ENGINES OF PROGRESS:
DESIGNING AND RUNNING
ENTREPRENEURIAL
VEHICLES IN
ESTABLISHED COMPANIES
ROSABETH
MOSS KANTER, JEFFREY NORTH,
ANN PIAGET BERNSTEIN, and
ALISTAIR WILLIAMSON
Harvard Business School
INTRODUCTION TO THE CASE REPORT SERIES
In order to create new revenue streams through new or improved lines of business, many
companies have established formal programs to stimulate and manage innovations and venture creation. We refer to such programs as “entrepreneurial
vehicles”+ngines
for driving
the creation of value through new ideas-and
the projects they nurture as “newstream”
operations in “mainstream”
(ongoing,
activities, to distinguish them from “mainstream”
established) lines of business (Kanter 1989). The core dilemma around entrepreneurship
in
established companies is, of course, organizing so as to manage newstreams in the midst
of mainstreams-even
when there are conflicting requirements for effectiveness in each.
Between 1986 and 1988 a Harvard Business School Research Team studied eight
corporate venturing programs in depth, covering companies in a large range of industries
and with strikingly different kinds of entrepreneurial vehicles. Burgelman (1983) identified
three major levels (or tasks and roles) in the internal corporate venturing process. These
levels are similar to the levels in Bower’s (1970) resource allocation model: corporate
management, which provides the structure and rationale for new business development, as
well as authorizing projects and monitoring performance; new venture development management, which delineates specific areas in which to seek project managers; and the venture
managers themselves, who generate the ideas, champion specific products or technology,
and oversee the technical work. The focus of the Harvard research was the middle level,
the integrative mechanism for linking corporate strategy and innovation projects.
This report covers one of eight programs examined by Rosabeth Moss Kanter’s research team in 19861988. Jeffrey North, Anne Piaget Bernstein, and Alistair Williamson collaborated on the report, and Gina Quinn
edited it. This report is based on multiple rounds of interviews in 1987 and 1988 and a review of company documents
and published materials. Research funding was provided by the Harvard Business School Division of Research,
whose support is gratefully acknowledged.
Address correspondence to Gina Quinn, Baker 400, Harvard Business School, Soldier’s Field, Boston, MA
02163.
Journal of Business Venturing 5, 415-430
0 1990 Elsevier Science Publishing Co., Inc., 655 Avenue of the Americas, New York, NY 10010
415
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R.M.
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The research examined the entrepreneurial
vehicles themselves-how
companies organize to find, nurture, and use newstream activities. The eight sites were selected to
maximize differences in strategic intent, and these initial differences in goals and strategy
were then reflected in operational differences, such as the linkages between newstream and
mainstream organizations,
as well as in the payoff to the companies. The Minnesota Innovation Research Project used a similar strategy of comparing projects that were quite
different in form, scope, intent, and context (Van de Ven, Angle, and Poole 1989).
The strategic intent continuum is anchored on one end by entrepreneurial
vehicles
designed to maximize newstream ventures, for purposes of corporate diversification,
and is
anchored on the other end by vehicles designed to impact back on mainstream activities,
by stimulating innovation through the mainstream. In short, the “ideal type” of strategic
choice is whether the primary goal is to be economic (creating new sources of revenue
regardless of the impact on the mainstream organization) or cultural (showing the mainstream
organization how to be more innovative regardless of the magnitude of the economic payoff
of newstream activities). In the latter case, newstream activities are certainly intended to be
profitable, but their assumed value as role models far exceeds any immediate bottom line
benefits. In practice, of course, there is a mixture of goals. When economic goals dominate,
however, top management intends to be more heavily involved in defining the newstream
strategy, there are more explicit biases in the selection of newstream projects, and there is
often more separation between mainstream and newstream, the newstream often being organized as independent,
stand-alone ventures. When cultural goals dominate, newstream
activites are more likely to come out of spontaneous submissions by lower-level managers
and employees, and many close linkages are maintained between newstream and mainstream.
Between the two extremes, various mixes of economic and cultural goals produce other
kinds of entrepreneurial
vehicles.
