-hand knowledge of each venture’s technology, markets, and personnel. Because of the almost equal mix of venture capital and internal investments during the 1 l-year time span of the program, the author was also in a position to compare the two modes of investment. Reflection on, and much discussion of this experience lead to several observations about those factors which may have affected the relative success or failure of the Exxon new ventures. Some of these factors appear to be quantifiable in relatively simple, ordinal

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values, providing an opportunity for a modest statistical analysis of factors influencing success or failure. Despite the inherent dangers of potential bias on the part of the single observer, and other issues of reliability, the data base affords a unique opportunity for study of several important variables within a relatively controlled environment. There must be few cases, if any, where a single company within a contiguous time span, organization and management has initiated so many new venture investments, witnessed by the same observer. This article proposes a rationale for classifying those factors which may affect venture success, and presents a statistical analysis of those factors which were quantified. These include technical and market risk factors, and degree of key venture manager prior operational and managerial experience in the technologies and markets of the business areas they have entered.

FACTORS AFFECTING VENTURE SUCCESS Factors affecting venture success may be broadly classified as intrinsic and extrinsic. intrinsic factors are those inherent to the venture itself, and are subdivided into two categories: product related and managerial. Extrinsic or environmental factors are those determined by the characteristics of the investment sponsor (e.g., corporation or venture capital fund). Extrinsic factors are also subdivided into two categories: structural (those determined by the organizational and functional relationship to the investment sponsor) and procedural (those related to managerial processes imposed by the investment sponsor). This article will deal statistically with certain venture Intrinsic factors which appear to affect venture success. However, in assessing the results it is important to understand the relationship of the ventures to their extrinsic environment. To do this we need to amplify on our explanation of the extrinsic factors. Table 1 outlines the above classification of extrinsic and intrinsic factors and may be used as a reference in following the ensuing discussion.

Extrinsic Factors: Procedural The extrinsic factors are largely determined by the relationship of the venture to its investment sponsor. Procedural differences especially stand out between venture capital (VC) funded ventures and most internally developed corporate ventures. Procedural differences mainly occur in the areas of: control, selection of venture management, incentive compensation, and financing.

Control-Autonomy in Decision Making Ventures which receive financing from venture capital sources or the public equity market operate relatively autonomously-most operating decisions are made by the venture management. General strategy and objectives are approved by the Board of Directors, only one rung above the venture management. In start-up VC ventures, the Board membership usually includes investor representatives. No further reviews or approvals are required, except, of course, by the customers. On the other hand, managers of internally developed corporate ventures (ICVs) often have a matrix of review levels to go through at both staff and line levels. This corporate

278

TABLE

H.B. SYKES

1.

Classification

of Factors

Extrinsic

Procedural

Affecting

Factors

Differences:

Control (Decision Making) Incentive Compensation Selection of Venture Management Financing Structural

Differences:

Technology Markets Organizational Independence People Background

Corporate

Venture

Success Intrinsic Factors

Product Related: Technical Development Market Development Years to Sales

Experience of the Venture Management Team: General Managerial Marketing and Sales (In the venture’s market area) Technical (In the venture’s field)

decision-review process varies significantly depending upon the stage the venture is in, and upon the relatedness of the venture’s product to the corporation’s base business products and markets. During early stages of the venture when expenditures are low, most decisions will be delegated to the venture management or those directly supervising the venture management. As the venture grows and needs larger financial or functional resources from the parent, the reviews extend wider and higher. Potential product or customer overlaps and conflicts with the base business need to be resolved. Conformance to company policies and procedures in legal, employee, and corporate image areas must be monitored. This competition with the base business for management and financial resources as the venture grows requires more intensive oversight by top management and must be anticipated as part of the venture management process. (George and MacMillan 1985) The author believes that the corporate review and decision making process is a critical factor affecting the success of ICV’s, and is a significant factor in determining the so-called “entrepreneurial environment .” However it remains one of the most difficult to prescribe. Most advice in this area can be bracketed by saying that it’s bad for a corporate sponsor to impose too much control in a venture’s creative, early stages and bad to exert too little control in a venture’s growth stages. More specific guidelines have been set forth based upon the observations of Block (1982), Fast (1979), and Hanan (1976).

Selection

of Venture

Managers

Before making their initial investment, venture capitalists place major emphasis on the prior business “track record’ of the founders and venture management team. (Bruno and Tybejee 1986; Kotkin 1986) They look for initial managers with the experience and capabilities to build the company to $50 to 100 million in revenues. On the other hand, the corporation often starts an internal venture with less experienced personnel and then upgrades the venture management team as the venture progresses, placing more seasoned managers in charge as the venture outgrows the product development stage and begins manufacturing and marketing .

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Incentive Compensation A third important procedural difference between management of venture capital investments (VCIs) and management of internal corporate ventures (ICVs) is incentive compensation for key personnel. VCIs offer key employees equity in the venture, the value of which is determined by the market place and the profit on which is usually taxed at capital gains rates. Incentive plans which provide an equivalent form of compensation for corporate ventures raise control, legal and tax problems which have discouraged most corporations from trying them. An offset is that corporations can provide job security for those who try new ventures and fail.

