Steve Blank

For decades large companies have gone shopping in Silicon Valley for startups. Lately the pressure of continuous disruption has forced them to step up the pace.

More often than not the results of these acquisitions are disappointing.

What can companies learn from others’ failed efforts to integrate startups into large companies? The answer – there are two types of integration strategies, and they depend on where the startup is in its lifecycle.

The Innovation Portfolio
Most large companies manage three types of innovation: process innovation (making existing products incrementally better), continuous innovation (building on the strength of the company’s current business model but creating new elements) and disruptive innovation (creating products or services that did not exist before.)

Companies manage these three types of innovation with an innovation portfolio – they build innovation internally, they buy it or they partner with resources outside their company.

Five Types of Innovation to Buy
If they decide to buy, large companies can:

1. license/acquire intellectual property
2. acquire startups for their teams (and discard the product)
3. buy out another company’s product line for the product
4. acquire a company for the product and its installed base of users
5. buy out an entire company for its revenue and profits.

Silicon Valley – a Corporate Innovation Candy Store
Corporate business development and strategic partner executives are flocking to Silicon Valley to find these five types of innovation. In response, venture capital firms like Sequoia and Andreessen/Horowitz are hiring new partners just to work with their portfolio companies and match them to corporations. They are actively organizing annual and quarterly activities to bring the portfolio and Fortune 500 decision makers together–  in both large events and one-on-one visits. The goal is to get a corporate investment or an outright acquisition of the startup.

VCs like acquisitions as much as IPOs because the acquiring companies often can rationalize paying large multiples over the current valuation of the startup. For acquirers this math makes sense since they can factor in the potential impact the startup has when combined with their existing business. However, these nosebleed valuations make it even more important in getting the acquired company integrated correctly. The common mistake acquirers make is treating all acquisitions the same.

Is the Potential Acquisition Searching or Executing?
Not all new ventures are at the same stage of maturity. Remember, the definition of a startup is a temporary organization designed to search for a repeatable and scalable business model. (A business model is all the parts of a strategy necessary to deliver a product to a customer and make money from it. These include the product itself, the customer, the distribution channel, revenue model, how to get, keep and grow customers, resources and activities needed to build the business and costs.)

Startups are those companies that are still in the process of searching for a business model. Ventures that are further along and now executing their business model are no longer startups, they are now early-stage companies. Large corporations come to the valley to looking to acquire both startups which are searching for a business model and early-stage companies which are executing.

Companies that acquire startups for their intellectual property, teams or product lines are acquiring startups that are still searching for a business model. If they acquire later stage companies who already have users/customers and/or a predictable revenue stream, they are acquiring companies which are executing.

What gets lost when a large company looks at the rationale for an acquisition (IP, team, product, users) is that startups are run by founders searching for a business model. The founding team is testing for the right combination of product, market, revenue, costs, etc. They do it with a continual customer discovery process, iterating, pivoting and building incremental MVP’s.

This phase of a new venture is chaotic and unpredictable with very few processes, procedures or formal hierarchy. At this stage the paramount goal of the startup management team is to find product/market fit and a business model that can scale before they run out of cash. This search phase is driven by the startup culture which encourages individual initiative and autonomy, and creates a shared esprit de corps that results in the passionate and relentless pursuit of opportunity. This is the antithesis of the process, procedures and rules that make up large companies.

In contrast, early stage companies that have found product/market fit are now in execution mode, scaling their organization and customer base. While they still may share the same passion as a startup, the goal is now scale. Since scale and execution require repeatable processes and procedures, these companies have begun to replace their chaotic early days with org charts, HR manuals, revenue plans, budgets, key performance indicators and other tools that allow measurement and control of a growing business. And as part of their transition to predictable processes, their founders may or may not still be at the helm. Often they have brought in an operating executive as the new CEO.

Predicting Success or Failure of an Acquisition
So what? Who cares whether a potential acquisition is searching or executing?

