"Are you being served?" is a question increasingly heard around the world as the services sector now accounts for 67% of global economic output, according to the World Bank.
But many of the largest firmsin the sector remain reluctant to takes shares rather than cash for their work.
Beneath the largest incumbents, however, the credit crisis since early 2007 has encouraged a host of boutiques to take shares in nascent third parties in lieu of fees as a way of building a longer-term relationship and potentially to profit from the clients success.
Outside the public, or government, sector, which makes up part of the services industry, the largest parts of the industry include financial, legal, accountancy, management and other forms of consultancy and marketing and advertising firms. (Financial services is considered a sepa-rate sector for corporate venturing.)
Lawyers are often uniquely aware of entrepreneurial activity and funding compared with most services companies. As trusted counsel, lawyers are often involved from the earliest stages of a nascent business, and though investors can often do without external advisers or consultants, they will still use law firms to prepare the documents recording the share purchase.
This puts law firms in a position to take equity in third parties either in lieu of, or as well as, cash to cover their fees. Firms dealing with the wider venture capital market have the best opportunities.
Chris Hale, head of private equity at UK-based law firm Travers Smith, said: "In the late 1990s, as the dot.com bubble was inflating, it was not at all unusual, although I would not say common, for accountants, lawyers and some corporate finance advisers to take stakes in clients, particularly those that were relatively small, had little cash but were perceived to have very good growth prospects.
"This was a notable feature of the Silicon Valley world and the advisory community that surrounded it. It was exported here, although not taken up to the same extent as seen there. When the dot.com bubble burst, it largely disappeared."
Some US-based firms,such as Wilson Sonsini Goodrich & Rosati, which was unavailable for comment, are regarded by peers as being relatively active in taking stakes in third parties, although such legal corporate venturing is almost unheard of outside the US.
Samuel Shafner, partner at US-based Burns & Levinson, said: "We do occasionally take stakes. I did one in the past month. There are rules – if you like an investment in a client it has to be offered first to all partners so there is no trading on inside information."
In December 2009, law firm Blooston Mordkofsky Dickens Duffy & Prendergast said it was investing in a client, xG Technology, operating a mobile voice-over-internet protocol trial.
Less often, law firms structure themselves so the investment can be reciprocal. Last year in the UK, Matthew Hudson launched his law firm,MJ Hudson, with clients owning part of its business and also selling equity interests in lieu of some fees (see case study in related content).
There are a number of cultural and professional reasons that limit its use. Shafner said: "Lawyers are a very conservative group and so often see the downside of life and are trained to be sceptical.
"I say to entrepreneurs, ‘sell shares to those with a rosy outlook as lawyers tend to undervalue’, and then use the money to pay us the cash for our services."
He added: "Lawyers tend to be overzealous towards their clients, which tends to interfere with objectivity needed to have good investment judgement. A previous investment I made ahead of a German company’s initial public offering, or flotation(IPO) was for equity instead a $20,000 fee.
"At IPO, its shares rose to $310,000 in value, which even after the lock-up ended were still worth $125,000. But I held on and sold them for $5,000 and I am still writing off the loss against tax each year."
Hale said: "For those organisations structured as partnerships, these arrangements do give rise to some difficulty. One of the hardest issues is the ownership of these stakes.
"Since partnerships change in composition each year, those who are partners at the time the stake was bought will be different, possibly quite different, to those who will be partners when it is sold. How are the proceeds to be split between old and new partners?"
Partly for this reason, MJ Hudson has been structured to convert into a company when the UK opens the legal profession to outside ownership in October.
Accountants and auditors are similar to lawyers as technology has yet to undercut its services substantially or offer significant opportunities to gain an advantage over peers.
During the dot.com boom in the run-up to the millennium, accountants, which often had large consultancy practices alongside, were active investors in dot.com start-ups.
But while lawyers are advocates for their clients, accountants and auditors must remain independent enough for others to rely on the financialstatements provided about a company’s health in an audit.
This potential conflict of interest caused regulatory scrutiny by the main US financial regulator, the Securities and Exchange Commission (SEC).
Edward Cleary, then director of the Minnesota Officeof Lawyers Professional Responsibility, in a May/June 2000 article of Bench & Bar of Minnesota, said: "Most partners of PricewaterhouseCoopers (PwC), the world’s largest accounting firm, violated rules requiring that they not have investments in companies audited by their firm… the SEC said 31 of the 43 partners in the firms top leadership had committed at least one violation, as had six of the 11 partners responsible for enforcing the rules."
Cleary said: "The impact was significant." He said 52 of the largest companies in the nation that had been audited by PwC were informed by the SEC that, "due to the conflicts found within the accounting company, the integrity of the companies’ financial statements were at risk".
PwC and the others of the then big five firmsthat also took equity stakes were unavailable for comment.
Partly or primarily as a result of pressure by the authorities worried about conflictsof interest, after the dot.com bubble burst from 2001 there was greater demand for separating audits and other services or connections to clients.