The establishment of a formal newstream channel raises significant issues. Organizations have long used “parallel organizations” to stimulate and guide activities outside of
the mainstream, as an outlet of communication and decision making that bypasses the routine
system and hierarchy in the interests of change (Stein and Kanter 1980; Kanter 1983). The
process of turning
most commonly researched “parallel systems” for the entrepreneurial
research into new lines of business in the established corporation has been the new venture
department (NVD). The rationale for a separate new venture department is to find a home
for radically new products or technologies that need more to be developed than simply proven
as a concept in a laboratory and then transplanted to an existing division (Burgelman and
Sayles, 1986). In short, an NVD is used for products that are both new and different.
Dzjj‘ierent means that the product or process may not fit well with the existing business flow;
new implies the need for a different managerial mode than that appropriate for ongoing
operations (Kanter 1986, 1989). Furthermore, autonomy-being
protected from the day-today operations and reporting requirements of the parent corporation and allowed a degree
of self-sufficiency until viability has been achieved (Burgelman and Sayles 1986, p. 125)has been found to be a major factor (along with top management support) in successful
internal corporate ventures (von Hippel 1977; Galbraith 1982) and corporate venture capital
departments (Siegel, Siegel, and MacMillan 1988).
But the NVD as a stand-alone entity has been found to be an unstable organizational
form. Fast (1979) studied 18 NVDs established between 1965 and 1975; half were inoperative
by 1976 in the form in which they had been established. But only a few had been disbanded
completely; others had retained the ventures they started and become an operating division
managing those then-established
businesses or had become a staff department, generally in
strategic planning.
ANALOG
DEVICES
ENTERPRISES.
1980-1988
417
This evolution is not surprising; it may even be inherent in the very definition of a
newstream channel. If a new venture organization is set up because there is no other way
to do things that are “different,” it may not produce results for the parent because it is
resource-starved,
skill-starved,
or increasingly detached in its operation. The economic
evidence is mounting that relatedness is a key ingredient in successful diversification, whether
through acquisition or internal venturing. For example, unrelated acquisitions tend to be
sold at a higher rate (Montgomery and Wilson 1986; Porter 1987) than related acquisitions.
So if “difference” is a problem, then stand-alone vehicles may either dissolve or gradually
migrate towards “ownership” by the established businesses. The closer they come to the
mainstream, however, the greater the domain conflicts, the fewer the justifications for standalone new venture operation, and the greater the pressures to be servicing the mainstream
with modest, incremental improvements.
Furthermore, there are numerous tensions and conflicts that arise from the establishment
of a parallel system or a newstream channel. Some of these are inherent in the difference
between mature management practices suitable for routinized, established businesses and
those appropriate for new ventures; others stem from the simple fact of establishing two
different channels side by side. Among the conflicts that are identified in the literature are
strategic conflicts of interest involving domain and synergy; administrative conflicts involving
the unwillingness
of other departments to share resources with the new venture or the
unwillingness of the venture to use the policies and systems of the established organizations;
“culture” clashes because of the more chaotic nature of innovation; and measurement and
reward issues, because it is often misleading to measure new venture performance in the
same way an established business is measured (Burgelman and Sayles 1986; Kanter 1986,
1988, 1989; Quinn 1985; Miller, Wilson, and Adams 1988; Sykes and Block 1989).
The success of innovation and entrepreneurship
in established companies, therefore,
depends on more than effective management of each innovation project. It also depends on
the effective management of the newstream channel that is producing ideas, nurturing them
to the point at which they are transferable, and linking them to the mainstream. Studying
the design of the new venture vehicle itself can illuminate the key considerations and tradeoffs involved in different mechanisms for producing new ventures in the corporate context.
Thus, entrepreneurial vehicles are dynamic and evolve over time as a function of the
strategies of their parent companies, the results achieved, and the experiences gained in
establishing and managing them. Since results are a matter of expectations, it is important
to assess the success or failure of a venturing program against the goals that are set for it.
Ventures with more modest goals are sometimes better able to produce results than those
established with greater expectations. Furthermore, longevity is only one measure of the
success of an entrepreneurial vehicle. The eight venturing programs studied in detail range
in age from almost twenty years to less than three years, but all of them have changed in
major respects over time, and they were still changing when the field research was completed
in early 1989.
