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How industrial incumbents can create new businesses

In the face of what can feel like nonstop threats from new entrants, incumbent industrial companies can create new businesses of their own that can mitigate the risk.

Successful tech-enabled transformations can help generate cash to outcompete new competitors, but don’t fundamentally help incumbents solve the strategic challenge of nimble attackers, which often combine data and software to quickly gain a foothold in their industries. IT, retail, and logistics are just a few sectors that have been reshaped by technology-first innovators such as Amazon Web Services (IT), Warby Parker (retail), and Uber Freight (logistics). In the industrial sector, especially advanced industries, a swarm of IoT startups have begun to chip away at incumbents’ positions. For instance, Brazilian startup Solinftec, which began with a focus on helping the sugarcane industry increase its production efficiency, has already won 60 percent of the Brazilian sugarcane market since it was founded in 2007 and will launch in the United States in time for the 2020 crop cycle of corn and soybeans.

To defend themselves from tech-enabled startups, incumbent industrials should complement their tech-enabled transformations’ existing corporate venture capital (VC) activities by creating new tech-enabled businesses of their own. With their cash reserves, existing customer base, established brands, and in-house expertise, incumbents should in theory create entirely new businesses with higher odds of success. But as with all strategic moves, creating and nurturing a new business as an incumbent is often aspirational yet difficult to implement. Among other obstacles, established companies must overcome operating models and cultures that emphasize iterative operational improvements to the core business over untested strategic choices that can result in immense upside.

To create organic growth in a new business area, incumbents should put aside the assumptions and mind-sets that help them run an established entity. For instance, incumbents will need to accept the near certainty of unprofitable periods for their new ventures and that new businesses may cannibalize parts of the existing business as they grow and even overtake the parent company. Above all, incumbents nurturing new ventures must be comfortable enough with ambiguity to enable the strategic pivots new ventures can require. This mind-set will help incumbents create new-business ideas, devise a business plan, then launch, scale, and extract value from a new business. Incumbents that are able to think like innovative attackers and cultivate new ventures can look forward to ongoing value creation while those that stand still, are less nimble, or proceed timidly for fear of failure are (by definition) at risk of being disrupted into irrelevance.

The value and pain of cultivating new ventures

The frequency and effects of disruption make cultivating new businesses urgent. Due to the rise of innovative tech-enabled companies and the retreat of old-guard businesses that have failed to react to threats or self-disrupt, the average age of companies on the S&P 500 has fallen to an all-time low of 22 years, down from 61 years in 1958. Technology will continue to be a major source of disruption: while the internet and mobile and cloud computing have already evolved from disruptive to foundational, quantum computing, virtual and augmented reality, and the IoT will likely propel the next wave of disruption. And with customers shifting their purchasing and information-gathering channels, competitors that are eager to expand across sectors, and ample VC funding for a nonstop stream of new entrants, incumbents’ best hope might be to create attackers themselves.

In theory, incumbents are better equipped than solo entrepreneurs to take the leap into new-business creation. Industrial Goliaths can give their new businesses the funding, distribution, and customer base that typical new businesses have to fight for. For example, one large machinery manufacturer used its large customer base, brand equity, 1 expertise, and cash flow to grow its IoT products business, which reached $20 million in new sales in its first year after launch.

Above all, incumbents nurturing new ventures must be comfortable enough with ambiguity to enable the strategic pivots new ventures can require.

In reality, McKinsey analysis found that only 16 percent of new ventures from the Fortune 100 have succeeded since 2000. It’s difficult for incumbents to assemble the right resources to establish and grow an internal attacker, especially if the new business’s offerings interfere with elements of the core business. 2 In the early stages, a new venture might be seen as a distraction and a drain on the parent company’s resources. What’s more, significant differences in key elements of incumbents and new entities, such as governance practices, funding models (approaches to make sure a business’s core activities are funded), and organizational structures, can result in the parent company being a drag on new ventures. For example, new businesses often make decisions quickly, with little (if any) institutional distance between the CEO and the rest of the company. The parent company, however, will almost certainly have more management layers and more processes to follow when making decisions. A new business whose parent company requires it to follow the parent’s processes would almost certainly be prevented from making and implementing the full range of strategic and tactical decisions at the frequency and cadence that would allow it to quickly find its footing in the market. If combined with loss aversion, the parent is even more likely to inadvertently smother the new business.

Setting up a disruptive business that can flourish

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Establishing and growing a new business within an established parent company requires the advantages of both incumbents and new companies. In addition to the aforementioned advantages of incumbents, internally cultivated attackers can retain their agile ways of working, push for innovation, and cultures and products that attract talent—as long as they can sidestep the common problems that afflict corporate ventures (see sidebar, “Common problems of corporate-led new businesses”).

Create concepts

An incumbent’s access to capital helps it cultivate a pipeline of new-business ideas as strategic opportunities arise. Its in-house experts and access to significant markets can also help new businesses’ teams investigate and develop concepts. Idea generation will require industrial companies to give up product-centric mind-sets and use their customers’ experiences as the impetus for new product and solution ideas.

