8
Organizing for Growth: The Separate-but-Connected Model
Deciding on the right organizational structure for a new business is a major challenge. As with all organizational decisions, it involves trade-offs. Tighter integration with the core business may enable the new venture to leverage corporate assets more easily. It can also reduce overhead, which can be a significant cost for a small entity. Finally, if a new business is integrated with the core business, it is less likely that the new business will be permitted to disrupt ongoing operations in the core.
Operating as a separate entity, on the other hand, allows the new venture to develop ways of doing things that are more appropriate to its status. It also protects the venture from political and budgetary challenges, which are deadly to many internal startups. Unfortunately, a separate entity inside a corporation often finds it difficult to leverage assets from the core business when it comes time to scale—and these assets may be at the very heart of competitive advantage.
According to Vijay Govindarajan, whose interview is included in this chapter, a new venture needs to do three things to operate successfully within the context of a larger business. It needs to forget some things, borrow others, and have the flexibility to learn still others.
Forgetting means walking away from deeply embedded assumptions that are not relevant to the new business. Many of the things to forget relate to the business model: Who the customers are, how they will be reached, what the nature of the offering is, and what level of support will be provided to customers. A new venture risks being shoehorned into the core business’s existing business model, to the detriment of both. Any truly new venture must question the assumptions held deeply by the core—figuring out which fit the new venture and which should be discarded.
A new venture inside a corporation also needs to borrow assets from the core business. The borrowed assets are the basis for competitive advantage for the new venture. Govindarajan estimates that a new venture inside a corporation should strive to have 40% of its required core competencies built on those of the core business. Leveraging these assets increases the chance that the new venture will be successful in the marketplace; it helps the venture to create a competitive advantage and overcome the disadvantages that derive from its corporate context.
Leveraging corporate assets is not easy. Borrowing assets from the core business creates immediate fears in the core: Fear that the new business will undermine the smooth functioning of the core; fear that it will succeed by cannibalizing the existing business; fear that the new business will bleed needed resources, both financial and human, from the core (which is already operating with demanding objectives). These fears must be managed if the assets are to be borrowed, which means that the manner in which these assets will be used and accounted for needs to be carefully designed and documented.
Of course, any new venture also needs to continue to learn what is necessary for success in its marketplace. Learning continues even once the business is in the market and being incubated. This in-market learning is an extension of the “with market” learning that was required to develop and test the offering and the business model. In order to do in-market learning, the venture needs a degree of independence. It must be able to make decisions quickly—about hiring, approaching customers, working with partners, or even competitors. The bureaucracy of the core business will suffocate the new venture if it is managed as part of the operating business.
The Separate-but-Connected Organizational Model for New Ventures
Govindarajan and Trimble propose that the tensions between a new venture and the core can best be balanced by setting up the new venture as an independent structure, with negotiated ties to the core business (see Figure 8.1). The NewCo sits parallel to the existing business. While it has many of its own functions, it leverages the necessary capabilities of the core business through carefully negotiated agreements. The nature of these agreements varies by company and by venture.
The Separate-but-Connected model adapted from Govindarajan and Trimble, 2010
Take as an example the Proactive Services business developed at Goodyear, discussed earlier in this text. The Proactive Services business monitors tires on commercial fleets in real time. It uses predictive analytics to alert customers of trucks that are at risk of a roadside tire failure due to poor tire maintenance. The concept relies on sensors, telematics, and cloud-based algorithms to create value. It must provide alerts for all tires, including those of competitors used by the fleet.
To succeed, the model needs to:
- “Forget” or relax the assumption that the company is a product company
- “Forget” the customer contact point within the customer to whom the offering will be sold, since the value proposition includes more than tires
- “Forget” or accept the fact that the offering may cannibalize roadside service and replacement tires.
It also needs to:
- “Borrow” access to customers
- “Borrow” access to the company’s call center and service network
- “Borrow” the brand.
Of course, it also needs to continue to “learn” about costs, pricing, market segmentation, technology gaps, and other elements of the business model. This learning may crosscut what the core business has already learned and internalized.
Some of the assumptions about what to forget and what to borrow have obvious practical implications, but some are subtle. Although many ventures try to borrow the core company’s sales force, for example, product salespeople can rarely sell a solution well. Trying to borrow this resource almost always fails. Similarly, the accounting system for a product business is very different than that of a services company, so services revenues will require both a specialized set of accounts and reconciliation with the corporate General Ledger system. This may not be obvious at first.