Changes in the nature of the entrepreneurial vehicle over time are a function not only
of internal organizational evolution, but also of external developments, especially for those
established in response to the environment. The impetus for some companies to start a new
venture program is reactive: to capture rather than lose people and ideas, to have a means
for commercializing
inventions produced with company resources whether or not they were
envisioned in top-management
strategy, and to retain potentially creative people. This was
often a response to a venture-capital-induced
brain drain in particular companies and communities at particular times (e.g., Oregon in the mid-1890s). It was also a response to the
perceived success of start-ups that had used technology developed in a large corporation.
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But, as the external environment changed (venture capital availability declined; high-technology companies took nosedives), companies whose entrepreneurial vehicles were defined
in response to that environment and that, meanwhile, had experience under their belts, came
to rethink their new venture approaches.
The eight research case reports, taken together, provide an opportunity to compare
and contrast venturing programs of different types and track records, to view their evolution
over time, and to access the conditions that make entrepreneurial vehicles able to serve as
effective “engines of progress” for their parent companies. The experience of Analog Devices
Enterprises, the first in the series, offers insight into the rise and fall of a corporate venture
capital group.
ANALOG DEVICES ENTERPRISES, 1980-1988
The mission of ADE was
growth. We seek to invest
thrusts. Our objective is to
option to eventually expand
to invest in young high technology companies with potential for high
in firms whose technology and products support our five diversification
make these investments in such a manner that Analog Devices has the
its technological base.
-Analog Devices Enterprises,
Progress Report, September 1983
Analog Devices Enterprises (ADE) was a venturing arm of Analog Devices Inc. (ADI).
Formed in 1980 as a vehicle for investing in emerging new technologies, by 1987 ADE
consisted of eleven companies in which ADI had an equity stake of between 10% and 70%.
Since 1980, ADI had invested $41 million in this portfolio in an effort to diversify Analog’s
technological base and eventually to contribute to the company’s technology-driven
growth.
But by 1988, the company was withdrawing its commi~ent
to ADE and rethinking its
newstream approach.
Founded in 1965 and headquartered in Norwood, MA, Analog Devices Inc. is a leading
producer of integrated circuits, data acquisition components, and subsystems used in computerized measurement and control systems, including medical instruments, industrial automation controls, avionic systems, and scientific instruments. In 1986, when the research
began, Analog Devices employed about 3,000 people in the United States and about 2,000
people abroad, where 40% of the firm’s sales originated. In 1988, net sales were $439
million and net income was $38 million. AD1 served more than 5,000 customers; the biggest,
IBM, accounted for 7.5% of Analog’s annual sales. ADI’s product line contained over 600
items with 1,000 variations. Technological innovation was key to the company’s past success
and to its strategy for future growth.
Like many newer technology-based
companies, Analog had a humble beginning. The
first production facility was located in the basement of the Cambridge apartment building
where founder Ray Stata and his co-founder and MIT roommate, Matthew Lorber, lived.
The pair started the firm with bank loans secured with their stock in Kollmorgen Corporation
as collateral. Kollmorgen had bought their first start-up, Solid State Instruments, a company
they had created for the production of testing devices for gyroscopes. ADI’s first products
were operational amplifiers, which process and strengthen electrical signals. In 1969, Analog
purchased Pastoriza Electronics Inc., a small firm with patents on analog-to-digital conversion
devices. This jnvestment of $1 million was at the beginning of what was to become Analog’s
main product line, which contributed $75 million in sales in 1986. In 1971 Stata became
president and, in 1973, chairman of ADI.
Stata attempted to establish a work environment
that would attract and retain the
ANALOG
DEVICES
ENTERPRISES,
1980-1988
419
technical talent he needed. For example, an English engineer, Gilbert, was given the choice
of working in Oregon, because it was his wife’s home state and the climate reminded him
of England. Analog provided Gilbert with a lab, a secretary, and the appropriate equipment
in a location 3,000 miles from Analog’s headquarters. At the same time, Stata placed
technology bets. In addition to developing analog-to-digital
products, he believed that integrated circuit (IC) technology would become a major industry in the years ahead.