Financing Financing from a venture capital fund is nearly always provided as a lump sum commitment to meet a stated milestone in the business plan such as completion of a prototype, or test marketing. If the milestone is missed there is no assurance of continued funding. Corporate venture funding is often provided on a continuing basis against a budget that is reviewed at prescribed intervals which fit with the corporation’s budget cycle for base business activities. Funds can be cut off at any time because of a change in corporate policy or direction, or may be continued beyond missed goal completion dates without go-no-go review. Block and MacMillan (1985) recommend milestone planning and funding for internal ventures as well.

Extrinsic Factors: Structural The relationship of internal corporate ventures to the parent is determined by four structural factors: technology, market, organization, and people. These are qualitatively measured as the degree of difference between the base business and the venture’s business.

Market and Technical D@erences Through research and observation a number of investigators have concluded that the greater the difference between an internal venture’s product technology and customer base and that of the corporation’s base business, the greater the risk of failure (Roberts and Berry 1985; Fast 1979; Drucker 1985). Large differences reduce the amount of functional support and business experience that can be rendered to the venture by the corporation, and increase the hazards of inappropriate corporate advice and decisions through lack of understanding of the new business area. In Ben-y’s study of actual cases (Roberts and Berry 1985), the one acquisition “success” that contradicted the difference “rule” was a well-established company that was allowed to continue to operate fairly autonomously. The other deviant (success in an unfamiliar area) was a minority venture capital investment, also a situation in which involvement by the corporate investor is limited. Roberts and Berry (1985) conclude that the choice of appropriate strategy for entry into a new business area should be guided by the degree of difference in technology and markets between the venture and the base business. If technology and markets are sufficiently

280

H.B.SYKES

different from the base business, Roberts recommends that the appropriate mode of entry is through joint venture or venture capital probes until the new business is learned. Acquisition and internal development should be postponed until such understanding is achieved. However, this raises a new issue-how effective are strategies for achieving such understanding, such as VC investment? After a review of experience with corporate venture capital investments, Hardymon, DeNino, and Salter (1983) conclude that the strategy “doesn’t work” in most cases.

There are two other st~ctural factors of importance which certainly had an effect in Exxon’s case. These two factors are background of the venture employees and degree of venture organizational independence. If the venture employees are mainly recruited from outside the parent because skills different from the base business are required, then expectations of performance and behavior will differ between venture employees and corporate personnel. Differences in cultural (business) background will tend to lead to inefficiencies in communication and misunderstandings regarding expected behavior. As noted by Tichy and Ulrich (1984, p, 67), indoctrination in a specific company organizational culture helps employees to understand and execute their assigned roles in the company. Block (1983) states that differences in values, goals, and attitudes should be considered in designing the format for the corporate/venture relationship. An independent organizational environment which permits venture level decision making without extensive reviews, and encourages initiative and self dete~ination, can be a very effective motivator for venture employees. Because of the enthusiasm, long hours, and quick decision process, product time to market is much shorter and less expensive than under the normal corporate functional organization. The corporate bureaucracy penchant for “doing things right” slows down the entrepreneurial process and sterilizes innovation (Hanan 1976). However, if the parent attempts to integrate the new venture into the base business, this entrepreneurial environment, which was so effective initially, now becomes an obstacle. Venture managers are reluctant to give up autonomy and subordinate their decision making to committees. Besides, what is optimum for the corporation overall, may not be optimum for the venture to which they have become committed and to which their incentive compensation may be tied. Motivation by promotion may solve the problem with regard to an individual manager in some cases (not ail entrepreneurs m~agers are seen as suitable corporate executives), but not for the venture team as a whole. In studying problem acquisitions, Jemison and Sitkin (1986) note that questions of “organizational fit” are often neglected because of primary focus on “strategic fit.” The appropriate degree of venture independence from the base business will usually be determined by the nature of the technology, product, or service. The farther removed from the base business, the more likely that the venture will have to rely on development of its own management procedures and functional capabilities, such as sales and manufacturing, and on recruitment of employees from its own industry. Thus, people and organization differences will, in most cases, derive from technology and market differences. Managements of successful conglomerate corporations have generally limited functional integration to the financial level and delegated operational decision making to the management of the industry sector.

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Structural Congruence The four structural factors (technology, market, organization, and people) can be summed up as the overall degree of structural congruence. The author postulates that the degree of congruence is directly related to venture success within the corporation. Total congruence would, of course, mean that the “venture” is no more than a new product extension by an existing operating division, and, even if innovative, would probably not qualify as “internal venturing” or corporate “entrepreneurship.” To take the corporation into new markets some incongruence is required. Too much incongruence (or “asymmetry,” cf. Fast 1979a) probably pushes the risk of failure too high. Too often corporations overlook innovative opportunities which are natural extentions of their base business and pursue diversity based on synergistic rationales that later prove inadequate. The next cycle of management begins a divestment and “back to basics” program. Overall, Rumelt’s studies (1982) suggest that profitability is an inverse function of diversity.

INTRINSIC FACTORS AFFECTING VENTURE SUCCESS The intrinsic factors are properties of the venture. Although their initial choice will be influenced by the investor environment, once in place they will have a self determinant effect on venture success. The intrinsic factors are product related and managerial.

