Innovation Strategy
When Telcos
Aim To Become Venture Capitalists
Corporate Venture Capital is an evolving tool for telecommunications companies, to
identify emerging business models and realize new market opportunities. We advice
Do’s and Don’ts.
20
Detecon Management Report dmr • 2 / 2015
ecling average revenue per user and growing competitive
D
pressure from new players is an ongoing challenge for Telcos. It
has triggered the need to quickly and new market opportunities
in the own core as well as adjacent industries. One evolving
tool to address this situation is Corporate Venture Capital
(CVC). CVC is the endeavor of corporations to fund start-up
companies external to their organizations. Unlike traditional
Venture Capital (TVC) funds, the primary objective of CVC
initiatives is to gain by getting access to new technologies, products, and services. In the past, CVC never really reached the
success of the TVC industry; until recently. Boundaries have
changed and there are first success stories where CVCs are even
out-performing their traditional siblings. This article discusses
the changing market conditions as well as the dos & don’ts for
corporations considering entering the VC arena.
One key driver is certainly the abundance of investment targets,
especially for Telcos. Traditional barriers to start a business no
longer exist. Cloud-enabled services have largely eliminated
hardware investments and the increasing availability of Venture
Capital alleviates entrepreneurs’ dependence on traditional debt
finance from commercial banks. But, perhaps the most critical
factor is the ongoing cultural change. Today, founding a startup is no longer perceived as the last resort for desperate college
drop-outs. It is an attractive alternative to traditional career
paths of bright and aspiring university graduates. Also Top-tier
business schools all over the world embrace start-up culture
and even governments acknowledge the economic value of new
ventures, especially with regards to employment. Particularly
for Telcos, there are (welcoming) indicators that the CVCs
prioritize long-term strategic value over short-term financial
success. Today, financial returns are still a nice-to-have, yet, proceeds from selling equity stakes in start-ups are usually too small
to really impact the bottom line.
Young & inexperienced – why collaborate with start-ups?
Traditional R&D is, unfortunately, often ineffective in identifying and executing disruptive trends, as it is often being
equipped without with the leverage or organizational authority
to push ideas through. On top, corporate strategy may limit
R&D activities, as it is more a game of upper management, pursuing a top-down strategy. The negligence of emerging microdynamics and potential disruptors in core markets turned out
to be (nearly) fatal for many established corporations. Nokia,
Blackberry, and Kodak; just to name a few. Meanwhile, telecommunications players have identified that bundling start-ups’
services with their own product portfolio can deliver a higher
value to subscribers. While some benefits can also be achieved
with partnerships, ownership provides corporations with a
stronger voice in the start-ups’ development. This assures that
portfolio companies’ strategic direction stays in line with the
corporate strategy of the investing corporation.
Riding the CVC wave – recent developments in the telco
industry
Nowadays, especially Telcos surf the most recent CVC wave as
their industry is especially vulnerable to unforeseen technologies
& services. Connectivity as the enabler and evolving smartness of
devices as the disruptor. One prominent example is WhatsApp,
an over-the-top messaging platform which led to a rapid decline
of Telcos’ return on text messaging. Since 2007, the number of
CVCs almost doubled and by 2012, every second carrier had
actively invested in emerging business ventures. In the same
year, Telco investments totaled 0.8 billion USD of which half
went into the US and 12 percent into Germany. It comes as no
surprise that two-thirds of US investments gravitated around
Californian ventures. Historically, the area of interest has been
in electronics & hardware, telecommunications & (mobile)
internet have meanwhile seen the highest growth. Also the share
of early stage deals is increasing, a clear indicator that Telcos
are is becoming more strategic (proactive) and less operational
(reactive).
Becoming a CVC – what you have to know beforehand
Facing the Unknown – Challenges in CVC: The overall CVC
industry turnover is buoyed by the performance of the stock
markets. On the one side, this has significant impact on the
availability and cost of capital of investing corporations. On the
other side, the performance of the stock markets affect the startups’ exit opportunities. In general, VC investments are highly
illiquid as investors can only cash out when portfolio companies
exit. Unfortunately, the most common exit channel of start-ups
is to file for Chapter 11. Thus, corporations have to adopt a
portfolio approach to deal with the relatively high number of
failures.
While these challenges also apply to TCV, CVC appears to
be even more challenging due to additional corporate-specific
obstacles. First, entrepreneurs do not trust corporations as they
fear that they might be bought from the market. Second, corporate bureaucracy potentially slows down CVCs. Third, the
tenure of Telco CEOs (by several years shorter than the time-to
IPO of start-ups) biases investment decisions towards the quick
buck. These three obstacles are critical to overcome as they have
a significant negative impact on a CVC’s deal flow. Nevertheless,
empirical studies have shown that, if done right, CVC can be
financially more attractive than TVC for start-ups.
21
Detecon Management Report dmr • 2 / 2015
Creating a Win-Win Situation – The Value Proposition of Telco
CVC: Despite negative notions, start-ups fueled by CVCs enjoy
27.1 percentage points higher revenue growth than start-ups
backed by TVCs as a recent study by Harvard Business School
suggests. This is due to the fact that venture capitalists primarily
provide funding, whereas Telcos can offer additional nonmonetary support such as reputation, knowledge, mentoring,
and access to markets and a huge base of potential customers.
But why are Telcos willing to take the high risk that is associated with CVC? The answer is simple: due to declining industry
profitability, Telcos are forced to rethink their current business
models and to look beyond their corporate boundaries to identify emerging opportunities.