Ironically, the business development and strategic partner executives who find the startup and negotiate the deal are not the executives who manage the integration or the acquisition. Usually it’s up to the CTO or the operating executive who wanted the innovative technology (and at times with a formal HR integration process) to decide the fate of the startup inside the acquiring company.

It turns out the success of the acquisition depends on whether the acquiring company intends to keep the new venture as a standalone division or integrate and assimilate it into the corporation.

Actually there is a simple heuristic to guide this decision.

If the startup is being acquired for its intellectual property and/or team, the right strategy is to integrate and assimilate it quickly. The rest is just overhead surrounding what is the core value to the acquiring company.

However, if the startup is still in search mode, and you want the product line and users to grow at its current pace or faster, keep the startup as an independent division and appoint the existing CEO as the division head. Given startups in this stage are chaotic, and the speed of innovation depends on preserving a culture that is driven by autonomy and initiative, insulate the acquisition as much as possible from the corporate overhead. Unless you want to stop innovation in your new acquisition dead in its tracks, do not pile on the corporate KPI’s, processes and procedures. Provide the existing CEO with a politically savvy “corporate concierge” to access the acquiring company’s resources to further accelerate growth. (It helps if the acquirer has incentives for its existing employees that tie the new acquisition’s success to those that help them.) The key insight here is that for a startup still searching for a business model, corporate processes and policies will kill innovation and drive the employees responsible for innovation out of the acquired company before the startup’s optimal value can be realized.

If the acquisition is in execution mode, the right model is to integrate and assimilate it. Combine its emerging corporate KPI’s, process and procedures with those of the acquiring company. Unless it’s the rare founder who secretly loves processes and procedures, transition the existing CEO to a corporate innovation group or an exit.

Lessons Learned

• Corporate acquirers need to know what they’re buying – is their acquisition searching or executing
• If the startup is acquired for its IP, talent or revenue, it should be rapidly integrated into the acquirer
• If the startup is acquired for its products and/or users, preserve its startup culture by keeping it an independent unit
  • Appoint a “corporate concierge” to access the acquiring company’s resources
  • Incentive programs need to tie together the new acquisition’s continued success and the rest of the company
• Acquirers need a formal integration and on-boarding process

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In the last few years we’ve recognized that a startup is not a smaller version of a large company. We’re now learning that companies are not larger versions of startups.

There’s been lots written about how companies need to be more innovative, but very little on what stops them from doing so.

Companies looking to be innovative face a conundrum: Every policy and procedure that makes them efficient execution machines stifles innovation.

This first post will describe some of the structural problems companies have; follow-on posts will offer some solutions.

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Facing continuous disruption from globalization, China, the Internet, the diminished power of brands, changing workforce, etc., existing enterprises are establishing corporate innovation groups. These groups are adapting or adopting the practices of startups and accelerators – disruption and innovation rather than direct competition, customer development versus more product features, agility and speed versus lowest cost.

But paradoxically, in spite of all their seemingly endless resources, innovation inside of an existing company is much harder than inside a startup. For most companies it feels like innovation can only happen by exception and heroic efforts, not by design. The question is – why?

The Enterprise: Business Model Execution
We know that a startup is a temporary organization designed to search for a repeatable and scalable business model. The corollary for an enterprise is:

A company is a permanent organization designed to execute a repeatable and scalable business model.

Once you understand that existing companies are designed to execute then you can see why they have a hard time with continuous and disruptive innovation.

Every large company, whether it can articulate it or not, is executing a proven business model(s). A business model guides an organization to create and deliver products/service and make money from it. It describes the product/service, who is it for, what channel sells/deliver it, how demand is created, how does the company make money, etc.

Somewhere in the dim past of the company, it too was a startup searching for a business model. But now, as the business model is repeatable and scalable, most employees take the business model as a given, and instead focus on the execution of the model – what is it they are supposed to do every day when they come to work. They measure their success on metrics that reflect success in execution, and they reward execution.

It’s worth looking at the tools companies have to support successful execution and explain why these same execution policies and processes have become impediments and are antithetical to continuous innovation.

