Misconceptions abound about what corporations and start-ups should expect from their partnerships on innovation projects. Yet these collaborations are growing in importance as companies of all sizes try to rapidly respond to shifts in the marketplace, as our recent article highlights. In this episode of the podcast, Miao Wang, a leader in McKinsey’s innovation practice, is joined by Tawanda Sibanda, a partner with Leap by McKinsey, which helps established organizations build and scale new businesses, and Tobias Henz, who focuses on bringing corporates and start-ups together around digitization and data, to discuss ways to improve the odds of success of such partnerships. This is an edited transcript of the conversation. You can listen to the episode on Inside the Strategy Room Apple Podcasts, Spotify, or Google Podcasts.
Sean Brown: Why is this an important time for collaborations between corporates and start-ups?
Tawanda Sibanda: It’s easy to see why corporate partnerships with start-ups make sense: start-ups can benefit from corporate funding, resources, and customer access, while corporations need to innovate to stay ahead of competitors and disruption, and also access new technology. We have seen a steady increase in corporate–start-up engagements. Between 2013 and 2019, there was 32 percent year-on-year growth in corporate venture capital (CVC) investments, and three-quarters of Fortune 100 companies have active venture units. Clearly, there is a huge appetite, although the pandemic slightly depressed collaboration activity. But the growth in digitization over the past year has driven the need to innovate, putting even more spotlight on getting these partnerships right.
Sean Brown: What are the main motivations for large and small companies to team up these days?
Tawanda Sibanda: Start-ups may be looking to get access to the corporate partner’s markets or to turn the partner into a customer. They are often interested in the corporate’s data on customers and the industry or in its development resources and capabilities, both technical and in terms of support functions. There is obviously the need for financing. Also, having a corporate partner can send a positive signal to investors. On the corporate side, faster innovation is a leading reason. Often, corporations find start-ups are ahead of them in their markets and want to bring them in-house. They might want to gain early insights into experimental technologies and new verticals. They may also be looking to transform how they work, to become more agile. Access to top talent is also a frequent rationale. And, of course, there is the potential return on investment.
Interestingly, when we surveyed companies participating in these partnerships, we found that financing is not the top reason for start-ups, or even among the top three. Their top motive is getting access to the larger partner’s market. On the corporate side, it’s primarily about the need for faster innovation and product development.
Interestingly, financing is not the top reason for start-ups to pursue partnerships, or even among the top three. Their top motive is getting access to the larger partner’s market.
Sean Brown: In your experience, do these collaborations pay off for both partners, at least in achieving their primary goals?
Tawanda Sibanda: The results are mixed at best. The majority of CVCs stop investing after two to three years, and when we asked start-ups about their satisfaction levels, only 28 percent said they were satisfied with their corporate partnerships. The success rate is higher when the corporates come in not just with one objective but a holistic approach to working with the start-up. A singular objective such as “all we want from this start-up is talent” ignores additional capabilities that the start-up could provide and can frustrate entrepreneurial companies that do not like being shoehorned.
Sean Brown: What other issues tend to derail these partnerships?
Miao Wang: There are five main themes we see come up. First is a lack of internal sponsorship and strategic buy-in, especially with the CVC’s units. Corporate development, the CFO or the prior CEO might have started an initiative, but it lacks commitment from the full executive team and is treated as a side project. This shows up in the resourcing as well. Without people from the corporate side leading these projects, the start-ups end up having to navigate the corporations themselves, and that’s challenging.
The second pitfall is lack of strategic clarity about what you are trying to accomplish. If you want to get a foothold in an emerging technology, for example, that requires a different mechanism and capabilities than, say, replacing a declining core business. Many corporations know they need to innovate, and know the technology trends, but have not translated that into what practically they need to do and therefore how they can leverage the external ecosystem to help them accomplish their objectives.
Another issue is that corporations have slow processes. If you bring in a start-up and say, “Let us know what resources you need for next year so we can work it into our quarterly budget,” that’s just not how start-ups work and think. Then, when they start working together, another problem is lack of impact tracking. Lastly, because of what we see with the first four issues, companies often get stuck in pilots, with no path to scale in terms of resources, stakeholders buy-in, and so on. You end up in a holding pattern that frustrates start-ups.
Sean Brown: At what stage are start-ups best suited to collaborating with large companies?
