Entering new businesses : selecting the strategies for success

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WORKING PAPER
ALFRED P. SLOAN SCHOOL OF MANAGEMENT

Entering New Businesses:
Selecting the Strategies for Success

Charles A. Berry+
F.dward B. Roberts^

October 1983
WP# 1492-83

MASSACHUSETTS

INSTITUTE OF TECHNOLOGY

50 MEMORIAL DRIVE

CAMBRIDGE, MASSACHUSETTS 02139

Entering New Businesses:
Selecting the Strategies for Success

Charles A. Berry+ October 1983

ndward B. Roberts* WP# 1492-83

+ MIT Program in the Management of Technology,
and Pilkington Brothers Limited

* MIT Sloan School of Management

-1-

ABSTRACT

Selection from the alternative strategies available for entering new
businesses is a key issue for diversifying corporations. Alternative
approaches include internal development, acquisition, licensing, joint
ventures, and minority venture capital investments. An intensive liter-
ature review is used to devise a matrix of company "familiarity" with
relevant market and technological experiences and to demonstrate the con-
ceptual utility of the matrix for entry strategy choice. Performance data
on 14 business development episodes by one successful diversified techno-
logical firm are used to support the selection concepts embodied in the
"familiarity matrix".

LITERATURE REVIEW

Extensive writings have focused on new business development and the various
mechanisms by which it may be achieved. Much of this literature concentrates
on diversification, the most demanding approach to new business development, in
which both the product and market dimensions of the business area may be new
to a company.

Rumelt has developed a now widely accepted scheme for classifying di-
versified companies. This scheme combines the extent of diversification with
a measure of the relatedress of the various businesses forming the company.
Although Rumelt identified nine types of diversified companies, these fell into
three basic categories: Dominant Business Companies, Related Business Companies
and Unrelated Business Companies. On analysing the performance of companies
within these categories, Rumelt concluded that Related Business Companies out-
performed the averages on five accounting-based performance measures over the

period 1949 to 1969.

12
Peters supports Rumelt':; conclusions on the superior performance of

related business companies. In his study of 37 "well managed" organizations

he found that they had all been able to define their strengths and build upon

them. They had not moved into potentially attractive new business areas which

required skills that they did not have. In their recent book Peters and

13
Waterman classed this as "sticking to the knitting".

Even in small high technology firms similar effects can be noted. Re-
cent research by Meyer and Roberts on ten such firms revealed that the most
successful firms in terms of growth had concentrated on one key technological
area and introduced product enhancements related to that area. In contrast,
the poorest performers had tackled "unrelated" new technologies in attempts to
enter new product-market areas.

-3-

The research work discussed above tends to indicate that in order to ensure
highest performance, new business development should be constrained within
areas related to a company's base business - a very limiting constraint. How-
ever, no account was taken of how new businesses were in fact, entered and the
effect that the entry mechanism had on subsequent corporate performance.

Possible entry mechanisms are now examined.

/'

Internal Development. Companies have traditionally approached new business

development via two routes: internal development or acquisition. Internal

r development exploits internal resources as a basis for establishing a business

^ new to the company. Biggadike studied FORTUNE 500 companies that had used this

approach in corporate diversification. He found that typically 8 years were

needed to generate a positive return on investment, and performance did not

match that of a mature business until a period of 10 to 12 years had elapsed.

19
However, Weiss asserts that this need not be the case. He compared the per-
formance of internal corporate development with comparable businesses newly
started l)y individuals and found that the new independent businesses reached
profitability in half the time of corporate effort - approximately 4 years
versus 8 years. Weiss attributes this to the more ambitious targets established
by independent operations, and sees no reason why large corporations should not
be able to achieve comparable performance levels.

Miller indicates that forcing established attitudes and procedures upon
a new business may severely handicap it, and suggests that success finally may not
come until the technology has been adapted, new facilities have been established,

or familiarity with the new markets has developed. This last factor is very

4
important. Gilmore and Coddington believe that lack of familiarity with new

markets often leads to major errors.

Acquisition. In contrast to internal development, acquisition can take weeks
rather than years to execute. This approach may be attractive not only be-
cause of its speed, but it may also offer much lower cost of entry into a

17
new business or industry. Salter and Weinhold point out that this is parti-
cularly true if the key parameters for success in the new business field are
intangibles such as patents, product image or R§D skills which may be difficult
to duplicate via internal developments within reasonable costs and timescales.
Miller believes that a diversifying company cannot step in immediately
after acquisition to manage a business it knows nothing about. It must set up
a communication system that will permit it gradually to understand the new
business. Before this understanding has developed, incompatibility may exist
between the managerial judgment appropriate for the parent and that required
for tlic new subsidiary.

