Is It Still Day 1?
The importance of corporate innovation for guaranteed high performance.
As we come to the end of the year, there is no doubt that high performers are reflecting on their companies’ achievements in the past year, and on what the future looks like. In his 2016 Letter to Shareholders, Jeff Bezos talked about how to ensure your company remains what he referred to as a “Day 1” company. This is a company constantly focused on innovation both to improve internal processes and to improve the quality of the company’s offering to customers.
Day 2 usually arrives for larger organisations – those that have experienced success but have become slow in decision making, are obsessed with process rather than achieving a positive result, and, when the company is especially not innovating – resulting in the company’s death.
So how do you make sure it is always Day 1 for your company?
Simply ask yourself whether you’re innovating internally to (1) improve the quality of your internal systems and product offering, and (2) more broadly contribute to the industry in which you’re operating.
There are many innovation strategies that a company can take on. As a larger organisation however, you can innovate through a standard test & development program, like how medical companies, for example, source funding to research and develop new medications. Test & development can however take a different shape, where the company aggressively focuses on flipping major operating expenses into sources of revenue. Another exciting approach is through corporate venture capital (CVC). We will look at both strategies briefly.
Option 1: Corporate Venture Capital
This is where corporates make equity investments into industry related startups using a venture capital model.
In the US, Asia, and Europe, CVC is a multi-billion-dollar space. According to the CB Insights State of CVC Report 2021, CVC backed funding for startups worldwide was a record $170 billion across 4661 deals. ~ $87 billion of that funding was directed towards US based start-ups, ~ $50 billion towards Asia, and ~ $23 billion towards European based startups.
The chart below shows the size of the CVC space worldwide, in Q4 2021 alone.
Reasons to embark on a CVC program can be determined using an investment matrix like the one below. On one plane is the objective of the company. This is whether the company is investing for strategic reasons such as to improve internal processes, finding ways to improve their own product offering, or keeping an eye on startups that can potentially disrupt the industry and negatively affect the company, if the company does not innovate. Alternatively, the company could be investing simply for financial reasons as a corporate finance investment strategy.
On the second plane you consider how the investment will influence the operational ability of the company. The sweet spot is finding the right mix that will ensure the corporate has the greatest impact on its industry, and on the world. However, most investments lie along a spectrum of reasons to invest.
Let’s look at a couple of examples from successful CVC programs…
Successful CVC Investments
Firm: Google Ventures (GV)
Invested in Stripe
~ $74 billion private valuation
the largest and most successful online payments processing company in the world
For GV, investing in Stripe allows penetration of a potentially new business since Stripe can be integrated into Google’s online retail activity, growing this part of Google’s business, and add to the trove of data Google collects to improve its offering.
90% of US adults have bought from businesses using Stripe
Stripe operates in 35+ countries and supports 135+ currencies and payment methods.
Invested in 23andMe
$1.5 billion market cap.
23andMe is a personal genomics and biotechnology company
For GV, investing in 23andMe compliments Google’s data collection strategy, allowing Google to learn new methods of data collection, and sharing, and again add to Google’s data stores and AI development – a core part of Google’s business model.
23andMe users can better track their ancestry and have a deeper understanding of their health and therefore better navigate their future
12+ million DNA kits sold since launch in 2006
13.4 million genotyped customers
23andMe recently published results from a study identifying regions in the human genome associated with pneumonia
23andMe launched a rare diseases study in rare conditions including systemic sclerosis, vasculitis, and more.
Invested in Uber
$49 billion market cap.
Uber disrupted the ride-hailing & transportation industry and is currently the leading ride hailing service provider
Uber’s business compliments Google’s GPS and mapping offerings.
Uber operates in 10 500 cities across 70 countries
21+ million trips per day
124 million monthly active platform consumers
As of September 2022, a cumulative $185 billion has been paid to drivers and delivery people.
Firm: BMW i-Ventures
Invested in Proterra
$1.5 billion market cap.
Proterra designs and manufactures power trains for its own line of electric buses
Investing in Proterra advances BMW’s exploration into electric vehicles, allowing BMW’s own line of electric vehicles (the i-line) to grow
Thomas Built Buses delivered 200 Proterra-powered electric school buses
70 buses ordered for Miami-Dade County.
Invested in Desktop Metal
$740 million market cap.
Desktop Metal (DM) designs 3D printing systems and currently has a design that 3D prints vehicle body parts
This investment allows BMW to reduce the cost of revenue potentially significantly for its vehicles as the 3D body part printing technology improves, and therefore compliments BMW’s current product offering
6 000+ customers, and a range of different 3D printing products
The success of companies such as DM will allow a reduction in mining activity and the negative impact this has on the environment. As 3D printing technology improves, we will see a significant drop in manufacturing costs for vehicles, and other products.
Firm: PayPal Ventures
Invested in Stitch
Series A stage, undisclosed valuation
Stitch is a South African API fintech startup allowing one click payments, a better UX, and fraud prevention, among other consumer focused services
Investing in Stitch allows PayPal to penetrate further into the digital finance industry, allowing PayPal to remain on top of changing trends in the digital finance space
Launched in early 2021, customers already include Chipper, Multichoice, Quicket, Zapper, and Binance.
