Divide and Conquer

Dec. 21, 2004
To extract maximum value from idle, orphaned, and breakthrough technologies, companies are splitting off new businesses based on a venture-capital model.

In January Lucent Technologies Inc. teamed up with Harris Corp. to offer digital-television encoding equipment, a critical link in the transmission of digital TV. Lucent provides the technology, Harris the distribution. What makes this unusual is that the new company, Lucent Digital Video, is operated as a separate entity within the Lucent New Ventures Group, a division of Lucent Technologies, Murray Hill, N.J. The New Ventures Group takes home-grown, noncore discoveries and businesses not effectively exploited in the traditional organization and liberates them as venture-capitalized companies within the corporate structure. Today more companies are turning to this venture-capital model as a creative way to convert new and existing technology and other intellectual property into high-value revenue streams. These opportunities can be as obvious as brand-new technology or lie hidden in a companys patented technology that never led to commercial products. They can be discoveries noncore to the business, technology in advance of the marketplace, products that support a nontraditional customer base, international opportunities where direct investment doesnt make sense, or simply underperforming businesses that could benefit from a new business environment. The agile, focused "start-ups" that result are free of company bureaucracy and able to strike quickly in fast-paced, emerging, or nontraditional markets. (Already half the stations in the U.S. that plan to convert to digital broadcasts have signed up to buy Lucent Digital Video equipment.) Likewise, entrepreneurial spirits are attracted by a sense of ownership and the high-risk, high upside earning potential, creating a win/win situation. Although many of these efforts are in their infancy, companies -- including Lucent, Xerox Corp., and Texas Instruments Inc. (TI) -- see excellent potential in this new growth strategy, with the ability to impact their multibillion-dollar organizations in the near future as these initiatives mature. "We depend on the other 10 Lucent businesses for our current success," says Tom Uhlman, president of Lucent New Ventures Group. "But there are people with technologies and opportunities that just dont fit well in the large corporate model, and we want to nurture and support those in a different way. We are not a major profit center right now, but we are looking at a three-to-five-year time frame before New Ventures makes an impact on this $30 billion company. This is a classic growth-business activity." Broken free With the breakup of AT&T in 1996, Bell Labs -- an R&D community of 25,000 researchers -- aligned with Lucent Technologies, the part of the business involved in systems and software. As part of Lucent, some of the Bell Labs technology can be sprung free for business development in the New Ventures Group. In fact, about 10% of Bell Labs research investment is unallocated to a business, and this effort is responsible historically for many Bell Labs breakthrough technologies, according to Uhlman. "There is plenty of firepower left over from the [established Lucent businesses] Bell Labs serves, and we want to leverage that knowledge and talent in the New Ventures Group." The Lucent New Ventures Group has equal status to the other 10 Lucent divisions, managing its companies as a portfolio of investments. In the basic model, individual companies are "ventured" with corporate funds, revenues from other ventures in the group, and possibly outside investors. Ultimately, the ventures can be reabsorbed into an existing Lucent business if they become large enough, take the IPO route via contribution of other investors, or remain in the group. Lucent employees moving to the New Ventures companies are issued phantom shares of stock in the new company in addition to maintaining their Lucent compensation package, though they lose bonus opportunities tied to Lucent corporate performance. At the end of three years the value of the ventured company will be determined, with a percentage of that value distributed to its employees based on number of phantom stock shares owned. For continuitys sake, Lucent Technologies employees typically lead the New Ventures companies, with outsiders often recruited to facilitate commercialization, adding expertise in marketing and manufacturing capacities. The new companies have their own boards of directors and benefit from the Lucent corporate legal, human-resources, and other administrative services for the first three years of existence, after which the connection will be reevaluated. Although some of the ventures in the group conceivably could align with a current Lucent business, "we chose not to have some of them fit," says Uhlman. "Some of our technology is based on breakthroughs that might not be exploited as effectively in one of the businesses. Existing businesses frequently focus on existing customers with existing technology and have limited funds. The new technology might compete and lose out in terms of research dollars in a larger business unit that cant take the risk of abandoning its current technology, and that doesnt have the money to do everything." New Ventures companies also can sell products to competitors of the other Lucent businesses. "We are more agnostic in the Ventures Group if that represents an opportunity for Lucent," says Uhlman. Currently eight companies are managed by the New Ventures Group, generating "tens of millions of dollars," according to Lucent, which does not publicly report individual division financials. Of the eight, only Veridicom Inc., a company that makes chips for fingerprint authentication, has actually spun out via an IPO with