20^th century Management Tools for Execution
In the 20^th century business schools and consulting firms developed an amazing management stack to assist companies to execute. These tools brought clarity to corporate strategy, product line extension strategies, and made product management a repeatable process.

For example, the Boston Consulting Group 2 x 2 growth-share matrix was an easy to understand strategy tool – a market selection matrix for companies looking for growth opportunities.

Strategy Maps

Strategy Maps are a visualization tool to translate strategy into specific actions and objectives, and to measure the progress of how the strategy gets implemented.

StageGate Process

Product management tools like Stage-Gate^® emerged to systematically manage Waterfall product development. The product management process assumes that product/market fit is known, and the products can get spec’d and then implemented in a linear fashion.

Strategy becomes visible in a company when you draw the structure to execute the strategy. The most visible symbol of execution is the organization chart. It represents where employees fit in an execution hierarchy; showing command and control hierarchies – who’s responsible, what they are responsible for, and who they manage below them, and report to above them.

All these tools – strategy, product management and organizational structures, have an underlying assumption – that the business model – which features customers want, who the customer is, what channel sells/delivers the product or service, how demand is created, how does the company make money, etc – is known, and that all the company needed is a systematic process for execution.

Driven by Key Performance Indicators (KPI’s) and Processes
Once the business model is known, the company organizes around that goal and measures efforts to reach the goal, and seeks the most efficient ways to reach the goal. This systematic process of execution needs to be repeatable and scalable throughout a large organization by employees with a range of skills and competencies. Staff functions in finance, human resources, legal departments and business units developed Key Performance Indicators, processes, procedures and goals to measure, control and execute.

Paradoxically, these very KPIs and processes, which make companies efficient, are the root cause of corporations’ inability to be agile, responsive innovators. 

This is a big idea.

Finance  The goals for public companies are driven primarily by financial Key Performance Indicators (KPI’s). They include: return on net assets (RONA), return on capital deployed, internal rate of return (IRR), net/gross margins, earnings per share, marginal cost/revenue, debt/equity, EBIDA, price earning ratio, operating income, net revenue per employee, working capital, debt to equity ratio, acid test, accounts receivable/payable turnover, asset utilization, loan loss reserves, minimum acceptable rate of return, etc.

(A consequence of using these corporate finance metrics like RONA and IRR is that it‘s a lot easier to get these numbers to look great by 1) outsourcing everything, 2) getting assets off the balance sheet and 3) only investing in things that pay off fast. These metrics stack the deck against a company that wants to invest in long-term innovation.)

These financial performance indicators then drive the operating functions (sales, manufacturing, etc) or business units that have their own execution KPI’s (market share, quote to close ratio, sales per rep, customer acquisition/activation costs, average selling price, committed monthly recurring revenue, customer lifetime value, churn/retention, sales per square foot, inventory turns, etc.)

Corporate KPI’s, Policy and Procedures: Innovation Killers

HR Process  Historically Human Resources was responsible for recruiting, retaining and removing  employees to execute known business functions with known job spec’s. One of the least obvious but most important HR Process, and ultimately the most contentious, issue in corporate innovation is the difference in incentives. The incentive system for a company focused on execution is driven by the goal of meeting and exceeding “the (quarterly/yearly) plan.”  Sales teams are commission-based, executive compensation is based on EPS, revenue and margin, business units on revenue and margin contribution, etc.

What Does this Mean?
Every time another execution process is added, corporate innovation dies a little more.

The conundrum is that every policy and procedure that makes a company and efficient execution machine stifles innovation.

Innovation is chaotic, messy and uncertain. It needs radically different tools for measurement and control. It needs the tools and processes pioneered in Lean Startups.

While companies intellectually understand innovation, they don’t really know how to build innovation into their culture, or how to measure its progress.

What to Do?
It may be that the current attempts to build corporate innovation are starting at the wrong end of the problem. While it’s fashionable to build corporate incubators there’s little evidence that they deliver more than “Innovation Theater.” Because internal culture applies execution measures/performance indicators to the output of these incubators and allocates resources to them same way as to executing parts of company.