Invested in Paxos
A blockchain infrastructure platform enabling stablecoin & payments, crypto brokerage, securities settlements, commodities settlements, among other services
A strategic investment that will allow PayPal to improve is digital finance business while keeping an eye out for changing processes
$50 billion in total commodities settlements
Paxos partnered with Nubank to help Nubank launch an in-app crypto trading service, which will be rolled out to Nubank’s 50+ million customers in Brazil.
Benefits of CVC for the Corporate
For the company, making equity investments in startups means the company will
1. Have an eye on new technologies and processes, ensuring the organisation remains relevant and remains a market leader
2. Possibly improve the company’s own product offering by creating new product lines, or significantly improving existing products
3. Improve its costs of revenues, largely benefiting customers and other stakeholders
4. Potentially benefit from boosting the size of its balance sheet and benefit from a profitable equity investment – creating new financial opportunities and income for the company in the form of either paid-out capital, shares sold at IPO, or dividends paid out at a later stage of the startup’s life.
Benefits of CVC for Startups
In standard practice, a startup will choose a venture backer that is reputable and can offer not just the required startup capital, but also the operational pipeline that will give the startup the highest likelihood of success. A reputable corporate can easily play this role. This can include lending the startup experience through advisory and operational management roles and allowing the startup to use the company’s facilities to build, test, run, and improve the startup’s product. Additionally, the corporate’s brand may signal the quality of the startup to other investors and to the market – extending the startup’s reach, especially in the initial stages of the startup’s life.
Challenges
As interesting as this type of project is, two important points must be kept in mind:
(1) Where is the capital sourced to deploy into venture investments?
If from cash reserves, these would need to be significant enough that the corporate can make a sizable and impactful investment, while still being in a good enough position to forgo other strategies such as share buybacks or declaring a dividend to shareholders – without push back.
Alternatively, the venture arm can source capital through a team of limited partners, remaining completely independent of the corporate. Or a mixture of these options.
(2) It may be preferable for the venture arm to run separately from the company itself.
To avoid cash problems for the company, and/or other red tape.
Alternatively, the corporate venture firm can partner with an existing venture capital firm – which will allow for fiscal responsibility and proven investment strategies. In this instance the company will function as a limited partner however, taking a back seat in the investment process but largely benefiting from the general partner’s expertise.
Whichever way the company decides to structure the corporate venture capital program, this is a great method that corporates can use to always have an eye on new potentially disruptive trends, and to therefore ensure the corporate is always innovating.
Option 2: Turn Major Expenses into Sources of Revenue
This strategy is an interesting spin on the standard test & development programs that most large companies adopt. We will use Amazon as an example.
Amazon spent ~ $18 billion over 10 years to turn almost every major cost line into a source of revenue. The result was $239 billion of value created – which was the 2015 total business value of the new business lines. Namely, these business lines were Amazon Kindle, Basics, Fire, Echo, Fulfilment, AWS, Amazon Prime, and Amazon Payments.
Briefly
Amazon Kindle, Basics, Fire, and Echo are Amazon’s own version of consumer products, created so that Amazon could spend less on buying other products and brands (Duracell, physical books, etc.) and reselling for a margin.
Revenue created:
Lower product costs. Instead, consumers now buy more Amazon branded consumer products. Additionally, this added to Amazon’s marketing returns.
Air Transport Services Group (ATSG) is an air freight company that Amazon part owns.
Revenue created:
Significantly lower shipping costs. Amazon became a provider of shipping services and are continuing to grow this part of their business with a recent larger investment in ATSG, while also expanding their in-house air cargo transport fleet.
Fulfilment by Amazon is the storage part of Amazon’s business.
Revenue created:
Less warehouse rental and warehousing storage costs. Amazon grew its own line of warehouses worldwide. Further investment into growing the fulfilment business allows more revenue from third-party sellers.
Amazon Web Services (AWS) was born from the fact that Amazon had to manage its own IT infrastructure.
Revenue created:
AWS now offers cloud storage and APIs to individuals and other businesses at a fee.
Amazon Prime is a VIP subscription service that Amazon offers. Benefits include fast shipping, discounts, and other priority services.
Revenue created:
Lower marketing expenses and larger word-of-mouth marketing returns for Amazon. By 2020, Prime was reported to create $126 billion of value for members.
Amazon Payments was created as a tool to process online payments for Amazon customers.
Revenue created:
Other online service providers were eventually able to use Amazon Payments to process payments on their sites, for a fee.
Note: Amazon fulfilment centres make use of bots to store and retrieve inventory – reducing the need for human warehouse capital and in turn reducing salary and wage expenses.
The creation of these new business lines played a massive role in enabling the enterprise value of Amazon to grow from $20 billion in 2005 to $312 billion in 2015.
Conclusion
Remaining a Day 1 company should be an essential goal for all company owners. Are you innovating, are you aware of what new products or processes are coming up in the market, are you aware of your competition, are you still a market leader? All important questions that can be answered positively by making focused business moves such as building a corporate venture capital program, or aggressive and focused test & development investment following Amazon’s footsteps.
The corporate venture capital space is a multibillion-dollar space for a reason, and companies such as Amazon are behemoths and industry leaders for a reason. For your company, how are you ensuring it is still Day 1?
I leave you with this quote from Jeff Bezos: “The outside world can push [your company towards death] if you won’t or can’t embrace powerful trends quickly. If you fight them, you’re probably fighting the future. Embrace them and you have a tailwind.”