Making the case: Are launching startups the new corporate strategy?
3 years ago a VP left her position, launched a company aimed at fixing a big, industry-wide problem, and just sold it for $800 million. So, what’s the problem?
Her employer-owned 0% of the company, despite the fact that they had unwittingly co-founded it (or, minimally, created the opportunity).
This story has been replicated hundreds — if not thousands — of times over the past handful of years: an employee with an idea — more often than not fueled by on-the-job experience — departs to solve the problem because the company cannot or doesn’t know how to solve it themselves. An idea borne from frustration and with an appetite for risk-taking (what the rest of us call an ‘entrepreneurial spirit’), the newly minted entrepreneur sets out with a tenacity not likely to have been experienced since her earliest days of employment with the company.
A primer on ‘Atoms’ companies
There’s a new reality for so many “atoms” companies. Atoms companies are a “traditional” variety business: banks, brokers, logistics companies, packaging, manufacturing and warehousing, distribution, and real estate, to name just a few. Governed by rules and repeatable processes, atoms companies operate in paradigms where most everything is known (and certainly, more predictable): long-standing reputations, well-established sales channels, reliable supply chains, and well-funded marketing apparatus.
Atoms companies were responsible for the vast wealth that was created after the Great Depression and still account for more than $200 trillion in annual revenues, globally. But whereas a corporation that achieved the pantheon of corporate success — joining the S&P 500 index, or becoming a Dow Jones Industrial listed stock — could expect their tenure to last upwards of 75 years (or forever, as it must have felt at the time), today’s stalwarts are anything but; today, the average lifespan of a Dow Jones listed industrial is less than 20 years — and declining.
Atoms companies, by their nature, are predictable and ripe for disruption.
The problems faced by atoms companies are well known, addressed by a vast ecosystem comprised of large corporate consultancies, smaller specialist consultancies and agencies, private equity firms, and so forth. Innovation, a trendy term in the space, is really just incremental improvement on the core business. Acquisitions are the growth strategy du jour where the hope for buying power improvement and other efficiencies (or access to new customer markets) compliment the increase in combined revenues. You’ll trade at a similar multiple to a larger number.
‘Bits’ companies take the stage
“Bits” companies are driven by algorithms that identify and create efficiencies, automate expensive processes, and aggregate disparate partners into value creating coalitions — they create brand new classes of companies. They’re platforms and multi-sided markets. They create entirely new markets. Bits companies are a disruptive force for which no well-established company has the antidote. Über, Airbnb, Amazon, and Google are several of the largest and most profoundly bits companies. Typically requiring nothing more than technology (and data), bits companies are infinitely more efficient and can scale with investments in data storage, programming, and marketing. Building factories, procuring raw materials, holding inventory, and government regulations don’t typically apply. Importantly, bits companies rarely pay taxes (at least during the first handful of years) and return capital gains to investors (as opposed to ordinary income). They also receive valuations that far exceed the companies they’re attempting— or in the process of — usurping.
If you’re a traditional business, its not a function of if, but rather, when you’ll be disrupted.
Below are a handful of reasons why I think launching startups will become the new corporate strategy for atoms companies:
For the cost of a single strategy consulting engagement, you can be running with 5 – 10 startups, or more. What if every single dollar you just paid to your consultant funded startups that directly solved one or more critical issues faced by your business? On a $1mm consulting engagement, the model should yield 5 – 10 startups.
If your problem to be solved is a problem faced by the broader market, you have a viable (and potentially massive) opportunity.
A $1b company should achieve meaningful revenue and margin improvement on a single startup. What if your relatively small investment resulted in a 3x increase in your profit margin, or more? Not too different than your favorite baseball team’s farm system, a pipeline of startups, over time, will begin to yield real and long-term results. The frequency of launches — and exits —will begin to be reflected in the valuation your business receives by the market and become a differentiator, not as a one-time gain, but as a core strategy. Getting back to the farm system analogy, a good farm system is going to send a handful of key personnel to the primary organization and help it win. 1 or 2 of those key players might even change the course of the season, if not many seasons to come. Think of this measurement as “Wins Over Replacement”, or WOP. Farm system development is essential to the success of any professional [baseball] team and the same holds true for corporations.
For the price of a single FTE, you can be developing a portfolio of startups. Learn how Salt Flats is helping corporations disrupt themselves.
Hiring and retaining top-quality talent is difficult. Attracting talent will become easier. The financial stability your organization brings coupled with the excitement and upside of participating in designing new businesses will attract a diverse mix of smart, capable, and ambitious people. Your workforce will evolve to meet the new speed of business. If by magic, transformation will happen.
Retaining talent will become easier too as exciting new projects come online and your team learns (or invents) the new tools needed to be successful well into the next epoch. And heck, your workforce can even benefit financially from the value created — a powerful incentive last I checked.
You’re your own unfair advantage. Startups need you to validate their business. A relationship with you drives their valuation, makes them more attractive to new money — and new customers — and provides the fuel they need to achieve their ambitions. You already have you. You have a sizeable customer base, many of whom you can call directly to sponsor ideas or provide critical feedback. You have leverage. When you launch your own startup, you’re immediately at a competitive advantage and are likely to onboard new customers at a fraction the cost required of more traditional startup marketing endeavors.
Remember our former VP-turned multi-hundred millionaire? If she had offered — or you had asked for — 20% in exchange for information and access to your customers, she would have agreed and you would have exited (in this case, 4 years later) with a $136mm cap gain, after tax. The company I’m referencing earned just under $20mm in profits that year. This single exit would have equaled their profits for nearly 7 years!
If you had originated that startup, you would have owned 50% or more depending on how you decided to fund and distribute equity. Now imagine a process where you own a portfolio of startups.
Nokia, the once-vaunted mobile phone manufacturer and communications company was at one time a pulp company. Without getting into the details of its transformation, the point I’m going to make is they created the opportunity to become a much larger company by creating options for growth outside their own core business. Today, Nokia, despite its struggles from a few years ago and the divestiture of its phone division to Microsoft, generates in excess of $23B (euros) annually and accounts for 70% of the Helsinki Stock Exchange market cap. In no other series of events or good decision making could that pulp company have grown organically to achieve the success of what was at one point a “startup”.
Every corporation should develop a direct startup strategy. In the next post, I’ll get into more of the how. But for now, keep your mind open to the incredible options you’ll create for your company by partnering with someone who can help identify opportunities and develop your own portfolio of startups.