Anti-trust legislation may be yet another complication in acquisition.

I 8
Shanklin discusses potential impacts, stressing that a company in a dominant

industry position may have great difficulty extending its base business by

acquisition. Indeed such companies may even encounter problems in internal

development.

I Licensing. Acquiring technology through licensing represents an alternative

1 8

\ to acquiring a complete company. Killing discusses licensing as a vehicle

^f- for product diversification, pointing out that it avoids the risks of product

development by exploiting the experience of firms who have already developed
1

and marketed the product.

Roberts mentions that many corporations are now adopting new venture

strategies in order to meet ambitious plans for diversification and growth.

Internal Ventures. Internal ventures have some similarities to internal de-

"^

velopmcnt, which has already been discussed. In this venture strategy, a firm
S*:^/ attempts to enter different markets or develop substantially different products
' from those of its existing base business by setting up a separate entity within
the existing corporate body. Overall the strategy has had a mixed record, but
some companies such as 3M have exploited it with considerable success. This
is due to a large extent to their ability to harness and nurture entrepreneurial
behavior within the corporation. Fast^ agrees that internal venturing has had
a mixed record, and suggests that major corporations can learn more details of
the venture development process by studying venture capitalists. He cites, as
examples, 3M and Coming who have invested as limited partners in venture capital
partnerships. This involvement in business development financing can keep the
company in touch with new technologies and emerging industries as well as pro-
viding the guidance and understanding of the venture development process
necessary for more effective internal corporate venturing.
Joint Ventures. Despite the great potential for conflict, many companies success-

9
fully diversify and grow via joint ventures. Killing points out that as pro-
jects get larger, technology more expensive and the cost of failure too large to
be borne alone, joint venturing may become increasingly important. Shifts in
national policy in the United States are now encouraging the formation of several
large research-based joint ventures involving many companies.

Hlavacek et al. and Roberts believe one class of joint venture to be of
particular importance - "new style" joint ventures. This refers to situations
in which large and small companies join forces to create a new entry in the
market place. Primarily the small company provides the technology, the large
company provides marketing capability and the venture is synergistic for both
parties.

-6-

Venture Capital and Nurturing. The venture strategy identified by Roberts
which permits the lowest level of corporate commitment is that associated with
external venture capital investment. Major corporations have exploited this
approach in order to participate in the growth and development of small companies
as investors, participants or even eventual acquirers. Roberts points out that
this approach was popular as early as the mid-to-late 1960s with many large
corporations such as DuPont, Exxon. Ford, General Electric and Singer, Their
motivation was the opportunity to secure entry into new technologies by taking
minority investments in young and growing high technology enterprises. However,
few companies in the '60s were able to make this approach by itself an important
stimulus of corporate growth of profitability. Despite this, ever increasing
number of companies today are experimenting with venture capital, many showing
important financial and informational benefits.

Studies carried out by Greenthal and Larson show that venture capital in-
vestments can indeed provide satisfactory and perhaps highly attractive returns,

14
if they are properly managed. Rind distinguishes between direct venture m-

v'estments and investment into pooled funds of venture capital partnerships.
He points out that although direct venture investments can be carried out from
within a corporation by appropriate planning and organization, difficulties are
often encountered due to a lack of appropriately skilled people, contradictory
rationales between the investee company and parent, legal problems, and an
inadequate time horizon. Investment in a partnership may remove some of these
problems but if the investor's motives are other than simply maximising fin-
ancial return, it may be important to select a partnership concentrating invest-
ments in areas of interest. Increasingly corporations are trying to use pooled
funds to provide "windows" on new technonogies and new markets, but these re-
quire special linkages with the investment fund managers.

-7-

In situations where the investing company provides managerial assistance
to the recipient of the venture capital, the strategy is classed as venture
nurturing rather than pure venture capital. This seems to be a more sensible
approach to diversification than a simple provision of funds, but it needs to
be tied to other company diversification efforts.
Summa ry

Major prior research work on large U.S. corporations has indicated that
highest performers had diversified to some extent but had constrained the de-
velopment of new business within areas related to the company's base business.
The range of mechanisms available for entering new businesses and a summary of
various advantages and disadvantages of each mechanism is given in EXHIBIT 1.