Rather than reinventing the wheel by starting at the beginning to develop what other
IC pioneers had already discovered, or buying a company that possessed state-of-the-art IC
technology, Stata devised an arrangement to obtain access to the technology with a more
modest financial and managerial commitment. In 1970, he proposed that AD1 provide $2.5
million in venture capital to a group of engineers to start Nova Devices, which would produce
silicon chips designed to replace transistors in analog-to-digital conversion devices. In return
for seed capital and marketing assistance, Analog received access to Nova Device’s developments and the option of acquiring 100% of Nova at a later date if the start-up proved
successful. To gain the approval of ADI’s board of directors, which was divided over the
decision to get into the IC industry, Stata put up his own AD1 stock as collateral to secure
a $1.5 million loan to Nova Devices along with ADI’s $1 million in equity investment. The
gamble paid off. In 1972, AD1 exercised its option to acquire Nova Devices. Nova Devices
became Analog Devices Semiconductor (ADS), which currently provides 70% of ADI’s
sales and 80% of its profits.
Despite this success, Analog’s core product lines and its research and development
activities were centered on only a few narrow fields of technology. Furthermore, ADI’s
marketing focus was toward producers of complete systems-AD1
made only the components. Top management believed that Analog’s customers soon would be demanding complete systems, not simply the components and the chips that composed Analog’s basic
business. Realizing how fast the electronics industry was growing, AD1 sought a way to
keep abreast of technological developments in industries close to those Analog had already
entered or might wish to enter in the future.
During the winter of 1979-1980, Analog’s top people, including officers, marketing
staff, and key technologists formed a diversification
task force. They met on Saturday
mornings to discuss the future and to develop a list of fields into which AD1 should be
moving. Among promising areas for Analog’s future, they identified digital signal processing,
high-speed computers, high-speed automatic test systems, industrial image processing, automation, and emerging high-speed semiconductor processes such as gallium arsenide, which
could prove to be important to Analog in the long-run.
But Analog did not have the resources to pursue all of these technologies alone. In
addition, there was a shortage of experts in several fields, a problem that money could not
solve. In the mid-1970s, when sales were nearly $100 million, Analog attempted to develop
electronic converters that could process high-frequency video information for use in radar
systems and other ultrafast instruments, but discovered a lack of internal expertise. The gap
was filled in 1978 through the acquisition of Computer Labs, a $3 million North Carolina
company.
The successful venture capital seeding and subsequent integration of Nova Devices,
along with the purchase of Computer Labs, probably made Stata such a firm believer in
owning interests in start-ups and early-stage companies. By 1978, after the established
success of Nova Devices’s other deals, AD1 was getting a reputation as a company willing
to invest in partnerships with smaller high-tech firms. Analog started to receive unsolicited
propositions for funding or acquisition from young technology companies. Many of these
420
R.M. KANTER ET AL.
were legitimate and potentially rewarding opportunities for Analog to participate in the
creation of blossoming technologies and fuel for its own long-term growth.
Describing the small firm’s view of the potential relationship, George Wilson, then
president of Bipolar Integrated Technology (BIT), a company in which AD1 initially invested
$3OO,ooO, indicated the allure of a high-tech company like ADI acting in a venture capitalist
capacity: “Ours was such an advanced technology that it was not realistic to go to venture
capitalists and expect them to understand it. We were going to need a company within the
industry that would understand our technology.”
At this time, all of Analog’s financial resources were committed to its existing operations and lines of business. Furthermore, AD1 was working toward some internal diversifications that further constrained available resources; there was no spare capital for venturing. Analog turned to another source, one of its own institutional shareholders, Amoco.
Analog had done business with Amoco since 1977. In the summer of 1977, Stata and
Larry Sullivan, the senior vice president of Corporate Development, had arranged a deal in
which Amoco (Standard Oil of Indiana) acquired 15% of Analog stock for $5 million. The
executive officers approached Amoco for funding because, as Sullivan explained, “the public
markets were dead, so we looked for private sources. The oil industry was awash in cash,
so we got into a deal with Amoco.” Gordon McKeague, president of Amoco Technology
Company, a Standard Oil subsidiary, and manager of corporate development for Amoco,
became a member of Analog’s board of directors and is still serving in that capacity.
In June 1980, when venturing opportunities were creating more of a need for new
capital, Analog approached Amoco again. The result was a novel financial agreement. Amoco
and Analog entered into a five-year agreement whereby Amoco would receive up to 10,000
shares of preferred stock annually, priced at $1,000 per share, in return for up to $10 million
in cash paid to Analog for use in investments in the selected ventures. At the end of the
five years, Amoco would have up to twelve months to convert the $1,000 preferred stock
into $2,000 common shares at the prevailing market price. Amoco would not share in the
profits or losses of the portfolio investments, nor would it have any active participation in
the management of the portfolio apart from Gordon McKeague’s seat on Analog’s sevenmember board.
