The quote “I know that half of my budget is wasted, but I’m not sure which half” was not uttered by a corporate venturer, nor by his or her chief executive but it perhaps should have been.
Depending on the side of the Atlantic, the well-known dictum is attributed to Lord Leverhulme, Unilever’s founder, or John Wanamaker, father of the modern department store, as they pondered the challenges associated with their advertising activities.
Nowadays, innovation is as critical to business success as marketing. In addition to internal research and development, firms are increasingly pursuing innovation through engagement with external partners.
Corporate venturing (CV) in particular emerges as a part of a firm’s innovation tactics (Innovation and Commercialization 2010: McKinsey Global Survey results).
Moreover, evidence suggests that although CV investment shares the aforementioned challenges, the current (fourth) wave of CV activity exhibits notable structural changes.
The 21st century hosts the most recent wave of corporate venturing after three earlier, short-lived periods in the 1960s, 1970s and 1990s. Dozens of firms have joined the corporate venture group of US trade body the National Venture Capital Association since late 2003, including 10 this year, and a number of leading corporations remained committed to CV investment even during the sharp declines and despite significant financial losses.
Although the absolute dollar amount of CV is far from its peak, corporate investors have accounted for about 15% of venture capital activity each year since the mid-1990s.
In many respects recent activity has much in common with the previous CV wave. Corporate investments continue to parallel broader interests of their independent counterparts – internet-based ventures remain a major investment target, as do other traditional venture capital target industries, such as semiconductors, telecommunication equipment and biotechnology.
The rapid growth of clean energy has attracted independent and corporate venture capitalists alike. However, there has been a marked realignment in investment activity.
The software and telecom sectors, which dominated CV portfolios in the 1990s, continue to attract significant but reduced corporate investment. Biotechnology ventures account for almost 20% of aggregate CV investment, up from about 5% in the previous decade.
The semiconductor sector exhibits a similar pattern. The realignment in the aggregate CV portfolio is driven by several factors. First, it reflects, in part, the return to moderate valuations of internet-related ventures.
Second, it also captures a shift in the interests of CV investors. The energy and industry sectors attract significant attention from independent venture capital funds and have experienced a surge in venture formation, which in turn stimulates CV investment.
Along these lines, it is important to note that some corporations invest in ventures that operate in their own sector while others invest in neighbouring sectors.
For example, nearly 50% of all CV investment by chemical and pharmaceutical companies went into ventures within those sectors, while only 18% of all CV investment by semiconductor firms went into semiconductor ventures. Finally, the maturity of certain sectors as well as currency fluctuations may also affect the relative breakdown of CV portfolios.
These patterns repeat in terms of the geographical diversity of CV investment. For instance, a growing fraction of CV portfolios includes ventures based outside the US, including many ventures in developing countries.
The fraction of CV investment in US-based venture declined from 88% between 1991 and 2000 to 75% between 2001 and 2009 (in nominal amounts). UK-based ventures continue to account for 2% of total CV investment.
The relative fraction of developing countries is on the rise. China-based ventures account for 4% of total investment during the fourth wave, up from 1% during the previous wave. And India entered the top five recipients of corporate venture capital, accounting for 1% of global CV investments.
The geographical location of CV programmes remains largely unchanged. We report key data below yet opt not to present graphical breakdown. Data provider VentureXpert records a slight decrease in the fraction of investment disbursed by US-based corporate investors: down from 83% (1991 to 2000) to 78% (2001 to 2009).
During the earlier period, top CV originating countries included Japan (5%), Canada (3%), Singapore, Hong Kong, Germany, the UK, South Korea, and Sweden (1% each). During the later period, top CV investors were based in Canada (6%), South Korea, United Kingdom, Japan, Germany (2% each), Singapore, China, Hong Kong, Switzerland, Israel, France and the Netherlands (1% each).
These numbers may mask the role of non-US CV investors as many of them are coded as US-based though the parent corporation is not headquartered in the US, such as Panasonic Ventures or Mitsui & Company Venture Partners.
Finally, the fact that CV, in aggregate, tends to originate in and reach the same country does not necessarily mean funds are invested domestically. As we discuss below, CV is used at times to learn about geographically distant markets or to access distant technologies.
On closer investigation, the fourth wave features a critical structural change. It is now the case that an increasing number of corporations view CV as a key component of their innovation strategy.
Structural Changes and Greater Longevity
Evidence on CV longevity seems to support that observation. In the past, the average lifespan of a CV programme was 2.5 years, or a third of the average span of 7.1 years for independent venture capital funds, according to academics Paul Gompers and Josh Lerner.
It was often suggested that a chief executive launched a CV programme only for it to be terminated by his or her successor. Nowadays the average CV programme has been in operation for 3.8 years, and many notable programmes are entering their second decade of activity.
Additional analysis reveals that between 2000 and 2009 there were upwards of 350 corporate investors and over 40% of them had been in operation for four years or longer, nearly double the length of those in the previous three waves. Indeed, over 80% of the 37 respondents to an Ernst & Young survey, Global Corporate Venture Capital Survey 2008 to 2009, (on which Dushnitsky was on the advisory board,) have had a corporate venturing programme in play for five years or more.
As the figure illustrates (click to see pie chart), the change is driven by significant persistence in venturing activity. The fraction of corporations that engage in equity investment as a oneoff activity – that is, invest only for a single year – is cut in half, while the fraction of those that invest for four years or longer has doubled.
The sustained commitment to CV investment alludes to the key role it has in a firm’s innovation strategy. This change did not happen overnight. Rather, it reflects a broader transition in corporate research and development (R&D) strategies: shifting away from an exclusivefocus on internal R&D, which, at the extreme, can lead to introvert behaviour, and towards embracing external sources of ideas and innovations – also known as the trend towards Open Innovation.
In that context, corporate venturing can be viewed as a vehicle for engaging and learning from one particularly innovative pool – that of entrepreneurial ventures.
As such, CV investment is an integral part of a firm’s innovation toolkit. Whereas the roots of the change have to do with a broader shift in corporate R&D strategies, the implication to corporate venturing activity remains unclear. Many scholars and practitioners viewed the limited lifespan characteristic of past CV waves as a major hurdle.
It creates internal challenges in terms of attracting talent and staffing the CV programme. It also leads to external difficulties and stifles dealflow: independent venture capitalists may hesitate to co-invest alongside an entity that could be dissolved by the time a follow-on funding round is needed.
The greater stability of current CV programmes has the potential to mitigate both internal and external challenges. The net impact on CV activity, however, has yet to play out in the data. The history of corporate venturing offers several insights.
At the macro level, the emergence of novel technologies is an important driver of CV investment as established firms seek to harness innovative entrepreneurial ventures. The financial markets played a key role as well. Not only did they serve as catalysts for entrepreneurial activity to begin with, but they also facilitated the transformation of new technology into high financial returns.
Interestingly, as CV becomes an integral part of a firm’s innovation strategy, it may be sensitive to the former factor – technological ferment – at the expense of the latter – financial markets. More recent changes in the macro environment, including the growing globalisation of venture capital activity and the shuffling of target sectors, is likely to shape the future face of CV investment.
At the corporate level, we continue to observe CV investment is predominantly a large company phenomenon. It is undertaken mainly by incumbents in turbulent industries as a response to Schumpeterian competition. This observation, as well as programmes’ greater longevity, suggests that CV activity is now an integral part of a firm’s external venturing strategies, also known as Open Innovation.
This is an edited version of a forthcoming chapter, Corporate Venture Capital in the 21st Century, in The Oxford Handbook of Entrepreneurship, Oxford University Press,
© Dushnitsky 2010