These various entry mechanisms require different levels of corporate in-
volvement j EXHIBIT 2 therefore extends Roberts' earlier "spectrum" of venture
strategics to include internal development and acquisition. The resulting
array of entry strategies is divided into three regions, each requiring a
different level of corporate involvement and commitment. Note that this spec-
trum includes an entry mechanism not discussed in the above literature - the
"educational" acquisition. The purpose of an acquisition of this type is to
provide a more transparent window on a new technology than a venture capital
investment. This mechanism will be discussed in more detail in later sections.

No one mechanism is ideal for all new business development. It may there-
fore be possible that selective use of entry mechanisms can yield substantial
benefits over concentration on one particular approach. If this is valid, then
perhaps there are ways to reduce the risk associated with new business de-
velopment in unrelated areas.

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EXHIBIT 1

ENTRY MECHANISMS: ADVANTAGES AND DISADVANTAGES

NEW BUSINESS

nr.vni.opMENT

MECHANISM

MAJOR
ADVANTAGES

MAJOR
DISADVANTAGES

INTERNAL
DEVEI.Ol'MENT

Uses existing
resources

Time lag to break
even tends to be
long (on average
8 years)

Un familiarity with
new markets may
lead to errors

ACQUISITION

Rapid market
entry

New business area
may be unfamiliar
to parent

Impacts of anti-
trust

LICENSE

Rapid access to

proven

technology

Reduced financial
exposure

Not a substitute
for internal
technical competence

Not proprietary
technology

Dependence upon
licensor

INTERNAL
VENTURE

Uses existing
resources

May enable company
to hold a talented
entrepreneur

Mixed record of
success

Corporation's
internal climate
often unsuitable

JOINT

vi;nture

Technological/
marketing unions can
exploit small/large
company synergies

Distribute risk

Potential for
conflict between
partners

VliNTURi;
CAPITAI,

Can provide window
on new technology
or market

Unlikely alone to
be a major stimulus
of corporate growth

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EXHIBIT 2
SPECTRUM OF ENTRY STRATEGIES

INCREASING CORPORATE INVOLVEMENT

'm/m///A

•
•

• ••

• ••

•
•

INTERNAL
DEVELOPMENT

LICENSE

^ VENTURE
CAPITAL

ACQUISITION

INTERNAL
VENTURE

JOINT
VENTURE

"EDUCATIONAL"
ACQUISITION

■10-

ENTRY STRATEGY: A NEW SELECTION FRAMEWORK

New l)usincss development may address new markets, new products or both,
in addition, these new areas may be ones that are familiar or unfamiliar to
a company. Let us first define "newness" and "familiarity":

"NEWNESS OF A TECHNOLOGY OR SERVICE"

- The degree to which that technology or service has
not formerly been embodied within the products of
the company.

"NEWNESS OF A MARKET"

The degree to which the products of the company
have not formerly been targeted at that parti-
cular market.

"I'AMIIJARITY WITH A TECHNOLOGY"

The degree to which knowledge of the technology
exists within the company, not necessarily em-
bodied in products.

"FAMILIARITY WITH A M.ARKET"

- The degree to which the characteristics and business
patterns of a market are understood within the company,
not necessarily as a result of participation in the
market .

If the businesses in which a company presently competes are its BASE
businesses, then market factors* associated with the new business area may be

* Here, "market factors" refers not only to particular characteristics of the
market and the participating competitors, but also includes the appropriate
pattern of doing business that may lead to competitive advantage. Some al-
ternative patterns are performance/premium price and lowest cost producer.

-11-

characterized as BASE, NEW FAMILIAR, or NEW UNFAMILIAR. Similarly, the tech-
nologies or service embodied in the product for the new business area may be
characterized on the same basis. EXHIBIT 3 illustrates some tests that may
be used to distinguish between "base" and "new" areas. EXHIBIT 4 lists
questions that may be used to distinguish between familiar and unfamiliar
technologies. (Equivalent tests may be applied to services). Questions to
distinguish between familiar and unfamiliar markets are given in EXHIBIT 5.

The application of these tests to any new business development opportunity
enables it to be located on a 3x3 technology/market FAMILIARITY MATRIX as
illustrated in EXHIBIT 6. The nine sectors of this matrix may be grouped
into three regions, with the three sectors comprising any one region having
broadly similar levels of familiarity. These three regions are illustrated
in liXllllUT 6.