Product Related Factors Three product related factors are postulated to be likely to affect venture success: 1) The degree to which the technology was developed at the time of the initial investment, 2) The degree to which the market had already been proven by others at the time of the initial investment, and 3) The number of years projected from initial investment until sales, e.g., development plus start-up time. If a venture requires development of totally new technology, and is commenced in the research stage, there is no doubt that it carries a higher risk of failure. The degree to which a market is new, and therefore unknown as to buyer response, will increase the risk of misjudgment of sales potential and increase venture risk (MacMillan and George 1985). Finally, in a fast moving technology area, the longer it takes to bring a new product to market, the more likely that competitive developments will have occurred that invalidate the original product specification assumptions. The longevity of a corporate venturing program may very well be influenced by the early venture failure/success history. The corporation’s tolerance for failure rate, financial risk and long term development costs should be assessed in setting the venture strategy. As Fast (1979a) noted, a common mistake of corporate venturing activities is to undertake a portfolio composed entirely of long term, high risk ventures.

Managerial Factors Most experienced venture capitalists, when asked what is the most important determinant in choosing to invest, will say, management. When venture capitalists are asked how they evaluate management they will say they look at the “track record” of the key members of the venture management team. They want to know what experience the team has that is

282

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relevant to the proposed venture’s business, and what their degree of responsibility was for managing a similar business in the past. In other words, does their prior experience provide credibility regarding their judgement about the technology and markets, and about their ability to manage the growth of the new business should it be successful. Most venture capitalists are generalists. They know they do not have the specific knowledge in a given technical or market area to make an independent judgement about the validity of a particular business proposal. They may consult with experts in the field, but the primary purpose of this is to assure themselves that the management team are the experts in their chosen field of endeavor. This approach reinforces the “familiarity” criteria proposed by Roberts and Berry (1985) as a prerequisite for successful entry into a new business area. But in the case of successful venture capital investment, the “familiarity” is required of the venture management team rather than the investor. Proven managerial experience is also prized by the venture capitalist. If the “track record” demonstrates that the management team has had prior profit and loss responsibility for a division, or has managed a line function such as marketing or sales in a growth company, or has headed a successful technical development, then he is more likely to invest. In their survey of 102 venture capital (VC) firms, MacMillan, Siegel and Narasimha (1985, p. 123) found that two of the four criteria most often rated as essential for VC firms to invest in a new venture were: the entrepreneur’s familiarity with the market targeted by the venture, and the entrepreneurs’ demonstrated leadership in the past. Bruno and Tyebjee (1986) polled 46 VC firms for their reasons for rejecting venture proposals. Multiple reasons were often given, but the most frequent (41 out of 121) reason given was “management skills & performance history.” Hanan (1974) recommends selecting a venture manager for his “superior marketing skills,” and Maidique and Zirger (1984) stress knowledge of the customer base. The intrinsic factors discussed above were quantified for statistical analysis of the 37 Exxon ventures. The following paragraphs describe the nature of this venture data base.

THE

DATA

BASE

Between 1970 and 1980, Exxon made 37 venture investments of two types: venture capital type investments (VCls) and internally developed and wholly owned venture investments (ICVs). There were a total of 18 VCIs and 19 ICVs. Table 2 lists the ventures by type of business and initial investment. Subsequent to the initial venture capital investment, equity positions in six of the venture capital funded ventures were increased to provide Exxon with control, and eventually, complete ownership. These six were then managed in a manner similar to the ICVs. All of the ventures were in “unfamiliar” market areas relative to Exxon’s base business, and with the exception of two of the ventures in the energy area, all were in unfamiliar technology areas. The ICVs were all set up as “independent” ventures, with their own development, manufacturing and sales personnel and facilities (depending, of course on the stage the venture was in). The strategy was to emulate a venture capital type organizational environment to the extent permitted by the corporation. Nearly all of the personnel for the internal Exxon ventures, including key managers, were recruited from outside Exxon. The few exceptions were personnel managers, legal counsel and controllers. The two energy R&D ventures were manned by a higher prounion of Exxon personnel, but most of the key managers were from the outside.

ANATOMY

TABLE 2.

37

OF A CORPORATE

VENTURING

PROGRAM

283

Venture Investments 19 Internal Ventures Started: Advanced Materials, Components and Systems Energy Conversion and Storage Systems Information Systems and System Components

7 5 7

18 Venture Capital Investments: Air Pollution Control Health Care Advanced Materials Energy Conversion and Storage Info~ation Systems

1 1 2 3 11

All 37 ventures were “high technology” oriented. Sixteen were started in the R&D stage with the objective of developing proprietary new technology which would have cost or performance advantages over existing products. In ten of these 16 cases, for example speech recognition, the new technology was to be applied to meet the assumed needs of new, undeveloped markets. All but five of the venture capital investments, (VCIs), were made prior to commencement of sales. Of the 37 ventures, only three entered established markets. Eighteen entered entirely new, undevelo~d markets. Ten of these 18 also started in the research stage.

