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June 30, 2014

3 Reasons Why Big Firms Should (and Can) Out-Innovate Start-Ups

Summary:

Yes, small and agile beats big and slow, but big and agile beats anyone—and that combination is possible.

The chief innovation officer of a Fortune 1000 company relocated to a Silicon Valley outpost far from her New York corporate headquarters. She now spends most of her time holding court with venture capitalists and entrepreneurs about stakes in hot start-ups. It is never clear who is courting whom in those meetings, though the general attitude in the Valley is that there is more dumb money than good start-ups. Her goal is not to maximize financial returns on her investments—even a 200% return would not be material to her corporation’s financials. Instead, she is essentially outsourcing her company’s innovation strategy to start-ups.

Do these stories sound familiar?

Like too many of their peers, these smart and savvy veterans were stymied in their efforts to get their companies to innovate. They resigned themselves to a conventional wisdom that has taken root in recent decades: that start-ups are destined to out-innovate big, established businesses. Consider, such pessimists contend, that 227 of the companies on the Fortune 500 list just 10 years ago are no longer on the list.

Based on personal experience with hundreds of large company innovation successes and failures, and research into thousands more, however, I have found that this conventional wisdom just isn’t true. Or, at least, it need not be. Yes, small and agile beats big and slow, but big and agile beats anyone—and that combination is more possible than ever.

There are three reasons why innovators at large companies should be optimistic about their ability to beat start-ups.

1. Start-ups aren’t all they’re cracked up to be.

Yes, Silicon Valley has the cachet, but Harvard Business School research shows that the failure rate for start-ups runs as high as 95%. Start-ups, as a group, succeed largely because there are so many of them, not because of any special insight.

What’s more, the National Bureau of Economic Research (NBER) found that entrepreneurs are saddled with most of the risk while financiers capture most of the rewards. Entrepreneurs invest their time, reputations and accumulated expertise for modest salaries and long hours in the hope of gaining huge rewards at “exit,” when the start-up goes public or is acquired. NBER researchers found, however, that start-ups rarely pay off for the entrepreneurs who slave away at them. Of companies that reached an exit (after a median time of 49 months from first venture funding), 68% resulted in no meaningful wealth going into the pockets of the entrepreneurs. These numbers add up to pretty long odds for corporate innovators looking to find greener pastures as an entrepreneur.

The story is not much better for strategic investors chasing start-ups through venture capitalists. Numerous studies, including a 2012 study by the Ewing Marion Kauffman Foundation and a more recent one by Cambridge Associates, show that venture capital has delivered poor returns for more than a decade. VC returns haven’t significantly outperformed the public market since the late 1990s, and, since 1997, less cash has been returned to investors than has been invested in venture capital. Risk and reward have not correlated.

Vinod Khosla, a billionaire venture capitalist and cofounder of Sun Microsystems, tweeted a revealing line from an executive at one of his companies in 2012: “Entrepreneurs really are lousy at predicting the future… VCs are just as bad.”

2. Scale is more valuable than ever.

In the context of today’s immense technology-enabled opportunities, large companies have growth platforms that would take start-ups years to build. Incumbents have products with which to leverage new capabilities such as mobile devices, pervasive networks, the cloud, cameras and sensors. Social media can amplify brand power and customer relationships. Large companies also sit on mountains of market and customer data and are therefore in the best position to extract knowledge from big data.

The possibilities are startling. And tapping into them isn’t optional. A perfect storm of six technological innovations—combining mobile devices, social media, cameras, sensors, the cloud and what we call emergent knowledge—means that more than $36 trillion of stock-market value is up for what some venture capitalists are calling “reimagination” in the near future. That $36 trillion is the total market valuation of public companies in the 10 industries that will be most vulnerable to change over the next few years: financials (including insurance), consumer staples, information technology, energy, consumer goods, health care, industrials, materials, telecom and utilities. Incumbent companies will either do the reimagining and lay claim to the markets of the future or they’ll be reimagined out of existence.

3. The roadmap for leveraging scale while avoiding innovation landmines is clearer than ever.

Since the start of the Internet boom some two decades ago, so many companies have looked to information technology to innovate that there’s now a track record showing what works and what doesn’t. The problems that have stifled innovation in large companies are now known and can be avoided. These problems are not inherent to bigness. 273 companies that were on the Fortune 500 list 10 years ago are still thriving and remain on the list. Compare that 55% success rate against the 90%-plus failure rate of start-ups.

Large companies can out-innovate both existing and start-up competitors by undertaking a systematic innovation process of thinking big, starting small and learning fast. I outlined this roadmap for how to—and how not to—innovate in a recent LinkedIn post. It is also thoroughly annotated in my books Billion Dollar Lessons: What You Can Learn From The Most Inexcusable Business Failures of the Last 25 Years and The New Killer Apps: How Large Companies Can Out-Innovate Start-Ups (both written with Paul Carroll).

* * *

I am not arguing that there is no place for entrepreneurship or start-ups. Start-ups as a group will continue to be an economic engine driving innovation, jobs and wealth. But any individual start-up, or even a small portfolio of start-ups, is far from a better bet for corporate veterans seeking better jobs or more successful innovation.

Rather than jumping from the frying pan into the fire, corporate innovators should consider staying put and focus on tearing down the barriers stifling their company’s innovation efforts. Yes, small and agile start-ups look very attractive when viewed from the confines of a big and slow bureaucracy. Big and agile is an even more attractive position.

Do you agree? I’d love to get your thoughts!

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About the Author

Chunka Mui is the co-author of the best-selling Unleashing the Killer App: Digital Strategies for Market Dominance, which in 2005 the Wall Street Journal named one of the five best books on business and the Internet. He also cowrote Billion Dollar Lessons: What You Can Learn from the Most Inexcusable Business Failures of the Last 25 Years.

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