additional investors, though the New Ventures Group still holds significant shares in the company. The Electroplating & Chemical Services (E&C Services) business, based on Bell Labs plating technology, was active before the birth of Lucent, but has since been ventured and positioned into the group to better serve its nontraditional customer set. In its first year in the Ventures Group, the rejuvenated E&C Services has experienced "significant growth." Corporate connection The Xerox New Enterprise (XNE) business sprang from the now defunct Xerox Technology Ventures Group, which also ventured new opportunities, but based on non-Xerox technology. XNE, on the other hand, is fed candidate technology from the Xerox labs in Palo Alto, Calif.; Grenoble, France; and New York. The basic venture model is similar to Lucent. However, for businesses actually spun off, Xerox will continue to hold a majority of stock (at least 51%). New ventures also ante up 1% of sales revenues to XNE, which provides them access to Xerox support services including HR, public relations, and assistance with international marketing. Also, in XNE companies, Xerox employees lose all ESOPs, profit sharing, retirement, and medical benefits in favor of stock options and a benefits package tailored to the new venture. When XNE was formed in 1996, all of the parts of Xerox that were not in mainstream printing, publishing, or copying were moved into the group. For instance, although not a software company, Xerox had a software division with 14 products, run by one set of management and distributed through one channel of distribution. Moved into XNE, several products were killed and others sold, while the remaining technologies were set up in three separate software ventures with their own boards, management-compensation systems, etc. One, InConcert Inc., which offers work- and process-management software, is scheduled for an IPO in 1999. Another, data-management-software-vendor Crystal Software Inc., is close behind. "We look at any assets that are underutilized or that you can characterize as lost within the corporation, anything that Xerox has spent money on that is underperforming, and move them into the group," says Colin OBrien, CEO of XNE. All told, XNE now is managing seven new ventures with two more in process. The original Xerox Technology Ventures had only limited success, says OBrien, because, in addition to being based on non-Xerox technology, the ventured companies wanted to get as far away from the Xerox structure and bureaucracy as possible. "By doing that, the mainstream corporation just divorced itself from the venture group. So the intimate bond that you need to be able to understand what the opportunities are, just the access to everything, generally collapsed. So now we have to be sure what we are setting up is a sustainable business in the long run." Grow your own While Lucent New Ventures and Xerox New Enterprises are venturing technologies from within their own organizations, Texas Instruments is using a venture-capital model to effectively grow its own customer base. The world leader in digital signal processing (DSP) technology -- chips that convert analog signals to digital data -- TI has formed a limited partnership with venture capitalist Hambrecht & Quist (H&Q), San Francisco. The partners will fund start-up companies that write code for the TI DSP architecture in applications that include cellular phones, digital TV, and disk drives. "One of our fears is that, on our own, we wont be able to discover all the new areas where DSP can be used," says Doug Rasor, vice president for strategic marketing at TIs semiconductor group. Already holding 45% market share in the DSP processor arena, pegged to grow tenfold to $50 billion during the next 10 years, the venture-capital initiative is designed to support an annual revenue growth target of 40%. "We have an overall metric to increase the number of software seats [programmers actively writing code for the TI DSP architecture] by 10,000 this year," he says. In the limited-partnership arrangement, H&Q manages the venture fund as general partner, providing the business acumen and deal flow from a venturing standpoint. TI assesses technical risk and strategic value to the corporation. Both parties jointly decide whom to negotiate with, but TI has the final say. The effort is supported by a corporate venture fund of $100 million over three years and, in most instances, H&Q matches the TI investment when a deal is struck. Established in September 1997, the initiative is attracting about 80 requests per month, with four or five per month receiving serious consideration. Ten investments had been made through April, though none has made an IPO as yet. Although both H&Q and TI are interested in sound financial return from the ventures, TI already has gained valuable information via the process itself. "By interaction with the companies applying for the funds, we are gaining a lot of market foresight, learning a lot about new markets and new ideas that no amount of market research or analysis inside the company would discover," says Rasor. As part of the selection strategy, TI is targeting small, early-stage companies of 20 to 30 people, with valuations of less than $10 million. "Early-stage investments put us a little more out on the limb in terms of risk, but we decided we wanted to bias the fund to high-risk, high-reward," says Rasor. "From the standpoint of promoting DSP and gaining market foresight, we want to make more investments in smaller operations as opposed to a handful of fairly large, solid bets. We expect to have 20 to 30 in the portfolio by the end of the three-year funding period."

Sponsored Recommendations

Voice your opinion!

To join the conversation, and become an exclusive member of IndustryWeek, create an account today!