RESULTS: OBSERVATIONAL ANALYSIS Financially, the Exxon venture capital program was very successful. Total investment in the 12 independent ventures which were not acquired was $12 million. The value of cash and securities from those 12 as of year-end 1982 was $2 18 million. Of the 12, eight achieved profitability. Operations of the other four were terminated. Three were eventually acquired by other corporations, and five went “public” and are traded in the OTC market. However, none of the intemai ventures achieved profitability. This striking difference in results between the internal and venture capital ventures begs for an explanation, and was the stimulus for this analysis.

Extrinsic Factors Based upon the congruence thesis, the lack of corporate familiarity with the ventures’ technologies and markets, the high degree of organizational independence and the differences in personnel backgrounds would be prime suspects for the poor performance of the internal ventures. With the exception of two energy technology ventures in the research stage, none were “familiar” enough for the parent corporation to be able to provide experience or functional support in technical, manufacturing or marketing areas. In fact, with few exceptions, most of Exxon’s ventures would be placed at the extremes on a scale of differences between corporate and venture technology, markets, organization and personnel. Table 3 compares the typical Exxon venture with the IBM PC venture with regard to these four

284

H.B. SYKES

TABLE 3. Venture/Corporate Structural Congruence (IBM PC vs. Exxon Ventures) Like Technology 1 ----IBM Market 1 OrganizationlpIBM Personnel )-IBMp~~m

Unlike

IBM

EXXEXXEXXEXX-

factors. The employees for the PC venture all came from within IBM, a fact which undoubtedly makes the current process of reintegration into the IBM mainstream much easier than will be the case for assimilation of Rolm. This lack of Exxon familiarity with the technologies and markets of the ventures not only slowed the decision making process, but severely reduced the ability of the parent to provide advice and functional support. For example, several of Exxon’s ventures developed highly successful products (the Z-80 microprocessor, and the Vydec word processor), but had to build manufacturing and direct sales organizations from the ground up to compete with Intel and Motorola, and IBM and Wang. The rapid growth in personnel and sales required to achieve and maintain position in these large, fast growing markets (e.g., semiconductors and office automation), as well as the aggressiveness of the competitors, placed extreme stress on the capabilities of venture management. Exxon was not unaware of the need to “learn” these new businesses. Exxon’s deliberate strategy had been to probe and assess new opportunity areas through venture capital investments and small technology ventures, and then integrate and consolidate those that appeared promising. The “probe and assess” strategy was very successful. Important new growth business areas were identified at any early stage. It was the acquisition and integration phase that was unsuccessful. The high degree of independence accorded the internal ventures, at least initially, subsequently became a liability. For example, several of the ventures in the office automation area had overlapping products in overlapping markets. Exxon’s requests for voluntary cooperation by the ventures to resolve produce compatibility issues and coordinate sales efforts were resisted, or reluctantly pursued. Reward systems designed to encourage cooperation were ineffective. Finally, several of the ventures were merged in the interest of efficiency. This solved the cooperation problem, but the disruption and changes in manager responsibilities caused by the reorganization led to new problems, including resignations of talented personnel. Procedures for management of the Exxon internal ventures were typical of those corporate procedures described earlier: decisions involved a matrix of reviews, most ventures were initiated with technical managers with limited managerial or marketing experience, and there was no equity compensation (although several venture related performance plans were tried). Milestone reviews were implemented, but these were overlaid on top of the standard corporate budget process. The structural and procedural differences (extrinsic factors) between the Exxon internal and venture capital ventures may account for much of the difference in performance, however, as the intrinsic factor analysis below shows, there were other important variables at play in addition to the extrinsic factors.

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Intrinsic Factors Of the 19 internal Exxon ventures, 12 researched entirely new technologies. The projected start for sales was often 4 to 5 years in the future. Twelve (not all the same 12) entered undeveloped markets. Venture capital originated ventures were usually oriented shorter term. Ventures originated by entrepreneurs seeking venture capital were usually based on application of existing technologies, and revenues were projected within one to two years. Only four of 18 were started in the R&D stage. In several cases prototypes of the proposed products had already been developed. Only six entered undeveloped markets. Another difference which could not be missed was the relative experience levels of managers of venture capital ventures versus internal ventures. The internal venture managers were usually technical managers with only one or two levels of prior supervisory experience and often without marketing or sales experience. The management personnel of VC funded ventures averaged a higher level of management experience, and a higher level of experience in their respective industries and technologies. For example, the initial 6 key managers of Intecom Corp (digital PBX venture), one of Exxon’s most financially successful venture capital investments, all came from executive positions in their former companies and averaged 15 years experience apiece. The president, marketing manager, and engineering managers for software and hardware development and installation all had prior experience in the PBX industry. Not surprisingly, these relative differences in managerial experience were observed to be a major factor in the relative success of the ventures.

RESULTS: STATISTICAL ANALYSIS Within each venture group (internal vs VC) the extrinsic factors did not show much variability. The intrinsic factors displayed greater variability between ventures within each group. The range was particularly broad within the group of 18 venture capital investments. For statistical analysis the intrinsic factors for all 37 ventures were graded using a range of 3 to 6 supraordinate values or ratings.