On July 31, 1980, ADI officially announced the formation of Analog Devices Enterprises (ADE), to augment internal expansion by affiliation with entrepreneurial
companies
in selected growth markets. ADE would supply expansion capital to young companies and
also share with them Analog’s experience and management tools.
Amoco had its own reasons for underwriting ADE. Amoco Technologies Company
was a subsidiary with its own mandate for diversification and venturing. Amoco technologies
already owned 21% of Cetus Corporation, a genetic engineering company, and 21% of
Solarex, a solar technology firm. Analog’s signal processors would aid Amoco’s exploration
and refining efforts.
Analog now had the financial resources to begin assembling a portfolio of investments
that would give the companies windows on new technologies.
Each of the agreements
between Analog and the portfolio companies was different. In general, however, these
agreements gave Analog an equity position and one or more of the following rights: the
option to acquire the company at a later date; access to the new technology or processes;
joint R & D agreements; or the option to market the new firm’s products.
ADI had an agreement with its auditors that losses in ADE would not be reflected on
the ADI profit and loss sheet. This would be important to insulate AD1 from the vicissitudes
ANALOG
DEVICES ENTERPRISES,
1980-1988
421
of risky start-up companies, and to avoid competition for resources between Analog’s mainstream and the new external ventures.
There were three specific reasons that ADE was organized as a corporate venture
capital group investing in a portfolio of stand-alone computers. First, to reduce cost. Second,
to minimize structural changes. Outright acquisitions would require frequent changes in
Analog’s financial and management structure; and increase in the portion of the company
consisting of acquired operations would cause Analog to lose focus on its core products and
marketing strategies. Finally, to contain risk. Blossoming technologies are extremely risky.
Often a product or a process looks both feasible and elegant on the drawing board, but
finding marketable applications can be extremely difficult. In the 196Os, Stata could afford
to bet the company on the gamble that integrated circuits would be the wave of the future,
but the situation had changed by 1980, owing to Analog’s responsibilities
as a public
company. Furthermore, if a portfolio company fails, the loss is localized, having a lesser
effect on the management and the morale of the core company.
By September 1983, there were eleven companies in the ADE portfolio. Analog
produced a report to shareholders describing its portfolio and venturing objectives. Analog
stopped adding companies to the portfolio in 1984. The strategy of ADE was then changed
to concentrate on “follow-on investments in those companies which continue to be strategically compatible with the Company and to sell its interests in the companies whose strategies
and future direction diverge from those of Analog,” according to ADI’s 1986, 10-K report.
In 1985, at the end of the five-year Analog-Amoco
agreement, Amoco did not renew the
agreement. Analog’s explanation was that a $30 billion company like Amoco needed larger
investments to aid its growth.
MANAGING THE NEW VENTURE INVESTMENTS
Sullivan served as the general manager of ADE, with primary responsibility for managing
the ADE portfolio companies. Sullivan was assisted by an internal, ad hoc board of advisors consisting of Robert Boole, ADE’s Director of Venture Analysis, Ray Stata, and
Sullivan himself. John Hudson, ADE’s controller, was frequently included as a member
of this board, as were various operating managers, senior technologists, corporate financial staff, and marketing staff from ADI. The idea was to assemble the most qualified
and knowledgeable group of people possible to make portfolio decisions drawing on ADI’s
experience, skills, and creativity, yet to retain the flexibility of ADE.
The ADE portfolio was selected after studies by ADI’s corporate marketing staff, who
used as a criterion areas that appeared to be relevant for the future, to offer good opportunities
for complementarity
with existing core businesses, and to have a distinct competitive edge.
Specific screening factors included the following:
l
The experience,
accomplishments
l
The strengths,
l
The size and potential
l
The presence of distinctive, innovative
for success relative to competitors.
creativity,
and balance of the management
team.
and caliber of the technologists.
growth-rate
of the market for the company’s
products.
factors in the products and the requirements
422
R.M.