To identify potential breakout business ideas, teams should take customers’ perspective to identify specific, compelling, and valuable problems a new venture could feasibly address. 3 Teams could then devise solutions to the problem using lenses that focus customers, competitors, and technology, then periodically solicit strategic direction from leaders. The best ideas should contain a “hook” around which teams can build an attention-grabbing value proposition. For instance, one advanced-industrials conglomerate took note of the fragmented security market and increasing demand for security software and decided to create an app store and operating system focused on IoT security software and devices.

Finally, teams should test the elements of a promising idea’s business model. For instance, teams could articulate the way they would launch the new business and confirm that the business would be (at least theoretically) profitable and scalable. One manufacturer had assembled technology partners who could help promote their new solution to prospective manufacturing customers before it directed a team to confirm the market demand for the offering. The team discovered that the solution was only applicable to a unique set of manufacturing plants and was not scalable in a time frame that would justify an investment. Up-front due diligence—performed in part by using the parent company’s advantages—can help ensure that there is a product-market fit before parent companies invest in new businesses.

Make a blueprint

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Once a concept has been validated, incumbents’ new-business arms should assemble a team around a promising concept to build a business plan. The team should define their new company’s operating model, including technology, governance, and the go-to-market approach and use this knowledge and the insights from the previous stage to build a blueprint for the business launch (see case study, “Launching an IoT security business”).

At this stage of development, a nascent business should already be a hybrid that has features of both new ventures and incumbents. The ideal team would have team members from the parent organization and the strongest candidates they could recruit from the market. The parent company should commit to allocating resources to the new venture, including moving dedicated, entrepreneurial employees there. Ideally, the parent company would ensure the employees are fully committed to the success of the new business by tying their compensation to its success and making it clear they won’t have the option to return to the parent company.

Similarly, the new venture’s operating model should combine the flat organizational structure, agile work cadences, and an emphasis on key results. This way of operating can be grafted to the parent’s assets—funding, relationships (with customers, suppliers, and partners), and brand equity.

Build and launch

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A new business can use its parent company’s customer base, brand equity, and expertise to smooth the way to building an MVP, then launching, testing, and learning from customers’ responses (see case study, “Creating a revenue-boosting product with customer input”). Although it’s the parent company’s responsibility to financially and logistically support the new business, the emphasis at this stage should be on removing risk for both the new venture and parent company. Teams that focus on building and perfecting products at the expense of testing assumptions and gathering customer insights tend to produce suboptimal product-market fit, waste resources, and miss opportunities to build relationships with customers that can make their launch a success. For example, Segway is an almost cliché example of a company that failed to test its assumptions about its product before launching. Although the Segway scooter is technologically effective, its weight (100 pounds), uncertain legal status (should users ride it in the street or the sidewalk?), and high cost ($5,000) limited its adoption.

Although the parent company can be helpful in this step, new ventures and parents must both set boundaries that can protect new business ideas. Because stakeholders at incumbents can be reluctant to support concepts that could grow into ventures that disrupt the parent’s core businesses, parent companies can minimize internal competition by managing the new business as if the parent were a VC firm. Instead of setting up new-business labs or incubators with minimal accountability or demanding financial results from an early-stage business, incumbents should instead test new businesses for progress and learning. One agricultural company held regular reviews to make sure that its new IoT business performed research to confirm that prospective customers wanted to use its products and were willing to pay the proposed prices. Milestones notched to learning and product development can then serve as triggers for additional funding.

Scale

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Scaling new businesses can help teams quickly capture returns on their investment—though industrial companies’ new businesses might be more likely to involve hardware, whose production is more expensive to scale than software. As with the launch, the team can access the parent company’s customer base, brand equity, and financial resources to help create positive financial outcomes. And because new businesses have their parents’ support, they can experiment more quickly and often and remain safe. For instance, testing new business models based on customer needs and feedback can help teams learn quickly as they scale their businesses (see case study “Scaling a telco attacker”). Amazon Web Services followed almost this exact path when it first expanded from storage services to cloud computing, and then to adjacent cloud services. 4

Of course, not all attempts to scale a product or solution yield financial results quickly, and teams should work with the parent company to ensure that a false start doesn’t doom a venture. Specifically, teams should evaluate whether the factors that led to lack of financial results might prove or disprove their original business case. Teams might discover that short-term results give them insights they can adapt to strengthen the business. Assuming that the business case holds, incumbents should fully invest in the new business to maximize its long-term value.

Contribute value

When a new business can sustain itself, it can interact with its parent company on more equal footing. By this stage, the new company should have its own customer base, expertise about its technologies and customers independent of its parent, and its own brand (which may be associated with the parent’s brand). When one is mature enough to create value of its own, it can operate as a business unit of its parent company, which would allow the parent company to enjoy ongoing revenue streams from its offspring. Alternatively, the new business could become a subsidiary of its parent or even file for its own IPO, which would give the parent company a liquidity event (which converts at least part of the parent company’s ownership into cash).


For established industrials, creating their own new businesses can mitigate the existential risk of disruption. Incumbents can accomplish this task by overcoming the pitfalls that can hamper efforts at each stage of new-business building. The ones that succeed will be rare giants that can also create and shape nimble attackers.

About the author(s)

Matt Banholzer is a partner in McKinsey’s Chicago office, Markus Berger-de León is a partner in the Berlin office, Subu Narayanan is a senior expert in the Chicago office, and Mark Patel is a senior partner in the San Francisco office.

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