Quantifkation of Intrinsic Factors The three product related factors assumed to affect venture measures of product risk, as defined below and in Table 4.

success were quantified

as

RM is the initial venture market risk. RM is given a value of 3 if the market for the product is a new, undeveloped market, and a value of one if the market has already been established. For example, prior to the introduction of the Apple computer, the market risk for personal computers would be rated as a 3 since the size and characteristics of the personal computer market were largely unknown. RT is the initial venture technical risk. RT is given a value of 5 if the venture is still in the research stage, developing new technology. However application of existing technology to the development of a product is given a technical risk rating of only 3. Once a prototype has been built and tested, the technical risk rating is reduced to a level of 2. When the product is in production, the technical risk rating is reduced to a rating of 1. The gap between the 3 and 5 ratings reflects the author’s

TABLE 4.

Product Risk Factors

RM =

Initial venture market risk rating: 3 = New market 2 = Intermediate market 1 = Established market

RT - initial venture technical status and risk rating: 5 = Research and development stage 3 = Engineering development stage

Pmsttypest;ige I = production stage

2 =

assumption that there is a greater reduction of technical risk in successfuliy completing the research phase than in applying existing technology to the development of a prototype, or in moving from prototype to production, Y is the number of years projected from date of investment until revenues. The experience of key managers within each venture were rated in three categories: technical, marketing and general management. The rating approach is described below and on Table 5. XT is the rating of the key t~cb~~~a~m~agement~s experience in their business area te~hoo~ogy, ranked from a low 5f 1 to 8 higfi of 3. X5 rates the average experience ofthe key sales and marketing managers in the venture’s industry area, from a low of 1 to a high of 3. XM rates the venture management’s level of genera1 managerial experience, ranked from a low of 1 to a high of 5, Venture success was rated in two categories: technical success (ST}, and financial success (SF). The ratings are based on the status of the program at the end of 1982. Since the venture starts were spread over the entire period from 1970 to 1980, some, especially the R&D based ventures, had not reached a commercial stage by the end of 1982. As the program was ended, some of &e infer& ~~o~~~s were merged into Exxon Office S~stems~ some were sold and others were shut down because a buyer could not be found. Most of the venture capital based ventures were either ~j~~ida~ed~ sofd or had been taken public by 1982. Because of the different status of each venture as of the end of 1982 (some in the R&D

stage and some with sales), use of a 1982 ROI would not be meaningful as a measure of financial success. Instead, market value, which assesses the potential for the venture was used in the rating of financial success. TABLE 5. ManagementExperience F;actors XT = Experience in the busiz~essarea technology,

ranked from 1 &wf to 3

ANATOMY

TABLE 6.

OF A CORPORATE

VENTURING

PROGRAM

Venture Database Relative Venture Succed

Venture Status at Time of Initial Investment

Product Risp Key

Row

VT

IA VA VB vc VD IB IC VE ID VF VG IE IF IG IH VH VI II VI IJ VK IK IL VL VM IM IN IO IP VN vo VP

1 2 3 4 5 6 I 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 21 28 29 30 31 32 33 34 35 36 31

0

IQ IR

VQ VR IS

287

1 1 1 1 0 0 1 0 1 1 0 0 0 0 1 1 0 1 0 1 0 0 1 1 0 0 0 0 1 1 1 0 0 1 1 0

Mkt Int New New Int New New Int Int Int Int Int Int New New New Int Est New Int New Est Int Int Int Int New New New New Int New New Int New Est New New

RM 2 3 3 2 3 3 2 2 2 2 2 2 3 3 3 2 1 3 2 3 1 2 2 2 2 3 3 3 3 2 3 3 2 3 1 3 3

TECH

RT

R&D Eng Dev Eng Dev Sales Eng Dev Eng Dev R&D Sales R&D Eng Dev Sales R&D R&D R&D R&D R&D R&D R&D Prototyp R&D Prototyp Eng Dev Eng Dev Sales Prototyp R&D Eng Dev R&D Eng Dev Sales R&D Prototyp Eng Dev Eng Dev Eng Dev R&D R&D

5 3 3 1 3 3 5 1 5 3 1 5 5 5 5 5 5 5 2 5 2 3 3

1 2 5 3 5 3 1 5 2 3 3 3 5 5

Mgmt Exp Rating’

Yrs to Sales Y

XT

XS

XM

ST

SF

5 2 3 0 2 3 3 0 5 2 0 4 5 4 5 5 2 3 2 5 1 2 2 0 0 3 2 5 4 0 4 1 2 4 2 3 5

3.0 1.0 3.0 2.0 2.0 1.8 2.0 2.0 3.0 3.0 3.0 3.1 2.2 3.1 3.1 3.1 2.7 2.2 2.0 2.0 3.0 2.0 2.0 3.0 3.0 1.0 3.0 2.0 20 3.0 2.0 2.0 1.0 2.0 3.0 2.9 2.0

1.0 1.0 2.0 2.0 1.0 1.0 1.0 1.0 1.0 3.0 2.0 1.1 1.0 1.0 1.0 1.0 1.1 1.0 2.0 1.0 2.0 2.0 2.0 3.0 3.0 1.0 1.0 I.0 1.0 2.0 1.0 3.1 1.0 1.0 1.9 1.0 1.0