Miao Wang: It goes back to the strategic objectives. If you are looking at adjacencies to your core business or go-to-market partnerships, you should look to growth-stage start-ups. However, those start-ups are also more expensive to participate in. A chemicals client of ours in the water-treatment business saw the industry moving toward water treatment as a service rather than providing chemicals. It didn’t make sense for them to go into equipment manufacturing, but they knew this shift would eventually take away their market share, so they placed several bets on early-stage companies that manufactured equipment to hedge against a decline of their core business. In that case, they were betting against an emerging technology rather than engaging in an active collaboration, so they were hands off. It made sense to choose early-stage companies because they could make ten bets for the price of one Series B investment.
Sean Brown: How should companies approach these collaborations to get the most value out of them?
Tobias Henz: There are several pillars you need to get right to reap the benefits Tawanda introduced. One is bringing your A-team to the collaboration, and that goes for both the start-up and the corporation. In our survey, start-ups’ satisfaction rose by 93 percent when they felt their corporate partner was highly committed and by 86 percent if top management was involved in the partnership. One client company, for instance, started to shift half the people in its corporate venture unit from sourcing deals toward working with the start-ups day to day. Start-ups also need to show commitment. Often they try to partner with numerous companies, but it’s important to be selective and not go for too many partnerships too fast.
It’s important to bring your A-team to the collaboration, and that goes for both the start-up and the corporation.
The second thing is around addressing cultural gaps. Just openly acknowledging that there may be problems in working together due to different cultures, methodologies, and philosophies and committing to working them out can drive partner satisfaction up by 30 percent—even if you can’t solve the issues. The third point is knowing where you are headed, with clear goals and key performance indicators (KPIs) for your partnership. Corporations and start-ups sometimes leap to partner just because they find a project cool and then in the middle of the partnership, they get stuck and no one knows where to go and whether the partnership should be continued. Especially during crises, large companies tend to resort to their standard metrics to measure the partnership’s success, and that does not work. We have seen partnerships fail for lack of established metrics up front.
Sean Brown: What are some of the metrics that corporate–start-up partnerships should be tracking?
Miao Wang: Corporations typically look at lagging metrics, such as revenue and EBITDA, but if you are working with an early-stage start-up, you should be thinking about strategic metrics tied to the value-added activity. If you are doing joint R&D, for example, you should track the number of projects in the pipeline and the total addressable market. If you are doing a commercial pilot, how many customers have you taken this offering to and what is the success rate? These are leading metrics that enable you to gauge the success of your strategic rationale versus looking at lagging metrics of financial outcome. Companies can learn from venture investors. There are well-known metrics shared across the industry for evaluating the health of start-ups.
It’s also important to have enough principals or managing directors in your corporate venture fund so they are not stretched too thin. A good rule of thumb is no more than eight companies per executive. Those people should have their fingers on the pulse of what is happening at each start-up. Does it still have a path to scale up the way we expected? That requires a holistic assessment, and it can get lost when corporates use roll-up dashboards on a portfolio of 30 companies.
Tobias Henz: I love that point. There is no dashboard that will track all of your start-ups in the way it should. Each partnership needs to be individualized.
Sean Brown: Tobias talked earlier about the cultural differences that often exist between corporates and start-ups. Can individual relationships between representatives on both sides help to bridge these gaps?
Miao Wang: The individual partnerships are quite important. It is not just about the two companies but the people in them. Research a few years back analyzed what makes cross-functional teams effective, and the number one factor was the team members liked each other. Making those connections becomes challenging in a pandemic, but you should not overlook it, particularly when corporates invest in start-ups in different cities or countries.
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Sean Brown: What other recommendations do you have for potential partners?
Miao Wang: You need to find the right size of pilot that proves a concept can scale. Companies will say, “We will run five experiments with R&D. Here is an interesting technology, here is a use case that worked.” But they don’t think about the full pathway across the development life cycle. The pilot needs to give you a good proof of concept, the confidence about a product–market fit that can move on to something bigger.
Sean Brown: How should partnerships fit into companies’ broader innovation strategies?
Miao Wang: The best innovators have an interplay between internal and external innovation, and that requires an overall operating model that gives you the full view of the innovation strategy and opportunity areas. You also need a portfolio-management process. One chemicals company was looking at a certain new biotechnology and had projects in its R&D pipeline. They also invested in a start-up and licensed a competitor’s molecule in that area. They ended up with three disconnected groups going after the same thing. It is important to make holistic resource allocation across the bets you make, not have each silo doing its own thing where you find you are overweighted in certain places or creating conflicts of interest.