WliJch entry strategies are appropriate in the various regions of the
familiarity matrix? The literature provides some useful guides.

In his discussion of the management problems of diversification, Miller
proposes that acquisitive diversifiers are frequently required to participate
in the strategic and operating decisions of the new subsidiary before they are
properly oriented towards the new business. In this situation the parent is
"unfamiliar" with the new business area. It is logical to conclude that if
the new business is unfamiliar after acquisition, it must also have been un-
familiar before acquisition. How then can the parent have carried out compre-
hensive screening of the new company before executing the acquisition? Most
probably preacquisition screening overlooked many factors, turning the acqui-
sition into something of a gamble from a business portfolio standpoint. Similar

arguments can be applied to internal development in unfamiliar areas and Gilmore

4
and Coddington specifically stress the dangers associated with entry into un-
familiar markets.

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EXHIBIT 3
TESTS OF "NEWNESS"

Is the technology or
service embodied with-
in existing products?

YES

NO

Base technology
or service

New technology
or service

Are existing products
sold within this
market

fc.

YES

NO

Base market

New Market

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EXHIBIT 4

TESTS OF TECHNOLOGICAL FAMILIARITY

DECREASING
FAMILIARITY

1) Is the technological capability used within
the corporation without being embodied in
products, e.g., required for component
manufacture (incorporated in processes
rather than products)?

2) Do the main features of the new

technology relate to or overlap with
existing corporate technological skills
or knowledge, e.g., coating of optical
lenses and aluminizing semiconductor
substrates?

7>) Ho the technological skills or

knowledge exist within the corporation
without being embodied in products or
processes, e.g., at a central RfiD
facility?

4) Has the technology been systematically
monitored from within the corporation
in anticipation of future utilization,
e.g., by a technology assessment group?

5) Is relevant advice available from
external consultants?

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EXHIBIT 5

TESTS OF MARKET FAMILIARITY

DECREASING
FAMILIARITY

1) Do the main features of the new market
relate to or overlap existing product
markets, e.g., base and new products are
botli consumer products?

2) Does the company presently participate in
the market as a buyer (relevant to backward
integration strategies)?

3) Has the market been monitored systematically
from within the corporation with a view
to future entry?

4) Does knowledge of the market exist within
the corporation without direct partici-
pation in the market, e.g., as a result
of previous experience of credible staff?

5) Is relevant advice available from external
consultants?

■15-

EXHIBIT 6

THE FAMILIARITY MATRIX

MARKET
FACTORS

NEW
UNFAMILIAR

NEW
FAMILIAR

BASE

BASE

NEW
FAMILIAR

NEW
UNFAMILIAR

TECHNOLOGIES OR SERVICES
EMBODIED IN THE PRODUCT

KEY:

Y///m*^* \

INCREASING CORPORATE FAMILIARITY

-16-

This loads to the conclusion that entry strategies requiring high cor-
porate involvement should be reserved for new businesses with familiar market
and technological characteristics. Similarly, entry mechanisms requiring
low corporate input seem best for unfamiliar sectors. In this way it is
possible to align the three sections of the entry strategy spectrum of
liXIIIRir 2 with the three regions of the FAMILIARITY MATRIX^EXHIBIT 6. Let
us now analyse this alignment for each region of the matrix, with particular
regard to the main factors identified in the literature.
Region 1: Base/Familiar Sectors

Within the base/familiar sector combinations illustrated in EXHIBIT 7,
a corporation is fully equipped to undertake all aspects of new business de-
velopment. Consequently, the full range of entry strategies may be considered,
including internal development, joint venturing, licensing, acquisition or
minority investment of venture capital. However, although these are all valid
from a corporate familiarity standpoint other factors suggest optimum entry
approaches .

The potential of conflict between partners may reduce the appeal of a
joint venture, and minority investments offer little benefit since the investee
would do nothing that could not be done internally.

The most attractive entry mechanisms in these sectors probably include
internal development, licensing and acquisition. Internal development may be
appropriate in each of these sectors, since the required expertise already ex-
ists within the corporation. Licensing may be a useful alternative in the
base market/new familiar technology sector since it offers fast access to
proven products. Acquisition may be attractive in each sector but may be
infeasible for some companies in the base/base region as a result of anti-
trust legislation.