Corporations that want to build continuous innovation realize that innovation happens not by exception but as integral to all parts of the corporation.

To do so they will realize that a company needs innovation KPI’s, policies, processes and incentives. (Our Investment Readiness Level is just one of those metrics.) These enable innovation to occur as an integral and parallel process to execution. By design not by exception.

We’ll have more to say about this in future posts.

Lessons Learned

• Innovation inside of an existing company is much harder than a startup
• KPI’s and processes are the root cause of corporations’ inability to be agile and responsive innovators
• Every time another execution process is added, corporate innovation dies a little more
• Intellectually companies understand innovation, they don’t have the tools to put it into practice
• Companies need different policies,  procedures and incentives designed for innovation
• Currently the data we use for execution models the past
• Innovation metrics need to be predictive for the future
• These tools and practices are coming…

Listen to this post here [audio http://traffic.libsyn.com/albedrio/steveblank_hplewis_140304_FULL.mp3]

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My friend Ron Ashkenas interviewed me for his blog on the Harvard Business Review. Ron is a managing partner of Schaffer Consulting, and is currently serving as an Executive-in-Residence at the Haas School of Business at UC Berkeley. He is a co-author of The GE Work-Out and The Boundaryless Organization. His latest book is Simply Effective.  For what I had thought were a few simple ideas about taking what we’ve learned about startups and applying it to corporate innovation, the post has gotten an amazing reaction. Here’s Ron’s blog post.

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What’s striking about Fast Company’s 2013 list of the world’s 50 most innovative companies is the relative absence of large, established firms. Instead the list is dominated by the big technology winners of the past 20 years that have built innovation into their DNA (Apple, Google, Amazon, Samsung, Microsoft), and a lot of smaller, newer start-ups. The main exceptions are Target, Coca Cola, Corning, Ford, and Nike (the company that topped the list).

It’s not surprising that younger entrepreneurial firms are considered more innovative. After all, they are born from a new idea, and survive by finding creative ways to make that idea commercially viable. Larger, well-rooted companies however have just as much motivation to be innovative — and, as Scott Anthony has argued, they have even more resources to invest in new ventures. Sowhy doesn’t innovation thrive in mature organizations?

To get some perspective on this question, I recently talked with Steve Blank, a serial entrepreneur, co-author of The Start-Up Owner’s Manual, and father of the “lean start-up” movement. As someone who teaches entrepreneurship not only in universities but also to U.S. government agencies and private corporations, he has a unique perspective. And in that context, he cites three major reasons why established companies struggle to innovate.

First, he says, the focus of an established firm is to execute an existing business model — to make sure it operates efficiently and satisfies customers. In contrast, the main job of a start-up is to search for a workable business model, to find the right match between customer needs and what the company can profitably offer. In other words in a start-up, innovation is not just about implementing a creative idea, but rather the search for a way to turn some aspect of that idea into something that customers are willing to pay for.

Finding a viable business model is not a linear, analytical process that can be guided by a business plan. Instead it requires iterative experimentation, talking to large numbers of potential customers, trying new things, and continually making adjustments. As such, discovering a new business model is inherently risky, and is far more likely to fail than to succeed. Blank explains that this is why companies need a portfolio of new business start-ups rather than putting all of their eggs into a limited number of baskets. But with little tolerance for risk, established firms want their new ventures to produce revenue in a predictable way — which only increases the possibility of failure.

Finally, Blank notes that the people who are best suited to search for new business models and conduct iterative experiments usually are not the same managers who succeed at running existing business units. Instead, internal entrepreneurs are more likely to be rebels who chafe at standard ways of doing things, don’t like to follow the rules, continually question authority, and have a high tolerance for failure. Yet instead of appointing these people to create new ventures, big companies often select high-potential managers who meet their standard competencies and are good at execution (and are easier to manage).

The bottom line of Steve Blank’s comments is that the process of starting a new business — no matter how compelling the original idea — is fundamentally different from running an existing one. So if you want your company to grow organically, then you need to organize your efforts around these differences.

Listen to the post here: or download the podcast here

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