How to Invest Effectively – Portfolio Considerations: CVC
pursues strategic goals at two hierarchical levels with differing
investment horizons: the corporate level and the business level.
Both strategic goals stem from the cicumstand that when it
comes to ideation, the number of external start-ups outnumbers
any in-house innovation teams by several orders of magnitude.
Figure: Eight Key Principles for Running a CVC Initiative
Suggested Behavior
Syndicate with
experienced
TVCs
Guarantee longterm existence of
fund
Behave live a TVC
Leverage corporate resources
Collaborate with
portfolio
companies
Offer VC like
compensation
schemes
Distinct between
VC/CVC and
incubation
Have independent
decision making
Keep VC/CVC
company lean
1. Guarantee Long-term Existence: Due to the long term nature of CVC,
capital has to be committed over multiple planning periods. Moreover, it
is critical to educate new executives about the strategic nature of CVC as
top-management changes appear to be dangerous.
2. Offer VC-like Compensation Schemes: Rigid corporate compensation
schemes with limited upside potential alleviate experienced TVC investors,
who are critical to generate deal flow. Offering carried-interest-based
compensation helps overcome this obstacle.
3. Have Independent Decision Making: Autonomous decision making
is critical to decrease corporate bureaucracy and to generate deal flow.
CVC and corporate managers should agree on financial thresholds and
investment targets. Moreover, rights and responsibilities of CVC managers
have to be clearly defined.
4. Balance Top-Management Involvement with Autonomy: The investment board of executives from the parent unit has to be kept lean, as
scheduling meetings with multiple C-level officers is difficult. Often, the
investment board consists of business unit managers and only one C-level
officer.
Source: Detecon
22
Detecon Management Report dmr • 2 / 2015
Balance topmanagement
involvement with
autonomy
5. Syndicate with Experienced VCs: Syndicating with experienced TVC
investors helps to overcome domestic market knowledge and to generate
deal flow. Moreover syndication decreases resistance from start-ups.
6. Collaborate with Portfolio Companies: Corporations should leverage
their corporate assets and provide mentoring with seasoned entrepreneurs.
Portfolio companies should stay autonomous and the payout of agreed
capital should not be linked to milestones.
7. Distinct Between CVC and Corporate Incubation: Incubators and
CVCs support start-ups at different maturity stages. Incubation precedes
Venture Capital. Yet, graduates from the incubation program should not
automatically receive funding and investments should not be limited to
these start-ups.
8. Keep CVC Company Lean: Carriers rarely develop technology
in-house, hence, a unit dedicated to knowledge exchange is often not
needed. Additionally, work packages such as technical due-diligence are
outsourced to experts from the Parent Corporation or third parties.
At the corporate level, the market scanning & evaluation
necessary for a succesful CVC can provide executives with
foresight into the market. Information on disruptive technologies and transformations in the core telco market allows leaders
to react to threats or embrace opportunities in a timely manner.
Strategic investments are early stage investments. They require
less capital, have extraordinary earnings potentials, but are also
significantly riskier than later stage investments.
At the more operational business level, the CVC can provide
carriers with e.g. cost-cutting opportunities. In the IT and
infrastructure sector there is a boom in the start-up community around operational efficiency. Carriers also seek to extend
& beautify their product portfolio, with the goal of attracting
and retaining customers. Such operational investment usually
include more mature start-ups that already have a market-ready
product. They are less risky, but also have a lower earnings
potential. At this maturity stage, the CVC advantage finally
comes into play as corporations can provide critical proprietary
resources and help start-ups to enter new markets.
Learning from others – eight key principles
Detecon believes CVCs will further rise in importance as
continued emerging technologies will put further pressure onto
telecommunications. The prime directive will remain on curbing costs and identifying new business opportunities in core
and adjacent markets. When entering the VC market, Telcos
should not be intimidated by established VC companies. Strong
brands, market know-how, powerful networks across industries,
and a pool of millions of customers are assets Telcos have, but
which TVCs usually lack. CVC allows start-ups to grow faster
than TVC; but only if the Telcos’ proprietary assets are leveraged effectively. Doing so will attract an abundance of prospective investment targets and generate a high deal volume. CVC
allows Telcos to tap into today’s unprecedented pool of external
innovation, which helps Telcos to ultimately grow profits again.
Detecon Opinion Paper
The Corporate Dilemma –
When Telcos Aim To Become
Venture Capitalists
Over the past decades, numerous CVC companies have risen
and fallen. This has triggered the motivation to investigate this
topic in more detail and beyond academic perspectives. Detecon engaged in discussions with several CVCs:
2015
Based on these dialogues and combined with in-house expertise,
eight key principles for success in CVC are derived. Depending
on the situation, corporations are advised to behave like a TVC,
or to leverage their corporate assets, or find a hybrid solution.
Summary
Despite its intrinsically risky nature, CVC can be an effective
means for Telcos to improve their innovation focus. Yet once
they engage, they enter unchartered territory characterized by
high uncertainty & strong cycles as start-ups’ exit opportunities depend on stock market performance. Countless CVC
units have failed as they were incapable of coping with these
challenges. Certainly, the eight derived principles for CVC have
to be taken with a grain of salt as they require strong individual
customization. Thus, the given principles are points of consideration rather than normative rules. While one principle can be
applicable for CVC A, it can be harmful for CVC B.
www.detecon.com/us/en/Publications/corporate-dilemma
Dr. Eric Dulkeith is a member of the Strategy group in Detecon’s
Silicon Valley office in California. The main focus of his activities is
on innovation management and business development of converging
technologies, products & services, and markets.
23
Detecon Management Report dmr • 2 / 2015