Proactive Services addressed these issues through a series of specific agreements, including, for example:
- Sales—A separate sales force for the new venture approached customers together with sales representatives from the core business; credit for any tire sales went to the representative of the core while credit for the services revenue went to the NewCo salesperson
- Product—Product required by the new business was purchased at “most favored nation” prices from the core business
- Service—Access to the service network was integrated into the new business; the cost of services was passed through to the services business P&L with no mark-up
- Customers—The new business updated customer records for the core business; the core maintained the master customer record; the NewCo maintained elements specific to its business.
Often, it is difficult for a business to accept the “Separate-but-Connected” model. Setting up a new business unit seems like a lot of overhead. The business argues that it currently manages a wide variety of projects; why should this one be so different?
Govindarajan’s research with many companies shows that it is. Everything in a well-functioning and established business optimizes the dominant business model. Its distilled principles become the governing variables for important decisions about the new venture.
When there is a conflict, the dominant business model almost always wins. Without a separate organizational structure, the innovative venture almost always loses over time.
Sometimes, this dilemma plays out dramatically and publicly.
Kodak set up a separate digital photography business in 2001. By 2005, its EasyShare product was the leading digital camera. The core business was under financial pressure, however, and Kodak decided to merge the new unit into the core film business in an effort to reduce duplicate overheads. In short order, the digital business was starved for resources and shut down [Christensen, 2015].
Xerox famously invented the office of the future at the Xerox Palo Alto Research Center. The inventions included the first personal computer (the Alto), the bit-mapped computer display (including the desktop and icons), the mouse, the Ethernet, the laser printer, the first object-oriented computing language, and many other innovations. The company tried to bring the personal computer to market to large businesses through its direct sales force, but the costs of this channel were too high for personal computers. Both the target customer and the channel were mismatched with the product. Xerox profited from some of the innovations (like the Ethernet and the bit-mapped computer display) by incorporating them into its copier business, but it missed the potential of these innovations because they were trapped in its core business model.
Even Amazon had to separate the Marketplaces business from the core business in its early days. It found, when the Marketplaces business was just starting, that the core e-tail business resisted the idea of opening up its customer base to competitors—especially exposing, in some cases, competitor prices that were better than those of Amazon! [Rossman and Euchner, 2018].
Overcoming Resistance
In practice, setting up a separate business unit is politically fraught. The first argument is that it is not necessary. Running a new business as a separate unit will create duplicative overhead, make it harder to leverage resources like the sales force, and increase the risk of confusing customers with multiple offers.
One useful practice for overcoming this reluctance to form a separate operating unit is to engage decision-makers in a case study of companies that have faced the same dilemma. At Goodyear, when trying to make the organizational decision for Proactive Services, we worked with Chris Trimble, Govindarajan’s co-author, to review the dilemma faced by the New York Times as it considered the organizational structure for the new digital arm of the paper [Trimble, 2002]. The case was different enough from Goodyear’s business to enable people to unlock from their organizational assumptions but, at the same time, highlighted a key issue that we faced. The leadership of the global commercial tire businesses participated actively in the discussion. At the end of the three-hour session, all participants recommended proceeding according to the Separate-but-Connected structure, at least for incubation. During that session, we also identified the key agreements that needed to be negotiated between the NewCo and the core business.
Another useful practice is to create a sequestered fund for the incubation of new businesses. This fund can be used for no other purposes; it is set aside so that it is available when a business is ready to go to market. The incubation fund takes away one of the major impediments to beginning incubation: The need to carve out the budget for doing so.
Incubation is for learning two key things: Whether the new business is profitable and what the alternative models are for bringing the business to scale. Once incubation is complete, the organizational decision must be considered again. The business-building strategy, for example, may be better executed by reorganizing some of the assets of the existing business as part of the NewCo. It may include an acquisition, which itself will have organizational implications. Or it may become clear that the NewCo can thrive within the structure of the core. I have seen all of these decisions succeed, as well as the decision to simply invest in the NewCo so that it can grow organically as an independent business. The right structure depends on circumstances. The key is to carefully reconsider the organizational question at key decision points and to do so with clear eyes.
Vijay Govindarajan on Making Strategic Innovation Work
In 10 Rules for Strategic Innovators and The Other Side of Innovation, Vijay Govindarajan and Chris Trimble discuss what it takes to innovate inside established companies [Govindarajan and Trimble, 2005, 2010]. They emphasize three concepts: Forgetting lessons from the past that may inhibit progress on a new venture; focusing on learning and clarifying key assumptions in the early stages of innovation; and consciously borrowing appropriate assets from the parent organization. These concepts may seem simple in principle, but they can be difficult to put into practice. The interview excerpt with Govindarajan included in this chapter discusses the practical implications of these ideas for innovators seeking to innovate within larger organizations [Govindarajan and Euchner, 2010].