MARKET
FACTORS

•17-

EXHIBIT 7

PREFERRED ENTRY MECHANISMS
IN BASE/FAMILIAR SECTORS

NEW
UNFAMILIAR

NEW
FAMILIAR

BASE

Internal Market
Development

or

Acquisition

(or Joint
Venture)

Internal

Base

Development

(or Acquisition) I

Internal

Product

Development

or
Acquisition

or
License

BASE

NEW
FAMILIAR

NEW
UNFAMILIAR

TECHNOLOGIES OR SERVICES
EMBODIED IN THE PRODUCT

KEY:

TRANSITIONS OVER TIME

•18-

It may therefore be concluded that in these base/familiar sectors, the
optimum range may be limited to internal development, licensing and acquisition
as illustrated in EXHIBIT 7. In all cases a new business developed in each
of these sectors is immediately required to fulfill a role within the corporate
business portfolio. For this reason, acquisitions in these sectors will be
referred to from now on as "portfolio" acquisitions.

I'inaily, since new businesses within the base market/new familiar tech-
nology and new familiar market/base technology sectors immediately enter the
corporate business portfolio, they transfer rapidly into the base/base sector.
These transitions are illustrated in EXHIBIT 7.
Region 2: {"amiliar/Unfamiliar Sectors

EXHIBIT 8 illustrates the sectors of lowest familiarity from a corporate
standpoint. It has already been proposed that a company is only competent to
carry out totally appropriate analyses on new business opportunities which lie
within its own sphere of familiarity. Large scale entry decisions outside this
sphere are liable to miss important characteristics of the technology or market,
reducing the probability of success. Furthermore, if the unfamiliar parent
attempts to exert strong influence on the new business, the probability of
success will be reduced still further.

These factors suggest that a two stage approach may be best when a company
desires to enter unfamiliar new business areas. The first stage should be de-
voted to building corporate familiarity with the new area. Once this has been
achieved, the parent is then in a position to decide whether to allocate more
substantial resources to the opportunity and, if appropriate, to select a
mechanism for developing the business.

Venture capital provides one vehicle for building corporate familiarity
with an unfamiliar area. By nurturing a venture capital minority investment

-19-

EXHIBIT 8

PREFERRED ENTRY MECHANISMS
IN FAMILIAR/UNFAMILIAR SECTORS

MARKET
FACTORS

NEW
UNFAMILIAR

NEW
FAMILIAR

BASE

1 Venture

1 Venture 1

1 Capital

1 Capital 1

1 or

1 or 1

1 Venture

1 Venture 1

1 Nurturing

1 Nurturing 1

1 or

1 or 1

1 Educational

1 Educational 1

1 Acquisition

i, Acquisition |

y/'l Venture 1

?

1 Capital 1

1 or 1

^ 1 Venturing 1

1 Nurturing 1

1 or i

1 Educational i

1 Acquisition 1

BASE

NEW
FAMILIAR

NEW
UNFAMILIAR

TECHNOLOGIES OR SERVICES
EMBODIED IN THE PRODUCT

KEY:

\

TRANSITION OVER TIME

■20-

the corporation can monitor, at first hand, new technologies and markets.*
Over time the new opportunity moves into a familiar market/technology region,
as illustrated in EXHIBIT 8, from which the parent can now exercise appropriate
judgment on the commitment of more substantial resources.

Targeted small acquisitions can fulfill a similar role to a venture capital
minority investment and, in some circumstances, may offer significant advantages.
In an acquisition of this type, the acquiring firm immediately obtains people
familiar with the new business area, whereas in a minority investment, the
parent relies upon its existing staff building familiarity by interacting with
the investee. Acquisitions for educational purposes may therefore represent a
faster route to familiarity than the venture capital "window" approach. Staff
accjuired in this manner may even be used by the parent as a basis for redirect-
ing a corporation's primary product-market thrust. Harris Corporation (formerly
Harris- Intertype) entered the computer and communication systems industry using
precisely this mechanism to acquire internal skills and knowledge through its
acquisition of Radiation Dynamics Inc.

One potential drawback in this "educational acquisition" approach is that
it usually requires a higher level of financial commitment than minority invest-
ment and therefore increases risk. In addition, it is necessary to ensure that
key people do not leave soon after the acquisition due to the removal of entre-
preneurial incentives. A carefully designed acquisition deal may be necessary
to ensure that incentives remain. When Xerox acquired Versatec, for example,
the founder and key employees were given the opportunity to double their "sell-
out" price by meeting performance targets over the next five years.