3.0 3.0 3.0 2.0 3.0 2.0 2.0 2.0 3.0 5.0 4.0 2.0 2.3 2.0 3.0 2.0 3.0 2.0 3.0 3.0 4.0 3.0 3.0 4.0 4.0 2.0 2.0 2.0 2.0 4.0 2.0 3.0 2.0 3.0 3.0 2.0 2.4

3.0 1.0 0.6 2.2 1.0 1.0 0.8 2.0 3.0 2.0 2.0 1.0 0.7 0.8 0.3 0.3 0.2 0.9 2.0 1.1 2.0 2.0 2.2 2.0 2.0 1.1 2.0 0.8 1.0 2.0 1.0 2.0 0.4 0.8 2.1 0.5 2.0

2.2 1.8 0.2 2.0 0.0 I.0 0.0 2.0 1.4 5.0 4.0 1 .o 0.0 1.0 0.0 0.0 0.0 1.0 2.8 1.2 4.4 1.8 1.4 4.2 4.0 1.2 2.0 1.0 0.0 3.0 2.0 3.0 0.0 1.0 3.0 0.0 1 .o

“Product Development Risk, R: RM = Market Risk Factor, #3 = new market, X2 = intermediate market, Xl = established market. RT = technical risk factor, X5 = new research development, X3 = new application of existing technology, #2 = established application, or prototype, #l = in production bRelative venture success rating, ST = Technical success, ranging from 0 to 3. SF = Financial success, ranging from 0 to 5 ‘Management experience rating X: XT = Experience in business area technology ranging from 1 to 3; XS = Exp. in business area sales and marketing, ranging from I to 3; XM = General managerial experience, ranging from 1 to 5.

288

H.B. SYKES

The ratings are relative and based on the judgement certain guidelines were followed.

of only one observer.

However,

ST is the rating of technical success, ranging from 0 to 3. If technical objectives were not met, the rating was 0. If achieved, but not on the original schedule, the rating was I. If achieved on schedule, 2, and if an outstanding achievement, 3. SF is the rating of financial success, based on market value determined by stock price or estimated worth at the time of sale, liquidation or merger. Six levels of market value were rated, ranging from 0 to 5. Ventures that were liquidated were rated 0, those sold at or worth less than book value at 1, those sold at or worth near book value at 2, those sold at or worth approximately the original investment at 3, those providing a good return on the original investment at 4 (actually, over 20% compounded annually), and those providing an outstanding return on original investment at 5 (over 100% compounded annually). Table 6, Venture Data Base, provides a tabulation

of all ratings for the 37 ventures.

Statistical Analysis First, correlation between variables was examined. A correlation matrix for the variables studied is shown in Table 7. Not unexpectedly there was a high degree of correlation, r = 0.867, between RT (technical risk) and Y (years until sales). Obviously, the earlier the technical development stage, the longer the venture would take to bring a product to market. Therefore, Y was dropped from the variable analysis as being more of a derivative of RT. Also RT provided a greater degree of correlation with success than Y. TABLE 7.

Correlation Matrix RM

RM

RT

RT

I.000 0.31 I*

I .ooo

Y

0.440**

0.867***

Y

XT

XS

XM

I .ooo

XT

~ 0.347*

- 0.003

-0.012

1.000

XS

-0.366*

-0.651***

- 0.655***

0.280*

1 .ooo

XM

-0.41

- 0.475**

- 0.438**

0.396**

0.722***

1.000

SF

- 0.426**

~ 0.622***

-0.609***

0.294*

0.767***

0.730***

ST

- 0.3so*

- 0.458**

-0.364*

0.209

0.482**

0.440**

VT

~ 0.366*

-0.545***

-0.629***

0.239

0.533***

0.452**

XS + XM

m-0.420** 0.617***

-0.600***

-0.581***

0.368*

0.918***

RM + RT

I**

0.940***

0.876***

ST

VT

-0.127

xs + XM

SF

1000

ST

0.698***

I .ooo

VT

0.474**

0.122

I .coO

XS + XM

o.i305***

0.495***

0.528***

RM + RT c 0.050 s 0.010. ***p s 0.001. */I

**p

-0.668***

-0.516***

-0.583***

- -0.671*** RM + RT

1.000 -0.648***

l.OGil

0.938*** -0.541***

ANATOMY

OF A CORPORATE

VENTURING

289

PROGRAM

The correlation between XS and XM, I = 0.722, probably is the result of two factors. Founders of VC ventures may tend to self-select equivalent levels of marketing and general managerial experience. Examination of the relationship between XS and XM for the 18 venture capital initiated ventures alone showed a similar level of correlation, r = 0.690. In the case of internal ventures, experience levels were imposed by the staffing rules for internal ventures. (Exxon internal venture managerial levels were determined by the current stage and size of the venture, rather than its future potential.) The relation between the product related factors and the management experience factors was also examined. (RT + RM) vs (XS + XM) resulted in an r = -0.648. One possible explanation of this degree of correlation is that a more experienced management team would choose a lower risk product/market combination. This idea was tested by looking at the VC data base alone since the founders of VC ventures have more freedom in choosing their business opportunity. However, the corresponding correlation for this group was lower, r = -0.538. A better explanation is that the more advanced the product development (low RT), and the larger the existing market (low RM), the more likely that the management team would be more experienced. An internal research stage venture would seldom have highly experienced sales people at the outset. The single variable correlation coefficients for success were:

Financial Variable

r

RM RT XT XS XM VT

-0.426 -0.622 f0.294 +0.167 +0.730 +0.414

*p s

Success

Technical t

-2.79** -4.69**+ + 1.82* +1.0-l*** +6.31*** +3.19**

r

-0.380 -0.458 +0.209 +0.482 +0.440 +0.123

Success

r -2.43 -3.05** + 1.26 +3.25** +2.90** +0.73

0.050.

