The Rapid Rise of Corporate Venture Investing: Will This Be the Answer to Large Company Growth?
Startups, Innovation, and Low Barriers to Entry
At the large corporate level there has been a lag in innovation. At the same time, the marketplace has sped up. Consumers expect rapid innovation. System re-engineering at scale can take a long time and big companies can’t move fast enough. This conundrum forces large companies into a make or buy decision. Do companies develop the product or service internally, should they buy an existing company or product (M&A), or do they partner with someone else to make the product?
Entrepreneurs often identify unmet needs long before big companies are aware that these needs exist. Their size allows for agile movement and rapid prototyping. Technology has reduced entrepreneurial barriers to innovation and scaling across more and more business sectors. Contracted manufacturing, distribution and sales forces have replaced the need to build these processes internally enabling production , sales and distribution to be done just-in-time and on-demand. Small companies can now scale their business without needing to build out their infrastructure. In addition, they can now join forces with a larger corporation and benefit from the scale, capital, synergies and other resources a big company partner can offer. Entrepreneurs and large companies alike must continue to identify needs and provide products and services to match those needs. Early success partnering with entrepreneurs is accelerating the pace of corporate venture investing across a number of sectors including consumer products, manufacturing, industrials and financial services, leveraging the long-standing success of corporate venture investing in the technology sectors.
Independent VC versus Corporate VC: What’s the Difference?
The US Small Business Association defines Venture Capital as “a type of equity financing that addresses the funding needs of entrepreneurial companies…generally made as cash in exchange for shares and an active role in the invested company. VC focuses on young, high-growth companies, takes big risks, and expects high returns.” Traditionally, independent Venture Capital (VC) helps startups scale quickly and optimize profits. However, VCs pressure and incentives for fast returns, can create a mismatch between longer term innovation expectations and the desire for financial return. VC fund managers typically receive 2/20 terms, a powerful incentive that can drive a single-minded focus – maximizing financial returns – and cause strategy and mission to take a backseat. Corporate VC can help circumvent these problems by designing an investment strategy, and a set of processes and structures designed to meet the larger corporate need for meaningful growth.
The Kaufman Foundation describes Corporate Venture Capital (CVC) as “an equity investment by an established corporation in entrepreneurial ventures. In contrast to individual venture capitalists, which are purely focused on financial returns, most corporations seek strategic benefits in addition to financial returns.” While CVCs still need to focus on return on invested capital, it should not be their immediate metric of success. CVCs need to foster innovation, keep up with markets and trends, grow products and services to scale, and integrate them into the core parent business to generate meaningful positive impact for the corporation. CVCs can be more patient with their investments and need not be concerned with immediate return on invested capital. Instead, CVCs can tap into their existing infrastructure and expertise (scaling, supply chain, marketing, sales, etc.) to bring new businesses along at an accelerated pace compared to the same business backed by a financial VC.
While Venture Capital (VC) and Corporate Venture Capital (CVC) may sound similar, a few key differences have developed between the two venture investing approaches. In fact, some say that if CVC firms follow the VC playbook too closely, they could risk failing to deliver the required growth in spite of achieving results that most VCs would envy. For example, if a VC fund invests $1 million in an early-stage company and turns that investment into $10 million in three-to-five years, that’s considered a huge success. If a CVC invests $1 million and turns that investment into to $10 million in three-to-five years, they haven’t moved the needle in the context of impacting the large corporation’s revenue or profits in any meaningful way.
Successful CVC investments leverage the insights, creativity and speed of the entrepreneur while accessing corporate skill and capabilities to achieve scale. For example, within about a year of acquiring the beverage company, Glaceau, The Coca-Cola Company was able to leverage its distribution power to enable Vitamin Water to quickly become a billion-dollar brand, something the younger company could not have done on its own.
From Pharmaceuticals and Technology to Consumer Products
Corporate VC isn’t new: CVC funds helped pharmaceutical companies catch up with rapid advances in bioscience in the 1990s. CVCs have steadily invested in technology startups since the mid-1980s. Tech investments, however, are relatively “safe”. In contrast to consumer goods, tech requires comparably less up-front investment and promises substantial returns in very short periods of time.
Consumer goods have a longer product development cycle, as they need to be manufactured, and distribution is often based on retail “seasons” and buying cycles. To make matters worse, it is also more difficult to tell if a consumer good is going to be a “fad” or a long-term success story. As a result, venture firms have historically avoided early-stage investing in consumer goods staying on the sidelines until a consumer product or service reached $10 million in revenue or more (giving more confidence in the longer-term sustainability of the product or service). With market pressures rising and cycle times speeding up over the last few years, Kellogg, Campbell Soup, Coca-Cola, and General Mills have all developed and enhanced CVC capabilities. Why has the CVC trend caught fire? Because consumers are changing how they buy and how they interact with companies, products, and services resulting in the big companies product portfolios coming under attack by a wide range of new, entreprenruial competitors.
Market Pressures Driving Corporate VC
The following three trends are reshaping the consumer marketplace and driving action and innovation by consumer goods based CVCs.
- The Rise of Natural, Organic and Sustainable Products. Consumers want products and services that reflect their values. They like locally produced products, products that are natural & organic, and they want the companies that produce what they consume to be socially responsible and authentic.
- The Changing Face of Retail. The consumer’s decision journey has changed dramatically. Online offerings have disrupted retail and financial services and the act of purchasing itself has shifted to include far less interaction. While customers are still willing to pay a premium for brand loyalty, their spending patterns are increasingly influenced by customer reviews rather than advertisements. Preferences are also getting more sophisticated. In the future if we want to buy a laundry detergent we may not select Tide or Arm & Hammer, but results oriented preferences such as “highest quality”, “whiteness”, “cheapest”. Shopping automation will be the future of retail.
- Ease of Building Virtual Companies. In the past, owning assets like big manufacturing plants was a huge advantage and the key to driving low cost, high margin products. Today, any and all business capabilities from formulation and design to manufacturing and distribution can be outsourced easily and efficiently. These new “asset lite” companies don’t have to wait months or years to reconfigure a manufacturing process so they can be agile and cost-effective competitors who can move fast to capitalize on changing consumer and customer preferences. By CVC investing in start-ups and entrepreneurial companies, not only do corporations gain access to new products, services but new business models that can potentially revolutionize their core businesses.
CVC Will Be the Answer to Large Company Growth
Sooner or later, all businesses, even the most successful, run out of room to grow. CVC when done right, will enable large companies to leverage their core capabilities (things like sales, marketing, manufacturing, supply chain, distribution, etc.) by partnering with innovative entrepreneurs who see the future and create products, services and solutions to meet tomorrow’s needs. Pairing these two important sets of skills will enable forward-looking companies to periodically reinvent themselves. The ability to pull off this difficult feat—to jump from the maturity stage of one business to the growth stage of the next—is what will separate high performers from those whose time at the top is all too brief.
Download a pdf of this article: The Rapid Rise of Corporate Venture Investing