Cross-Industry Venture Capital Feeds the Innovation Cycle (CVC Series, Part 1)
‘Here’s what is different this time: innovation has become absolutely essential for large corporations, and Corporate Venture Capital is becoming a significant tool to manage innovation.’
‘That’s exactly the hole in the innovation economy that Corporate Venture Capital is filling. They are strategically investing in early stage companies with promising new technologies and good management teams.’
A Search for True Innovation
To understand the new developments in Corporate Venture Capital (CVC), let’s briefly review its history. The success of pioneering venture capitalists inspired U.S. corporations to begin investing their free cash in technology and innovation intensive industries in the late 1960s. The primary exit mechanism was an initial public offering (IPO), so many companies closed their Corporate Venture Capital units down when the IPO market collapsed in 1973. There was a similar boom & bust cycle in the 1980s (ended with 1987 stock market crash) and another one in the 1990s (ended with dot-com implosion/recession of 2001).
According to a recent report on Corporate Venture Capital (CVC) by the Boston Consulting Group (BCG) titled “Corporate Venture Capital: Avoid the Risk, Miss the Rewards”, innovation-hungry companies are again investing increasingly in venture programs. Furthermore, evidence indicates that CVC has entered a more mature phase where companies across multiple industries have embraced venturing. This resurgence of Corporate Venture Capital has been noted recently by the Wall Street Journal.
Here’s what is different this time: innovation has become absolutely essential for large corporations, and Corporate Venture Capital is becoming a significant tool to manage innovation. Corporations are realigning resources and complementing internal R&D with external innovation and doing so in diverse adjacent and downstream industries. Current CVC is more strategically sophisticated. Risk can be balanced by partnerships with leaders from different industries coming together for promising new ventures. The BCG report analyzed several hundred corporations that are engaged in venture-related activities, segmenting the 30 largest companies into industries to analyze CVC trends within each industry, internal vs. external R&D spending, and other best practices.
Not your ‘classic’ Venture Capital Business Model
Classic Venture Capital investment returns are not what they used to be. Over the past decade, traditional Venture Capital (VC) firms have reduced their involvement in riskier investments and thereby have significantly lowered their potential returns and diminished their role in early-stage innovation – according to Matt Palmquist in his Recent Research column in the Autumn 2012 issue of “Strategy+Business”. Citing analysis done on thousands of IPOs, mergers and acquisitions (M&As), and the thousands more failed deals that resulted in neither, researchers at the University of Virgina and Loyola University Chicago noted a large increase of M&A and a large decrease in IPOs.
It is no wonder returns are down when you consider that IPOs generate the extremely high returns that help lift overall VC performance. Furthermore, M&A exits forced increased emphasis on downside risk. Some feel that the Sarbanes-Oxley act of 2002 may have stunted IPOs, but others argue that IPO-active industries of the 1990s have naturally matured and therefore are not growing as rapidly. We do know VCs have cut back early stage investments in the face of more uncertain exit strategies and more difficult access to capital.
That’s exactly the hole in the innovation economy that Corporate Venture Capital is filling. They are strategically investing in early stage companies with promising new technologies and good management teams. They are taking minority positions and trusting their smaller partner organizations for their expertise in their own market spaces. With sustainability, corporate image and product branding considerations more salient, CVC leaders have adopted a distinct set of ground rules for partnering and healthy interdependencies to manage the innovation process.
New Industries are Following in Corporate Venture Capital Leaders’ Footsteps
‘To access the most innovative technologies, leading corporations are looking past internal R&D and Product Development towards other innovation channels including CVC.’
The technology, pharmaceuticals, telecom, and media & publishing industries have been active leaders in CVC in previous cycles. The chart below illustrates the penetration of CVC at of 2007 (blue conical bases) and the incremental penetration as of 2012 (red spiked tips). The data is from the BCG analysis previously referenced. Notice that half of the top 30 companies in CVC leading industries have corporate venture units in place. According to BCG, CVC managers regard venturing as a critical innovation complement to internal R&D in these traditional first mover industries.
A unique characteristic of this wave of corporate venturing is that leading companies in new industries including consumer, power and gas production, machinery, medical technology, and construction are now heavily engaging in CVC activity. Although not traditionally driven by the need to innovate, these industries increasingly responding to demands for cleaner technology, more sustainable operations, and an improved user experience. To access the most innovative technologies, leading corporations are looking past internal R&D and Product Development towards other innovation channels including CVC. Certainly there is an encouraging upward trend in R&D spending according to the “Global Innovation 1000: Making Ideas Work” annual survey published by Booz and Company in there Winter 2012 Issue of Strategy+Business. However, the same survey results also report that the ratio of R&D spending to sales has been on a fairly steady downward trend the past few years.