Corporations are burning cash trying to build disruptive business models. Unless they have taken the time to install four key strategic enablers, they will fail. I call these enablers ‘The Four Freedoms’.

The drive to disrupt

“Disruptive Innovation” is a hot topic; there are daily announcements from FTSE250 companies about open innovation ecosystems, startup partnerships, CVC funds, incubators, accelerators and fostering ‘intrapreneurship’.

Incumbents are right to be worried. Although market share erodes imperceptibly at first, disruptive models that stick can grow exponentially. At that stage even piles of cash can’t always help a corporation catch up because replicating successful startups is time-consuming and risky, and successful disruptors attract huge valuations that can make them unattractive to acquire. Just ask senior executives from Kodak, Xerox or Blockbuster. As the old adage says “The best time to plant a forest is 20 years ago, the second-best time is today.” FFS don’t wait until you need the timber.

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Incumbents are also right to want to invest in disruption; markets see much more value in firms with a proven ability to disrupt at an industrial scale. Just think about the PE ratios of two of the world’s largest retailers, Amazon (130) and Walmart (25). Or hardware manufacturers Apple (28.4) and Dell (8.4)

Baked-in failure

But the majority of corporate disruption projects and strategies that I see are a waste of time and money, with failure baked in on day one. Most result in a huge amount of cash and calories being burned, but fail to deliver real value.

Disruptive projects, which often begin with rational commercial objectives, will slowly devolve over time into sideshows with soft, poorly articulated goals such as “learnings”.  An unwillingness to kill the project then results in hoards of ‘walking dead’, which limp along with no real chance of success.

 

When I’m asked to advise on corporate startups, my recommendation is usually: “kill it as humanely and as possible”.

This stems from the fact that most corporate cultures and operating models have been meticulously designed to deliver highly predictable growth over the next 12 months. As a result, most corporate environments are extremely hostile towards risk, failure and contrarianism, yet this is exactly where ill-fated ‘speedboat teams’ are asked to build startups.

As a result, the cash and calories invested will at best deliver nil return. Far more likely, however, is that these projects carry a significant opportunity cost; cash could be spent on proven growth tactics and brilliant minds can be focussed on strengthening the core business that they understand so well, focussing on winnable challenges.

That’s why, when I’m asked to advise teams or sponsors of corporate startups, my recommendation is usually “kill it as humanely and as possible.”

A model for success

If a company does want to pursue disruptive innovation at a meaningful scale, they should start by learning how the VC industry works.

VCs have spent 40 years refining a model to develop disruptive new businesses, profitably and at enormous global scale. I’m unaware of any others that come close (PLEASE educate me via the comments section).

The GP/LP structure that VCs are built around offers entrepreneurs four strategic enablers for success. Without all four enablers, even an entrepreneur who achieves early success will be highly uncompetitive vs a venture-backed competitor in the wild and therefore will ultimately fail.

My strong recommendation to any leaders charged with building profitable disruptive innovation at an industrial scale, is to focus all your resources on putting the following enablers in place, creating a competitive environment for disruption to flourish. In other words, make the ground fertile before planting seeds!

The Four Freedoms

  1. Aligned incentives

    The founding team has real skin in the game, and no one gets rich until everyone gets rich.

    Startup: All founders have taken a significant pay cut — often 100% — and abandon the concept of a “career path” in return for the possibility of private-island wealth if the business succeeds.

    Corporate: High base salary, performance bonus based on “in-year performance”, career development based on repeated in-year performance.

    Impact: The lack of safety net and massive upside will motivate the startup founder to run through walls for 12+ hours a day. They will eat the corporate founder for breakfast.

    Possible solution: Give the founder a paycut and suspend annual bonuses in return for retirement-level wealth if they succeed. Success = you would fight to acquire it as an independent business

  2. Operational freedom

    Build what customers need, optimising for pace of learning and adaptability.

    Startup: Investors back a founding team. The founding team can choose their team, ways of working, supply chain, target market, business targets based on the best solution for today and change these as required.

    Corporate: Investors back a specific idea. Founders are encouraged to use existing talent, supply chain, procurement, shared services and approved vendors to deliver the idea, and discouraged from competing with the existing portfolio.

    Impact: Corporate “intrapreneurs” are reliant on a toolkit that was designed for Engine 1. This is slow, expensive and distracting to both the startup and the corporation.

    Possible solution: Ask your CEO to give the founder a “Letter From The Leader” that explains why the project is important, why the team needn’t follow the rules, and asks that colleagues are supportive if needed and absent if not.

  3. Long-term financial commitment

    Whilst there are a handful of outliers, it typically takes 7–10 years for disruption innovation to deliver a return.

    Startup: Angels and VCs invest with the expectation to lose money for a long time, and likely invest increasing amounts each round. Investment rounds (quantum and timeframe) fit the unique situation. Investors understand the KPIs that describe success in early-stage, loss-making startups.

    Corporate: ‘Investors’ make annual investment decisions, with the ability to reduce budget mid-year. If funded from P&L, the startup will have to compete with projects that will deliver a guaranteed return in a short timeframe. Disruptive innovation will likely take longer to realise value than the investors, sponsors or other stakeholders remain in their role.

    Impact: The disruptive project takes longer to create value than the original sponsor and other key stakeholders areis likely to stay in their role. And there is no scope for career development for the ‘founders’ during that time, who likely care about job security and progression as much as their corporate colleagues; running the project becomes career kryptonite.