KANTER
ET AL
l
The ability of the company
customer base.
l
A credible business
to develop,
and financial
market,
and direct new products
to their
plan.
The portfolio was assembled in a carefully focused process. First, Robert Boole, who
was reporting to Sullivan, would find the companies and make initial evaluations from a
venturing standpoint, along with Larry Sullivan. A special emphasis was placed on the
technical and marketing staff of the proposed portfolio company. Since it was felt that the
necessary technical expertise was to be found inside Analog, outside help was rarely sought
in evaluating the ventures.
By the summer of 1983, “the peak of VC madness,” approximately seven companies
were in the portfolio, and closings were occurring every two or three months. Although the
extremely favorable valuations on many companies were, at this time, attractive to the
majority of investors, Analog followed a different investment strategy. They demanded
strategic links with the potential portfolio companies and refused several attractive companies
because they disagreed with the method of valuation used and the unrealistically
high
projections.
The process of negotiation with potential portfolio firms was often a lengthy, openended process, taking months to reach an arrangement in line with Analog’s strategic objectives and the entrepreneur’s goals.
Analog was not the only investor in many of these deals. In the case of BIT (see
Appendix I), Analog took a small equity position, and other needed capital was sought from
venture capitalists and banks. ADE helped the founders of BIT to locate and to negotiate
additional funding from venture capitalists and banks. Venture capital groups, which did
not take BIT seriously at first, were eventually impressed when BIT conducted market
research, using ADI customers as a survey pool, and formulated a complete business plan
with help from Analog officers.
Once the candidate company underwent the screening process and the decision was
made to invest, an agreement would be drafted that called for monthly profit and loss
statements and balance sheets to be reported to ADI, supplemented with quarterly reports
containing greater detail. An Analog vice-president was chosen to sit on the young company’s
board, and Analog retained absolute visitation rights. However, Analog did not interfere
with the company’s day-to-day management or decision-making.
Rather, an emphasis was
placed upon building and maintaining
effective lines of communication.
Regular board
meetings and frequent telephone conversations-when
Sullivan found a reason to call-were
the norm. John Hudson, ADE’s controller, frequently met with or had telephone contact
with the CEO of each company. Whether or not this worked in practice depended on the
openness and the integrity of the start-up’s CEO. The flow of information was critical to
monitoring the companies.
Boole sat on the boards of directors of three portfolio companies, and at least one
Analog representative sat on the board of every portfolio company. Sullivan served on seven
boards. Analog’s philosophy toward management of the portfolio companies was “handsoff.” But ADE was very active in maintaining communication
links between Analog and
portfolio company managers, as well as in giving advice and attempting to influence strategies
and policies whenever the entrepreneurs seemed to ADE to be “going off into left field.”
But power was limited: Sometimes the advice was taken; sometimes not.
Over the years, however, ADE grew and its focus shifted from building portfolios to
making strategic decisions about investments that were already in the portfolio, specifically,
ANALOG
DEVICES
ENTERPRISES,
1980-1988
423
deciding whether to stay with an investment or divest it. According to Boole,. ADE did not
have much luck divesting companies.
Although ADE did not attempt to manage the day-to-day activities of the portfolio
companies, ADE officers did step in to make changes in portfolio company management,
-that
is, if the company team was not working effectively in their estimation, and especially
if they felt that their investment was being threatened and the company was in danger of
failure.
Sullivan was instrumental in removing the CEOs in four of the portfolio companies,
and altering the management structure in another. In one case, in which he was able to move
quickly, the change of management was swift and fairly painless. In another situation,
however, it took a year to convince two of the founders that the CEO was incompetent. By
then, the damage had been done and the investment was subsequently lost.
There were also attempts to develop relationships among the portfolio companies, to
pursue possible synergies. In the fall of 1983, Analog brought together people from the
portfolio companies at a conference in Monterey, California. Although the companies were
diverse in their missions and operations, the entrepreneurs discovered a range of overlapping
interests as they met and talked. IS and Numerix decided to share the cost of hiring a salesrepresentative to penetrate the oil industry. Other companies began discussions that led to
a purchasing pool to get volume discounts on memory chips and other components. Some
companies discussed buying and selling with one another. They exchanged ideas on how
to reward and motivate employees, and how to buy test-equipment.
As always, there were
opportunities to refer entrepreneurs to various experts within Analog for technical and
marketing advice.