It is clearly essential that if the investment is to be worthwhile, the in-
vestec must be totally familiar with the technology/market. These must be
his base business.

-21-

It is also important that the performance of acquisitions of this type be
measured according to criteria different from those used to assess the "port-
folio" acquisitions discussed in the previous section. These "educational"
acquisitions should be measured on their ability to provide increased corporate
familiarity with a new technology or market, and not on their ability to per-
form immediately a conventional business unit role within the corporate business
portfolio.
Region 3: Marginal Sectors

The marginal sectors of the matrix are the base/new familiar combinations
plus the new familiar market/new familiar technology area, as illustrated in
liXHlBlT 9. In each of the former sectors, the company has a strong familiarity
with cither markets or technologies, but is totally unfamiliar with the other
dimension of the new business. In these situations joint venturing may be very
attractive to the company and prospective partners can see that the company
may have something to offer. However, in the new familiar tec hnology /market
region the company's base business does not advertise familial ity with that
technology or market. Hence, prospective partners may not perceive that a
joint venture relationship would yield any benefit to them.

In the base market/new unfamiliar technology sector the "new style" joint
venture discussed by Roberts and Hlavacek et al. is appropriate. The large
firm provides the marketing channels and a small company prov; des the technolo-
gical capability in a union that can result in a very powerful team. The com-
plement of this situation may be equally attractive in the new unfamiliar
market/base technology sector.

Joint ventures such as these not only provide a means of fast entry into
a new business sector, but also offer increased corporate familiarity over time
as illustrated in EXHIBIT 9. Consequently, although a joint ^'enture may be the

-22-

EXHIBIT 9

PREFERRED ENTRY MECHANISMS
IN MARGINAL SECTORS

MARKET
FACTORS

NEW
UNFAMILIAR

NEW
FAMILIAR

BASE

Joint
Venture

Internal
Venture

or
Acquisition

or
License

'New Style"

Joint

Venture

BASE

NEW
FAMILIAR

NEW
UNFAMILIAR

TECHNOLOGIES OR SERVICES
EMBODIED IN THE PRODUCT

KEY:

\

TRANSITION OVER TIME

-23-

optimum entry mechanism into the new business area, future development of that
business may be best achieved by internal development or acquisition as discussed
in the earlier Base/Familiar Sectors section.

In the new familiar market/new familiar technology sector, the company may
be ideally placed to undertake an internal venture. Alternatively, licensing
may provide a useful means of obtaining rapid access to a proven product em-
bodying the new technology. Minority investments can also succeed in this
sector but, since familiarity exists, a higher level of corporate involvement
and control may be justifiable.

Acquisitions may be potentially attractive in all marginal sectors. How-
ever, in the base/new unfamiliar areas this is dangerous since the company's
lack of familiarity with the technology or market prevents it from carrying out
comprehensive screening of candidates. In contrast, the region of new familiar
market/new familiar technologies does provide adequate familiarity to ensure
that screening of candidates covers most significant factors. In this instance
an acquisitive strategy is reasonable.
Sector Integration: Optimum Entry Strategies

The foregoing discussion has proposed optimum entry strategies for
attractive new business opportunities based on their position in the FAMILIARITY
MATRIX. EXHIBIT 10 integrates these proposals to form a tool for selecting entry
strategy based on corporate familiarity.

TESTING THE PROPOSALS

In testing the proposed entry strategies. Berry studied 14 new business
development episodes that had been undertaken within one highly successful di-
versified technological corporation. These episodes were all initiated within
the period 1971 to 1977, thus representing relatively recent activity while
still ensuring that sufficient time had elapsed for performance to be measurable.