Andersen, one of the then big five accountancy firms and one which had set up a $300m corporate venturing fund just before the millennium, broke up over public concerns about its closeness to the clients it had audited, such as energy group Enron.
When asked by Global Corporate Venturing, none of the six biggest accountancy firms that replied said they took stakes.
Cal Hackeman, managing partner of the private equity initiative at Grant Thornton, said: "I am aware that we had a short-lived fund during the dot.com boom – that is a long time ago, pretty much ancient history as far as I am concerned and nothing of consequence ever came of it as far as I know.
"As for corporate venturing in the services sector generally, I think you would do better to talk to someone outside the accounting and auditing industry. As you point out, the SEC is not keen on accounting firms doing this and as such it is not something that I even have on my radar."
A number of financial advisory, non-auditing boutiques, however, are understood to take small stakes as part of a longer-term mandate.
Consultants generally have no regulatory or other pressures that could cause a conflict of interest, and where they are advising on how companies can open up to third parties or make greater use of intangible assets, it is often a logical step to see if equity can be shared. However, with many of the large consultancy firms burned by taking stakes in dot.bombs around the millennium, such corporate venturing has largely been left to boutiques, with PA Consulting Group demerging its Ipen Capital in 2008.
Accenture, a management consultancy spun off from Arthur Andersen (with the accountancy operation retaining the name Andersen), is adviser to New York City’s NYC Partnership fund taking stakes in local companies.
However, Accenture’s spokesman said it was "not making investments but rather facilitating the overall programme".
Roland Harwood, co-founder of 100% Open, a UK-based consultancy spun out of UK government-backed National Endowment of Science Technology and the Arts last year, said: "As an open innovation agency we are all about helping organisations innovate with partners by sharing risk and reward.
"Therefore, we like to practise what we preach and are always looking for new business models ourselves, including reducing direct fees in exchange for a royalty or equity stake in the products, services or ventures that we help to create."
Jim Spanfeller, former executive president at news provider Forbes.com, left in July 2009 to set up a media management firmto run others’ websites in return for a percentage of the expense structure as a management fee and an equity stake in the online portion of the business.
At the time, he told news provider Folio: "We will train and put management in place, then turn the keys back to the publishers."
A decade after launching, Yet2.com, a US-based open innovation consultancy firm,formed its first fund in 2009 to help large companies’ corporate venturing investments drive value in their portfolio companies.
Last month, the firm set up its second Yet2 Ventures fund to provide follow-on investment and liquidity to small companies.
Ben DuPont, founder of Yet2 and manager of the Ventures fund, said: "Yet2 has been doing two transactions per month, but in 2009 we looked at why some deals were not closing and it came down to two reasons.
"First, a spin-out technology from a Fortune 500 company was unable to raise financig or, second, a small company was able to gain licences but not financeoff these contracts.
"Now, Yet2 can offer expertise and capital and we are really good at helping little companies grow and have jumped into the venture space with both feet.
"A quarter of the Fortune 500 companies round the world use our services from officesin Boston, Liverpool and Tokyo so we can help small companies find the right guy at Sony or Siemens as they are already our clients."
Design consultancy Method looks to take equity in about three-quarters of its smaller clients, such as Boxee, where it helped develop its business plan.
Kevin Farnham, chief executive of Method, which set up its Method Ventures corporate venturing unit in the past few years, said: "It makes sense to partner start-ups and companies in a second round as they are cash-strapped and want to come to market with as low an outlay as possible.
"It also shows a sense of togetherness, which is motivating for them and for Method employees. It is not a business driver for us but we are very quick to mention it as an option if we can cover our costs with cash and take the rest in equity."
However, he said it was difficult to gain equity in some highly-regarded start-ups if they could raise sufficient external funding elsewhere to pay its fees without using relatively expensive equity to do so.
British Design Innovation, the UK-based trade organisation for industrial designers and innovation professionals, told the local Design Council magazine the time was right for consultancies to consider different models, particularly those groups working in product development and innovation.
It said: "The design and innovation climate is changing rapidly. The challenges of convergence, tighter budgets, less risk-taking, free pitching, and the impact of international competition have all played their part in applying financial pressure to designers.
"As a result, strategic designers might now benefit from being more open to – and sometimes actually instigating – different payment models. By introducing an element of sharing and participation, there is an opportunity for the unique input of strategic designers to be more easily embraced and encouraged, and in a way which works to the benefit of all the parties involved in the innovation chain."
Intangible assets, such as brands built up through a service or intellectual property (IP) rights often based on patents, are notoriously difficult to value and judging the worth of contributions made and potential implications of using free open source software as code within a larger project is complicated (see related articles on IP, analysis on patents and Mark Radcliffe’s comment).
But while corporate venturing is useful as a tool to support existing relationships and share in potential benefits, it is often started and maintained in areas where there is substantial change and disruption through new technology or business models being developed that can affect incumbents.
There is also increased use of services as a way of maintaining or building customer relationships. The line between product and service is blurring, with information technology platforms increasingly hosted by remote third parties under a "software as a service" concept.