    Possible solution: Fund disruption from the balance sheet, not your P&L. Appoint founders with a typical ‘founder’ profile, recruiting fresh talent if necessary.

  4. Effective, aligned governance

    You buy decision-making rights with significant skin in the game, not grey hair.

    Startup: Everyone at the board table has aligned their incentives with the project (see above).

    Corporate: Decisions are influenced by countless senior stakeholders who are personally incentivised by the wider business P&L performance.

    Impact: Founders are encouraged to pursue profit before scale or product-market fit. Unprofitable projects are massively under-funded vs competitors ‘in the wild’ and are shut down in years 2-5.

    Possible solution: A 3-5 person steering committee, including an independent expert, all of whom have aligned incentives (see above).

What next?

So, am I saying that all you have to do is put the Four Freedoms in place and then sit back and count your money!? No. There is a whole host of execution risks that could continue to frustrate your ability to disrupt.

A well-managed portfolio of competing projects, full-time founders, experienced teams, clear strategic goals, and an innovation strategy that compliments your core will all massively increase the odds for success. But, in the absence of any one of the four freedoms, not even these measures will lead to market-winning success.

 

Stephen Rapoport founded Crashpadder.com and PactCoffee.com and is former Vice President, Disruptive Innovation at Unilever. Stephen is currently helping a number of corporations develop disruption strategies whilst planning his next venture.

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Alex Bazin
Alex Bazin

This is one of the best summaries I’ve read of why corporate innovation tends to fail. From what I’ve seen, the most successful startups have long-term, arms-length investors with long-term, empowered founders. As is correctly pointed out, this can’t be achieved from within a corporate P&L. I think that corporates need to look to set up semi-autonomous organisations (like Google Ventures or historically PARC) with a significant balance sheet to make these types of investments and achieve that long-term focus. The lack of alternative investment choices for corporate startups is another challenge that affects the long-term financial commitment. When a… Read more »

stephen rapoport
stephen rapoport

Awesome builds, Alex. Thanks! Fully agree with the point about a corporate startup’s ability to raise money from aligned investors (who care about Horizon 2 or 3 returns). As for the wealth side, you’re the first to raise this challenge and I’m sure the first of many! My favourite startup founders are driven by a vision of a better world, after their startup has succeeded. I certainly am. But I disagree that upside potential and downside risk are not motivators, enough to give a startup in the wild a competitive advantage over a corporate competitor. Finally, you’re absolutely right that… Read more »

Alex Bazin
Alex Bazin

Thanks Stephen. You’re absolutely right that while the averages favour the corporate pay check, the standard deviation is much much higher in the startup world. It’s of course a matter of risk tolerance, and some will be drawn to the higher risk, higher reward lifestyle. The upside/downside risk is interesting. I’m sure they’re motivational at some level, it’s just hard to measure how much that is a driver of success rather than a consequence of other motivational factors. What I wonder is how do companies like Apple, Adobe or Disney continue to make fairly big innovative leaps without having those… Read more »

ian forshew
ian forshew

I agree that the four freedoms will enable disruption. However, I think first and foremost you need to decide what kind of culture you are trying to create and then deploy them in that context. Or risk disturbance, rather than disruption.

stephen rapoport
stephen rapoport

Such a good build. It’s chickenegg. Only an accepting culture will actually put the four freedoms in place (rather than nodding then doing something half-arsed) BUT without the four freedoms it’s hard to imagine developing a truly innovative culture.

stephen rapoport
stephen rapoport

Perhaps the best solution is a separate entity staffed with fresh, experienced entrepreneurial talent AND corporate employees who are exiting because their heart is in disruption and they know they are in the wrong place!?

Jordan Schlipf
Jordan Schlipf

Firstly, I couldn’t agree more with the article and the Four Freedoms – all necessary elements to avoid guaranteed failure. But, as you mention, we’re still a long way off from a 50%+ chance of success – even with the Four Freedoms in place. One of the common challenges (and there are many more) I see that prevents corporates from achieving anything close to 50% chance of success (when building new ventures themselves). [Bearing in mind that, on average, less than 8% of corporate ventures reach any kind of scale!]. Is what they start with or what ideas they force… Read more »

stephen rapoport
stephen rapoport

Shit in, shit out is spot on. So often a corporate disruption is started as a senior leader’s hobby horse and a junior member of the team is asked it execute it. Often you find that the project is exciting to leadership because, if it achieves massive scale, it will solve a company problem (often low margin portfolio, no leverage with distributor or stagnating growth). But it’s far less clear what consumer problem the idea would solve. The way I would address this: Ask the senior leader to articulate what consumer problem they hope the project solves, and then give… Read more »

Andrew Campbell
Andrew Campbell

Jordan. I love your “Shit in. Shit out” point. See my comment above. I may have a tool for distinguishing between shit and shine.

Andrew Campbell
Andrew Campbell

Love this article Stephen … and love the title. I published a piece in HBR titled “Stop kissing frogs” making the same point “most corporates should stop their new business innovation efforts”. A couple of points. First, the average venture capital investor, like the average angel investor, does not earn a return sufficient to cover the cost of capital. So even the VC model that you are trying to emulate does not pay. This is because innovation does not give a decent return to investors (on average), which is why governments subsidize it … and many of the great successes… Read more »