■24-

EXHIBIT 10

OPTIMUM ENTRY STRATEGIES

MARKET

FACTORS

1 Venture

1 Venture 1

1 Capital

1 Capital 1

NEW
UNFAMILIAR

Joint
Venture

1 or
1 Venture
' Nurturing

1 or 1
1 Venture 1
1 Nurturing 1

or
1 Educational

1 or 1
Educational |

Acquisition

1 Acquisition i

Internal Market

Internal

Venture |

Development

Venture

Capital 1

NEW

or

or

or 1
Venture j

FAMILIAR

Acquisition

Acquisition

Nurturing |

(or Joint
Venture)

or

or I
Educational ,

'

License

Acquisition i

Internal

Internal

Product

Base

Development

"New Style" |

BASE 1

Development |

or 1

Joint 1

(or Acquisition)

Acquisition |

or 1

License |

Venture |

BASE

NEW

NEW

FAMILIAR

UNFAMILIAR

TECHNOLOGIES OR SERVICES
EMBODIED IN THE PRODUCT

-25-

The sample comprised 6 internal developments (3 successful, 3 unsuccessful),
6 acquisitions (3 successful, 3 incompatible) and 2 successful minority invest-
ments of venture capital. These were analysed in order to identify factors
which differentiated successful from unsuccessful episodes. The scatter of
these episodes on the familiarity matrix is illustrated in EXHIBIT 11. Internal
developments are represented by symbols A to F, acquisitions by G to L, with
M and N showing the location of the minority investments.

The distribution of success and failure* on the matrix gives support to
the entry strategy proposals that have been made in this article. All high
corporate involvement mechanisms (internal development and "portfolio" acqui-
sitions) in familiar sectors were successful. However, in unfamiliar areas,
only one of this category of entry mechanism, acquisition G, succeeded. This
acquisition was a thirty year old private company with about 1000 employees,
producing components for the electronics and computer industries. It was
believed to offer opportunities for high growth although it was unrelated to
any of the parent's existing business. The deal was completed after a period
of two years of candidate evaluation carried out from within the parent. The
only constraint imposed upon Company G following acquisition was the parent's
planning and control system, and in fact the acquired company was highly re-
ceptive to the introduction of this system. This indicated that Company G
was not tightly integrated with the parent and that any constraints imposed
did not severely disrupt the established operating procedures of the company.

Success here is defined as fulfilling a satisfactory role within the corporate
business portfolio. Failures had not achieved this and had been discontinued
or divested.

-26-

EXHIBIT 11

EPISODE SCATTER ON THE FAMILIARITY MATRIX

MARKET
FACTORS

NEW

UNFAMILIAR

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= FAILURE

-27-

All factors surrounding the acquisition of Company G - its size, growth
market, low level of constraint and low disruption by the parent - suggest
that Company G may have continued to be successful even if it had not been
acquired. Representatives of the parent agreed that this might be the case
although they pointed out that the levels of performance obtained following
acquisition might not have occurred if Company G had remained independent.
Hence, if an acquired company is big enough to stand alone and is not tightly
integrated with the parent, its degree of success is independently determined
by itself.

It is important to point out that despite the success which occurred
in this instance; an acquisition of this type in unfamiliar areas must carry
risk. rhc parent is liable to overlook many subtle details while screening
candidates. It is also important to point out that when an established company
is acquired and continues to operate with a high degree of independence, ident-
ification of synergy becomes difficult. Synergy must exist in any acquisitive
development if economic value is to be created by the move. Consequently,
an acquisition of this type not only carries risk but may also be of questionable
benefit to shareholders.

The other success in an unfamiliar area, episode N, is a minority invest-
ment of venture capital. By the very nature of minority investments, corporate
involvement is limited to a low level. Although some influence may be exerted
via participation on the Board of Directors of the investee, again the investee
is not tightly bound to the parent. Consequently, the success of the investee
tends once again to be determined to a large extent by itself.

Detailed examination of episodes G and N has therefore suggested good
reasons for the subject companies' success despite their location in unfamiliar
sectors - the companies didn't require a significant input to decision making

■28-

from the unfamiliar parent. This suggests that new business development success
rate in unfamiliar areas may be increased by limiting corporate input to the
decision making process to low levels until corporate familiarity with the new
area has developed. These experiences support the entry proposals already out-
lined in til is article.