External collaboration is a tool, but it is not the only tool you can use. A company could pursue innovation through R&D, start-up collaborations through a CVC or accelerator, or M&A. You may be building something internally and you find a piece of technology or a capability you need in a start-up and it may make sense to acquire it. But you still need an internal innovation capability.
Sean Brown: What value does an internal accelerator provide in these corporate–start-up collaborations?
Miao Wang: Many accelerators are short-lived. Those that work well are similar to a disciplined CVC approach: you take equity in a particular company and aim to do a particular thing. The struggle with accelerators is you have to manage a cohort because you have a program of companies coming through. That entails a lot more resources that are probably better dedicated toward value-added activities with individual companies than toward program management of a large portfolio. Secondly, an accelerator creates a lot of noise. It can drive some partnerships that should not exist because you feel like something should be happening given all the activity.
Tobias Henz: I wholeheartedly agree. This goes back to the point about a good partnership being individualized, and if you have a number of strong individual partnerships, at some point you might decide to bundle them in an accelerator program, with some infrastructure and office space, but you keep those partnerships just as individualized. If you start with the accelerator program and then try to fill it with start-ups, you end up with half that don’t make sense.
Sean Brown: How often do you see start-ups enable incumbent companies to move beyond their core businesses?
Tawanda Sibanda: I have seen examples in financial services. I worked with a few traditional banks that partnered with start-ups to get into a new segment. What made them successful is that they started with very clear insights and strategic pushes, clarity about the segments they were going after, and an understanding of the start-ups with great assets and capabilities in that space. Secondly, they then built that start-up into their infrastructure, both technically so they could integrate their banking products with the start-up, and from a people perspective so they could support the start-up as it scaled.
Miao Wang: There are two aspects to that question. Is a start-up a value-add to the corporate platform? Absolutely. I would echo everything Tawanda said. Will a start-up help the company innovate and drive change management? The answer is no. The people in start-ups are busy trying to make their companies work. They do not have time to take on second jobs as change-management professionals in your company and move that ship.
The people in start-ups are busy trying to make their companies work. They do not have time to take on second jobs as change-management professionals in your company.
Sean Brown: Generally, what types of value-add models do you see in the corporate–start-up collaboration space?
Miao Wang: There are plenty of CVC models in which companies are effectively institutional investors with good insight plus value-added services such as access to corporate leadership, coaching, platforms, and resources. In terms of an active collaboration with a start-up, one is the outsourced R&D model, where the start-up has a complementary capability or technology that the established company wants to acquire. This is basically a build, invest, or buy decision, because it makes more sense to work with the start-up than try to develop something from scratch. Commercial or scale-up partnerships are more appropriate for later-stage start-ups where you have a proven market offering that you could take to your customers or use to address adjacencies. That kind of partnership is about the corporate being a commercialization engine to help a start-up grow bigger faster.
Another model is the anchor customer or supplier. The start-up could, for example, do analytics for operations, where the corporate is a customer. It’s a value-add for the corporate, driving cost efficiency or performance improvement, and you work closely to tailor the value proposition to your needs. The flip side is the corporate building an ecosystem that drives underlying demand for its products or technologies. Then there is hedging against disruption. These partnerships are typically more hands off, because, quite candidly, corporate managers are terrible at running start-ups. But you need to be very explicit before making some of these bets or hedges. Is that 10 percent of your discretionary cash? Is that 10 percent of our portfolio? What allocation do we want to make in the context of the whole thing?
Sean Brown: Do you have any perspectives on industries that are particularly well suited to corporate–start-up collaborations?
Miao Wang: There is a mix in terms of the value created. If I look at pharma, it has a mature model of outsourcing R&D technology and there is a clear linkage of the corporate adding value and commercialization to the start-up. As we move further upstream, looking at chemicals, industrials, energy, some are starting to build that muscle. When you get further upstream to commodity chemicals, they have less experience with start-up collaboration because they are far from the customer. At the same time, significant value can be created in internal projects around digitization or analytics for operational improvement or risk management. In consumer industries, there is a lot of partnership activity, which makes it seem fairly mature, but the jury is still out on which partnerships are delivering shareholder value. Some companies’ portfolio can be best described as brand roulette.