Making Strategic Innovation Work
An Interview with Vijay Govindarajan
If you’re serious about spending money to innovate a new business model, then get serious about the organizational question, because if you don’t get that right, the opportunity is never going to materialize. When I’m asked for advice, I look into the CEO’s eyes and say, “If you are really serious about innovation, you’ve got to make some tough, important decisions up front.” …
[Some of these decisions involve structure. In deciding how to structure for innovation,] the criteria to use is whether the innovation is breaking away from your current business model [or not]. You need to really think critically about the business model [implications] …
A business model answers three questions: Who’s your customer? What value is the customer seeking? And what is the process by which you’re going to create that value? For your core business you have evolved an answer to these three questions.
If you are launching a new venture, and the innovation breaks away from your core business in its answer to any one of these three questions, then I’d say that you have to overcome [what I call] the forgetting challenge [emphasis added]. And one of the most effective ways to do that is to set up a separate venture …
[The second challenge is] the learning challenge [emphasis added]. The reason you’re experimenting is that you have a lot of unknowns. You want to get at least some firm understanding of what those unknowns are before you scale up and spend large amounts of resources. My golden rule is “spend a little, learn a lot.” Because there are so many assumptions, you may be tempted to spend a lot. But in the experimental stage, what you’re trying to do is to focus on your critical assumptions: those in the showstopper category and those in the category that requires you to fundamentally rethink your business strategy …
[The borrowing challenge is one of deciding what you should] borrow from the host company to make a venture worth pursuing internally. [I do not suggest] moving into areas where you cannot leverage any of your critical assets. In that case, you would have no competitive advantage and the venture would be a pure startup. Pure startups, in Silicon Valley or somewhere else, have a big advantage in that they’re not burdened by bureaucracy. They are nimble; they are fast; they can move. But the biggest advantage of a large company … is its large resources, the established customer relationships, the core competencies. The only way the [large companies] of the world can win is by entering new spaces where they can leverage their capabilities.
[T]he projects with the most chance of success are what I would call adjacency-oriented new business model innovation. By adjacency, what I mean is adjacent to your core business. So, you are taking your current core competencies to a new customer. Or taking your core competencies and satisfying a need of your current customer better. Or taking your current competencies and pushing out into an adjacent space. Adjacency-oriented new business model innovation will utilize probably seventy-five percent of your core competencies.
The next step of innovation is what I call step-out. Step-out is not adjacency: you’re stepping out of your core. [For Step-out adjacencies], if you have fifty percent of [the core competencies required] inside, I think that’s a good step-out opportunity.
[Finding the balance between forgetting and borrowing can be difficult.] Using the framework [in Ten Rules for Strategic Innovators], you can increase your chances of getting it right on day one. It’s better to get it right on day one, because if you overplay the forgetting challenge or underplay the borrowing challenge, you isolate and reduce the chances of success. The core business can sometimes squash such a venture.
On the other hand, if you keep the venture too close in order to maximize borrowing, then it may not have the ability to move to a new business model. The needs to forget and to borrow can pull you in different directions. It is possible to strike the right balance on day one, but keep an open mind because it may need to evolve. …
[A key challenge companies have is how to] move from a large set of ideas to a few that you experiment with, and how [to] select the ones to scale up? I would say the following: most companies do it wrong because they only focus on the financial attractiveness of an idea. Financial attractiveness is fine, but I would ask another set of questions. For each of the ideas that you have, try to understand the assumptions you are making in order for this to be an attractive idea. Any kind of financial justification you can make for these ideas is all guesswork anyway, because there are so many unknowns. So instead, ask the question, what are the assumptions we are making for this idea to be a very profitable idea?
Take the assumptions that you are making and classify those assumptions into three groups. First are the showstopper assumptions; if these go wrong, the game is over. The second set of assumptions [are] those that require you to fundamentally rethink your strategy. And the third group of assumptions is ones you can tweak as you implement.
For … NewCos, the operating review has to focus on the assumptions, because when you prepare your financial projections for a new venture, it’s guesswork … In the operating review, I want to focus on the ten assumptions that you identified up front, the critical assumptions. Use the operating review to tell me the experiments that you have done. Tell me what you have learned and how you are revising your plan as a result. Preparing a plan is important for clarifying the assumptions. Then you revise the plan based on what you have learned about those assumptions. That’s what I’m going to judge NewCo on.
Key Insights
- Organization of a new business within an existing business is a critical issue
- The most successful practice is the formation of a separate NewCo with clear agreements with the core business about who does what, who will pay for what, and how joint work will be managed
- The organizational issue needs to be considered twice: First at incubation and then again at scale
- An incubation fund, sequestered for the sole purpose of incubating new businesses, is a key enabler in most companies.