Internal vs External: The Dilemma For Scaling Disruptive Innovations

The study also reveals that new businesses make up about 12% of total sales across industries already, with an expectation that this will double in the next five years.

Challenging the widespread notion that cost-cutting is the way out of economic headwinds, new business building is no longer optional for forward-looking CEO’s.

Beyond The Core: Horizon 2 and 3

As innovators, we often use the “three horizons” framework. Horizon 1 focuses on core renovation, Horizon 2 explores adjacencies and slightly new business, and Horizon 3 refers to disruptive innovation. To be clear, "new business building" is the label for efforts that focus beyond the core, which means in Horizon 2 and Horizon 3.

That means moving from existing brands and categories to new ones. For example, a consumer goods company offering dairy products might want to expand into plant-based alternatives. Another example is a shift in offerings; while the core focuses on physical products, beyond the core, the company offers services leveraging its huge amounts of data. Or, the change is in the business model- from shipping via dealers to direct-to-consumer.

When a company expands beyond its core, there is less customer knowledge. We may not fully understand certain types of customers or their behaviors and needs in different spaces. Also, our internal expertise may be less applicable to the new context. Often, that makes management to be more careful to endorse and support these efforts. They prefer to stick with what they know rather than take risks, also because their remuneration is tied to traditional business metrics.

Internal vs External

Building new business away form the core could be done by emerging models like internal venture building. This involves creating teams with an intrapreneurial mindset, providing them with funding and space, and allowing them to invent something new. While these teams have more freedom, the control is still high within the corporate structure.

As such, it may be more effective to turn to external channels. This can include M&A, partnerships with startups, and corporate venture capital. However, most acquisitions tend to fail, predominantly because of cultural differences. These differences can manifest in various ways, such as different metrics, horizons for profitability, and attitudes toward growth and innovation. Additionally, many acquisitions come at significant costs. When acquiring a start-up or scale-up, it is not uncommon to pay exorbitant amounts, such as 20-30x EBITDA or 10x revenues.

Recently, a new phenomenon called "excubation" has emerged, positioned between internal venture building and M&A. It entails the financing of an external venture, run by dedicated entrepreneurs and a few intrapreneurs.

In excubation, the corporate entity plays the role of investor in AND buyer from the start-up or scale-up, and as such is a partner that has a bigger involvement in the company and interest in its success.

Compared to internal innovation efforts, these new ventures can develop a lot faster. And compared to just purchasing the technology in the market, there is a strong financial incentive and potential uptake for the corporate too.

In fact, the corporate doesn’t just invest in one particular venture but in a unit that is tasked to build several ventures- a venture studio.

The Model for A Venture Studio

From a corporate perspective, the main goal of an excubation venture unit is to scout, build, and scale a portfolio of new businesses outside of the core. This requires taking multiple bets, as not all projects succeed.

Evaluating the success of an excubator should not only be based on revenues but also on valuations and the potential market value of the businesses being developed, similar to how venture capitalists assess investments. For example, BP Launchpad aims to build a unicorn, a start-up valued at over $1 billion. The metrics used in excubation are different from traditional business measures and require a more venture capital-like mindset.

For a typical corporate venture studio, the first stakeholder is the corporate as investor, putting in money in exchange for shares or convertible bonds. The second stakeholder is typically a venture building company, putting in the work (and sometimes money) in exchange for shares and/or fees. In many cases, external investors are brought in to provide the necessary industrial expertise and additional financial resources.

The studio then recruits a team of that starts ideating and validating new business ideas with the funds provided. Some of these MVP’s are validated and moved forward to the Investment Committee for approval. Upon approval, a new company will be created and founders are recruited. They typically get a significant stake of up to 70% in shares, which incentivizes them to launch, grow, and raise external capital. External investors are more likely to invest if the founders have a strong command and personal investment in the venture.

Let’s say the studio tests 20 ideas with 2mio, and 3 ventures reach the exit-stage (acquired by the corporate mothership is an option too), that could easily triple the value of that investment in less than 5 years. Compared to the 7-10 years it takes a typicaly VC to get there, this is an attractive route.

In order for your venture studio to be successful, there are four key factors that need to be in place.

1. Firstly, having a clear strategy and the support of the board is crucial. Without these elements, nothing will ever come to fruition. It is important for the CEO to fully understand and be convinced about the strategy before moving forward.
2. Secondly, having a well-articulated legal framework is essential, as it can be complex to bring all the stakeholders together. This framework ensures that everyone is on the same page and provides a solid foundation for the venture.
3. Thirdly, engage the founders of the venture as early as possible. These individuals will be leading the ventures when they are ready, so their involvement from the start is critical.
4. Fourthly, bringing in external investors can provide discipline to the venture. Their perspective and expertise can help shape and guide the endeavor toward success.