=s 0.010 ***p s 0.001 **I,

This table indicates that, except for XT and VT in the case of technical success, all of the intrinsic variables are individually significant in predicting success. A multivariant statistical analysis was carried out to determine the relationship between success and the six intrinsic variables. Because of the interaction between product related and managerial factors, the analyses were carried out on each group separately. The initial venture type VT was included in each group as a categoric variable (VT = 0 for internal ventures, and VT = 1 for venture capital investments) to control for type. The results are tabulated below. The correlation between financial success and RT, XS and XM appears significant. Of even greater interest, the intrinsic factors are more signiJicant than the venture type.’ The correlation between technical success and the intrinsic factors is less but also significant. The correlation between ST (technical success) and XS (managers’ sales experience) seems odd, but may be explained by the observation that managers with more sales experience are likely to enhance technical success by setting product specifications that are less of a departure from the competition and from proven market needs. Also, a review of the single variable correlations shows a significant rela-

290

H.B. SYKES

SF =

f(V7’, RM, RT):

ST =

RZ = 0.457 BVT RM RT

I= +0.82 - 1.65 -3.10**

t-O.36 -0.51 -0.46

SF = f(vT,

xs. XM,

B= +o.i6 + 0.99 + 0.65 +0.01 0.050.

B= -0.41 -0.38 -0.26

t= - 1.53 - 2.07* ~ 2.92**

ST = f(VT, XS. XM. XT): RL = 0.283

VT xs XM XT <

VT RM RT

XT):

RZ = 0.654

“p

f(Vr, RM, RT):

R2 = 0.320

**p

t= +0.44 f 2.9!?** + 2.27* +0.04

c 0.010.

1-p

VT xs XM XT

B= -0.32 + 0.42 +0.19 +0.07

f-1.20 +1.90* t-O.88 10.36

s 0.001

tionship between ST and XM, suggesting that general managerial experience is helpful in meeting technical goals-probably through setting realistic schedules, and monitoring progress. The experience factors, XS and XM, were added together and correlated with SF. As the matrix table indicates, the r = 0.805. The t factor was 8.02. A scatter plot of SF vs. (XS + XM) is shown in Figure 1. On this chart the solid points represent those ventures initiated as VC investments. Note that the VC points cover a wider range than those for the internal ventures, which are grouped at the lower end of the scale. It is evident that the internal ventures by themselves would not provide as conclusive a correlation of SF vs. (XS + XM). However, the internal venture points fall in an area that supports the trend of the venture capital points. A major surprise was that XT (experience in the venture’s field of technology) was not a very significant factor in accounting for success-even technical success. One theory to account for this is that when a venture is conceived and initiated by highly technically oriented managers, there may be a tendency to underestimate the difficulties in translating the technology into a commercially feasible product. In other words, extremes in technical (or scientific) capabilities may become a negative factor in venture success, thus offsetting the expected relationship.

~PLICAT~ONS

FOR ~NAGE~ENT

The data provide strong evidence that venture managers’ prior experience in the venture’s target market area and their general managerial experience are the factors most important to venture financial success. General managerial skills needed for successful venturing can partly be taught, but knowledge of the customer base requires direct interaction and experience with the market. If a corporate internal venture enters a business quite close to the experience of the

‘Since six ventures were acquired from the VC portfolio and subsequentty became internal ventures, an analysis was also run identifying the six as internat ventures. Results similar to the above were obtained. The cot-relation of venture type (VT) was somewhat less than above.

ANATOMY OF A CORPORATE VENTURING PROGRAM

5-

291

l l

4l

l l

3SUCCESS RATING 2-

l-

0 2

a

P

0

8

0

&o

0

abn 1

P

l

;

5

3

,

l l

08

I

6

I

7

I

8

MANAGEMENTEXPERIENCE

FIGURE 1. Financial success vs. management resent venture capital investments.