Virtual goods can also be more expensive than the physical equivalent despite the lack of production and shipping costs.
The latest book by Henry Chesbrough, executive director of the Center for Open Innovation at Haas School of Business in Berkeley University, Open Services Innovation, is more expensive to download to Amazon’s Kindle electronic reader than to buy as a hardback through the same online retailer (see box, below).
One services area undergoing significant change as a result of new technology and disruptive business models is marketing and advertising services.
Mid-sized and large firms,such as US-based Global Advertising Services through its Diversified Worldwide Holdings (DWH) corporate venturing unit, and UK-listed WPP, have sophisticated corporate venturing operations within a wider partnerships and business development model.
WPP, the world’s largest advertising company, is ranked the most influntial corporate venturing unit in the services sector for its scale and influenceon portfolio companies and within its sponsoring parent, according to Global Corporate Venturing (see table and profile).
In the mid-range, Jesse Williamson, vice-president of international client services at Global Advertising Strategies, said: "Global is unique – by being big enough to partner internationally, nimble enough to react quickly to unique opportunities, but small enough so that there is an outsized benefit to Global if the model is successful.
"There is a requirement for a certain scale, in order to maintain the management muscle necessary to integrate and do corporate venturing, creative investments and part-nerships of the type that Global facilitates internationally.
"We look for firmswhere there are synergies to Global, where Global can provide value-added services to the firmbeing acquired, or where Global can leverage the firms technology or service offerings on behalf of our clients.
"This leverage is derived either via preferred access or pricing, or by an ability to get a jump on industry trends via the perspective provided by Doug and DWH."
Doug Cress, director at DWH and Global, added: "DWH actively seeks new opportunities for Global and its partners – this may include investment in public companies, earlier-stage ventures, or companies operating in neighbouring verticals with a solution that can be repurposed to fit Global’s needs."
Cress set up DWH after his previous start-up was acquired by Global, and structuring these types of opportunity can be an important way to retain talented staff.
Last month, Chris Clarke, as executive director and co-chief creative officerof integrated marketing and technology services company SapientNitro, part of Nasdaq-listed Sapient, left to set up his venture capital group and launch two brands later this year.
But Clarke, who has linked with investor Ray Chambers of Wesray Capital and Chris Burch, co-founder of Tory Burch, for his new venture, will remain working closely with SapientNitro through a strategic consulting arrangement.
Services is growing in global importance and covers a broad spectrum, from property developers Lend Lease, which operates probably Australia’s largest corporate venturing unit under Anthony Pascoe, to Japan-based Transcosmos (see related content for Q&A).
In developing countries, the share of their gross domes-tic product generated by services has been growing – from 37% in 1970 to 45% in 2006, according to the Global Services Coalition in its September report.
Vijay Shekhar Sharma, chairman and managing direc-tor of India-based phone services provider One97 Communications, which set up its One97 Mobility Fund, said: "At this stage of One97, we want to keep the innovation momentum going on. In order to continue to lead the sector, we could either build products ourselves or invest in the products that will be game changers.
"While we do the firstone aggressively anyway, the second strategy makes a lot of sense to us as the [lessons] in the mobile value-added service [sector] are immense and are ready to be shared with the next generation of entrepreneurs.
"The dynamics of the sector have ensured there are enormous opportunities outside companies such as ours."
Services provide a way to magnify the opportunities in other sectors, such as agriculture and manufacturing, as well as being a potentially high-margin good itself and one that is increasingly international itself.
Services exports grew from $365bn in 1980 to $3,800bn in 2008, according to the Global Services Coalition in its September report.
As globalisation and technology encourages innovation globally and in all sectors, the services industries provide the lubrication to discover, understand and use the opportunities created.
Open Services Innovation
Henry Chesbrough, executive director of the Center for Open Innovation at the Haas School of Business in the US, has called on technology, or product, companies to develop services to escape a "commodity trap".
In a presentation on the Management Innovation Exchange forum hosted by consultant Gary Hamel, Chesbrough said rather than services being the last thing in a value chain the model needed to be updated to create a services value web (see graphic).
The model is part of Chesbrough’s latest book, Open Services Innovation, released last month.
Chesbrough, who coined the term "open innovation" in a book in 2003, said: "Great ideas these days are everywhere. This is the principle behind open innovation and other ideas. It requires a change of mindset to make use of these ideas."
He said companies faced a "commodity trap" when the company was only as good as its next product. To "escape the trap" Chesbrough said companies needed to wrap services around a product, turn a product into a solution, co-create with customers in order to use openness to get more from specialisation and build a platform to attract others to the solution.
A solution rather than a product meant saying a customer wanted a hole rather than a drill that creates one, he added.
Chesbrough added that companies and managers needed to increase the utilisation of their assets by thinking how they could be used by other people and not necessarily bundling it into the product without a charge.
In answer to a question by Hamel, Chesbrough said companies needed to create a coalition of developers using its plat-form by sharing revenues.
Buy the book at openinnovation.haas.berkeley.edu