Academic journal article The McKinsey Quarterly

The Curse of Too Much Capital: Building New Businesses in Large Corporations

Academic journal article The McKinsey Quarterly

The Curse of Too Much Capital: Building New Businesses in Large Corporations

Article excerpt

Large corporations often finance their fledgling businesses too generously I They should take a hint from venture capitalists

Driven by ever-increasing equity market valuations and growth challenges, many large corporations are bestirring themselves to build new enterprises that have the potential to grow much faster than their core businesses. Yet in doing so, senior managers at the parent companies often make the same well-intentioned mistake that children do with their first goldfish: overfeeding.

It seems to be common sense that if you seriously want to build a business quickly, you shouldn't skimp on funding and other resources. Many senior managers believe that the financial and technical support the parent corporation gives to its start-ups is their main source of competitive advantage.

Although this is often the case when companies invest in projects to extend core businesses in familiar or strongly related markets, when they invest in new businesses the opposite may well be true. Apple's Newton personal digital assistant (PDA), General Electric's "factory of the future," and a host of other unsuccessful new ventures show that lavishing capital does not guarantee success.

In fact, bestowing too many resources on new ventures undermines the discipline they need to grow Excessive amounts of capital can make the managers of a new venture expand its product range too quickly, invest in too much infrastructure, and delay going to market for too long--all potentially fatal mistakes. By contrast, successful start-ups, such as Excite (Internet media), Amgen (biotechnology), and Tivoli (network management software), grew and prospered under the constraints of venture capital-style funding.

The logic of these constraints, which force new ventures to focus and to limit the degree of risk they impose on their sources of funding, rests in part on the fact that few such fledgling enterprises turn out to be successful. For corporations, the challenge is to ration the financial resources they provide in the early stages and to concentrate on exploiting their nonfinancial resources, such as access to people and partners.

The power of penury

A large technology company recently attempted to build a business in the ill-defined but potentially very large area of home automation. As enthusiasm for the project swelled, this effort to bring a single product to market ballooned into a venture aimed at developing a suite of six new products, each designed to provide a different type of functionality and targeted at a different market segment. Instead of creating a winner in a single niche as a platform for building a broader position, the company spawned a full line of mediocre losers that were shut down within two years.

By contrast, consider the success of independent start-ups funded by limited amounts of venture capital--projects that focused on winning in a niche before attacking related markets. A highly visible example is Amazon.com, which reached a market capitalization of more than $30 billion in 1999 by establishing itself as an on-line retailer in a number of segments and as a provider of related services, such as on-line auctions. Amazon reached those heights by starting with a highly focused model in the niche of on-line book sales. It was then able to refine its initial approach to on-line retailing quickly by intensively gathering data on the usage patterns and buying behavior of its customers. With this understanding of the marketplace, an enticing brand, and significant market credibility, the company has been able to launch itself successfully into other kinds of retailing. Indeed, its most significant advantage as it takes on more experienced and established retailers of all shapes and sizes may be the insig hts about customer behavior it learned in the early days.

The experience of a product development leader at a successful biotech start-up shows how a tight-fisted approach to funding sharpens a new venture's focus:

We had to push our device over one major technical hurdle before we could do the IPO. …

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