experience

[SF = f(XS + XM)]. Solid points rep-

people in the base business (e.g. IBM’s venture in personal computers for business use), then this expertise is available. If the new venture lies well outside the corporation’s experience, then experienced personnel must be recruited and probably be given a fair degree of autonomy. In order to yield this autonomy, the corporation will need to have confidence in the general managerial experience of the venture management team. The increase in likelihood of failure with increases in technical and market risk makes common sense. However it should not be concluded that high product risk ventures are bad, just that the individual odds for their success is lower. The opportunities for creating a major new growth business are more likely to be found by entering new markets with new technologies, e.g., Xerox, Polaroid, Texas Instruments, Digital Equipment Corp. However, the corporation will need to have greater staying power and patience if it undertakes long term technical and market development ventures. Selection of the influential extrinsic and intrinsic factors is largely within the control of corporate management. An approach to selection of these factors similar to that used by private venture capital fund managers should greatly improve the overall success of internal corporate ventures, particularly when entering areas new to the corporation. The relative chances for success may be rated within a contiguous group of ventures by using scaling factors similar to those set forth in this article. The results challenge some corporate research department beliefs that technology expertise is the key to corporate new business opportunity. The results indicate that marketing and business managerial experience in the area to be entered must be coupled with the technology if its development is to be commercially productive. Also, don’t wait until the technical development is completed before adding the marketing experience-technical success may be enhanced by the inputs from an experienced marketer.

292

H.B. SYKES

~PLI~A~ONS

FOR FURTHER RESEARCH

The intrinsic factors are primarily selected or imposed by the venture funding sponsor. Therefore, extrinsic factors influence the intrinsic factors. The analytical treatment in the article attempts to separate the two on fundamental grounds, but this may not be a realistic approach for management of a real world situation. In the Exxon case, the variability in the intrinsic factors within the group of internal ventures was quite limited. Additional study to find examples where there is greater variability in the intrinsic factors for internal ventures (approaching that for the venture capital ventures) is needed to confirm that the conclusions can be successfully applied to the management of internal ventures. A major limitation of this study was that the variability of extrinsic structural factors was limited because the data were for a single comp~y’s activity, and nearly all of the ventures were at the extreme end of the familiarity scale. Data bases which provide a wider range of variability in these factors arc needed to further test the congruence hypothesis. Roberts and Berry ( 1985) and MacMillan and George (1985) used qualitative criteria such as “newness” and “familiarity” for assessing such differences. A more graduated scale would be useful for further research. Such a scale would rate gasoline vs. semiconductors (one of Exxon’s ventures) with a far larger difference than say computers vs. communications. Measures of success can be ambiguous. In this article success was rated for each venture individually. Possible benefits derived from experience with preceding ventures, which may have individually failed, was not assessed. Overall program success is more important than the percentage count of failures. In a typical venture capital portfolio, 20 to 30% of the ventures account for most of the portfolio capital gains. One big winner for a coloration can justify many losers if they were terminated at an early stage. In addition financia1 success was measured by market value of the venture, not by long term return on investment, which is a measure of more interest to the corporation than to the venture capitalist.

REFERJZNCES Block, Z. Fall 1983. Can corporate venturing succeed? Journal ofBusiness Strategy, pp. 21-33. Block, Z., and MacMillan, I.C. Sept.-Oct. 1985. Milestones for successful venture planning. Harvard Business Review, 63(5):184-188. Bruno, A.V., and Tybejee, T.T. Winter 1986. The destinies of rejected venture capital deals. Sloan Management Review. pp. 43-53. Dessauer, J.H. 1971. My Years with Xerox-The 3iL~~~nsNobody Wanted. New York: Doubleday & CO.

Drucker, P.F. 1985. Innovation and Entrepreneurship, New York: Harper & Row, p. 175. Fast, N.D. 1979. The future of industrial new venture departments. Industrial Marketing Management, 8:264-273.

Fast, N.D. March 1979a. A visit to the new venture graveyard. Research Management,

pp. 18-22. George, R., and MacMillan, I.C. Fall 1985. New venture planning: Venture management challenges. Journal of Business Strategy, 6(2):85-9 1. Hanan, M. May-June 1976. Venturing corporations think small to stay strong. Harvard Business Review, pp. 139-148. Hardymon, G.F., DeNino, M.J., and Salter, MS. May-June 1983. When corporate venture capital doesn’t work. Harvard Business Review, pp. 114-120. Jemison, D.B., and Sitkin, S.B. Mach-Ap~l 1986. Acquisitions: The process can be a problem. Harvard business Review, pp. 107-l 16. Kotkin, J. Feb. 1986. The “Smart Team” at Compaq Computer. INC., pp. 48-55.

ANATOMY OF A CORPORATE VENTURING PROGRAM

293

MacMillan, I.C., Siegel, R., and Subba Narasimha, P.M. Winter 1985. Criteria used by venture capitalists to evaluate new venture proposals. Journal of Business Venturing, 1: 119-28. MacMillan, I.C., and George, R. Winter 1985. Corporate venturing: Challenges for senior managers. Journal of Business Strategy, 5(3):344I. Maidique, M.A., and Zirger, B.J. July 1984. The success-failure learning cycle in new product development. Working Paper: Department of Industrial Engineering, Stanford University Teman Engineering Center (in review at Research Policy). Roberts, E.B., and Berry, CA. Spring 1985. Entering new businesses: selecting strategiesfor Success. Sloan Management Review, pp. 3-17. Rumelt, R.P. 1982. Diversification strategy and profitability. Strategic Management Journal, 3:359-369. Tichy, N.M., and Uhich, D.O. Fall 1984. SMR forum: The leadership transformational leader. Sloan Management Review, pp. 59-68.

challenge-A

call for the