Some companies have already adopted entry strategies that seem to fit the
proposals of this article, and Monsanto represents one of the best examples.
Monsanto is now committed to significant corporate venturing in the emerging
field of biotechnology. Its first involvement in this field was achieved with
the aid of its venture capital partnership Innoven which invested in several
small biotechnology firms, including Genentech. During this phase Monsanto
interacted with the investees, inviting them in-house to give seminars on their
work. Once some internal familiarity with the emerging field had developed,
the decision was then taken to commit substantial resources to an internal
venture. Monsanto is effectively entering biotechnology by moving from top
right to bottom left across the familiarity matrix of EXHIBIT 10. They used
venture capita] to move from an unfamiliar region to an area of familiar tech-
nology and market. Joint ventures with Harvard Medical School and Washington
University of St. Louis are further enhancing its familiarity with biotech-
nology, while producing technologies that Monsanto hopes to market. Contract /

research leading to licenses from small companies is another strategy Monsanto >^

'i

is employing. -. )

CONCLUSIONS
A spectrum of entry strategies was presented in this article, ranging from
those requiring corporate involvement, such as internal development or acquisition,
to those requiring only low involvement, such as venture capital. This was
then incorporated into a new conceptual framework designed to assist in select-
ing entry strategy into potentially attractive new business areas. The frame-

-29-

work concentrates on the concept of the corporation's "familiarity" with the
new business area and a matrix was used to relate familiarity to optimum entry
strategy.

In this concept, no one strategy is ideal for all new business development
situations. Within familiar sectors virtually any strategy may be adopted and
internal development or acquisition is probably most appropriate. However, in
unfamiliar areas these two approaches are very risky and familiarity should be
built before they are attempted. Minority investments and small targeted
"educational" acquisitions form ideal vehicles for building familiarity and
are therefore the preferred entry strategies in unfamiliar sectors.

Despite recent criticism , venture capital may be the most important of
these approaches. By means of a corporate venture program using either
direct funding or partnerships of pooled funds, a company has the opportunity
to interact with investees and gain insight into a wide range of unfamiliar
technologies or markets without large financial commitment. The knowledge
that can be developed in this situation increases the likelihood that decisions
on subsequent commitment of more substantial resources have addressed all re-
levant factors.

At the start of this article, research results were outlined which had
indicated that in order to ensure highest performance, new business develop-
ment should be constrained within areas related to a company's base business.
However, this research had not accounted for alternative entry mechanisms.
This article proposed that a multi-faceted approach, encompassing internal
development, acquisitions, joint ventures and venture capital minority in-
vestments, can make available a much broader range of business development
opportunities at lower risk than would otherwise be possible.

-30-
REFERENCES

1. Berry, C.A. "New Business Development in a Diversified Technological
Corporation", MIT Sloan School/Engineering School Master of Science
Thesis, 1983.

2. Biggadike, H.R. "The Risky Business of Diversification", Harvard Business
Review, May /June 1978.

3. Fast, N.l). "Pitfalls of Corporate Venturing", Research Management,
March 1981.

4. Gilmore, J.S. and Coddington, D.C. "Diversification Guides for Defense
Firms", Harvard Business Review, May/June 1966.

5. Crcenthal, R.P. and Larson, J. A. "Venturing into Venture Capital",
Business Horizons, September/October 1982.

6. Ilardymon, G.F., Denvino, M.J., and Salter, M.S. "When Corporate Venture
Capita] Doesn't Work", Harvard Business Review, May /June 1983.

7. Hlavacek, J.D., Dovey, B.H. and Biondo, J.J. "Tie Small Business Technology
to Marketing Power", Harvard Business Review, January/February 1977.

8. Killing, J. P. "Diversification through Licensing", R5D Management, 8, 3,
1979.

9. Killing, J. P. "How to Make a Global Joint Venture Work", Harvard Business
Review, May/June 1982.

10. Meyer, M.H. and Roberts, E.B. "New Product Strategy in Small High
Technology Firms", Alfred P. Sloan School of Management Working Paper
WP 1428-83, April 1983.

11. Miller, S.S. The Management Problems of Diversification, John Wiley, 1963.

-31-

12. Peters, T. "Putting Excellence into Management", Business Week,
July 21, 1980.

13. I'eters, T.J. and Waterman, R.ll. In Search of Excellence, Harper and
Row, New York, 1982.

14. Rind, K.W. "The Role of Venture Capital in Corporate Development",
Strategic Management Journal, Vol. 2, 169-180 (1981).

15. Roberts, E.B. "New Ventures for Corporate Growth", Harvard Business
Review, July/August 1980.

16. Rumelt, R.P. Strategy, Structure and Economic Performance, Harvard
Business School, Division of Research, 1974.

17. Salter, M.S. and Weinhold, W.A. "Diversification via Acquisition:
(treating Value", Harvard Business Review, July/August 1978.

18. Shanklin, W.i,. "Strategic Business Planning: Yesterday, Today and
Tomorrow", Business Horizons, October 1979.

^221

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