Some of the benefits have also been specific financial cooperation. For example, BIT
and ADS worked out a margin split agreement, whereby the gross margin of a product after
production and marketing costs is split equally between producer and developer. This provides both an incentive and a degree of fairness to the financial rewards of a venture.
However, it may not have been possible if BIT and ADS were not “part of the same family.”
Analog Devices, Inc. became the exclusive marketing agent for BIT products sold in
Europe. This was a significant boost for BIT, which would find it difficult to maintain its
own foreign marketing program because of its small size. “It makes sense,” said Boole.
“We had an excellent marketing organization in Europe, and they fit in well with products
that we make internally.” In this example, managers at BIT were able to learn a great deal
about marketing in Europe and the Far East by sharing Analog’s experience. In the United
States it is not uncommon for a young firm to contact potential customers during early stages
of product development. In foreign markets, where credibility is sometimes a more delicate
issue, BIT pushed Analog to do the same, but reluctantly backed off when they learned
from Analog that it would not be advisable to aggressively pursue customers until their
products were ready to ship.
ORGANIZATIONAL
AND MANAGERIAL
CHALLENGES
In addition to the risks inherent in new technologies, the uncertainties of the marketplace,
the ambiguities of power, and of the (theoretically) hands-off ADE approach, there were
also growing problems at the interface between ADE and its parent cqmpany operations.
The distinction between Analog divisions and external start-up companies posed a challenge
for the ADE newstream managers, when mainstream division managers saw the outside
companies getting investments while the internal divisions were operating under strained
424
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KANTER
ET AL.
budgets. The solution was further separation. ADE managers explained, to mainstream
employees who expressed concern, that the money came from different places for different
things, and that the venture employees were risking their careers in ways that Analog regulars
were not, since mainstream employees would not lose their jobs if their projects did not
succeed.
Furthermore,
Analog tried its own internal start-up, Digital Signalling Processing
Division. But DSPD, as an internal venture, had much tighter control and faced conflicts
with the ADE ventures. DSP was established in 1984. By 1986, it had introduced ten new
products, including a single-chip digital processor that performs the functions previously
done by an entire circuit board, and, soon, had established itself as an industry leader. DSP
experienced its own problems of fit within the mainstream organization; as a start-up venture,
it was expected to perform like an aggressive, fast-moving,
independent entrepreneurial
business. Yet it had to contend with the same constraints as any other Analog division.
However, as an internal start-up, DSPD did not have the freedom of the ADE venture to
establish its own systems. The original general manager complained that his group was
trapped in a compensation system designed for the rest of Analog but insufficient for a startup. The bonus system was tied to a company and not the division’s performance,
and
although there was some discussion of a bonus of 10% to 20% of base salary tied to division
performance, it was not considered enough to keep people working long hours and weekends.
In portfolio companies, however, employees had equity and a share in the profits. Thus,
DSPD had problems attracting and retaining qualified people, and many positions at DSP
remained unfilled. The result was an overloaded and undermotivated
staff, especially as
they compared themselves with the ADE ventures. Finally, the general manager was asked
to work with portfolio start-ups on joint ventures; the result was more strain on his divisions
resources. Ultimately, he left the company. His conclusion was that internal start-ups face
challenges that do not put them in a favorable position to support or take advantage of
ventures with external start-ups.
Some of Dintersmith’s comments further indicate that there is great difficulty in coordinating the development of a number of complex new technologies simultaneously
and
also in arranging synergistic cooperative arrangements between different teams of technologists. For example, joint definition can be a problem when two teams do not agree. Each
team sees the other as a distraction that hinders them from achieving their separate goals.
The resulting effort becomes frustratingly weak, and is often far less than would be possible
if all energies were focused toward the same definition and goal.
ANALOG’S ASSESSMENT
OF ADE
A rule of thumb for new businesses is that 2 of 10 might be expected to succeed. Indeed,
U.S. government statistics support this, indicating that 80% of new businesses fail within
the first five years. Against this probability for success, ADE performed adequately, but
below Analog’s expectations, which led to an increased emphasis on financial results and
a proposal to end ADE.
Since the portfolio investments we studied began in 1980, through 1988, 6 of 13
investments have yielded positive resultspither
technological advances or financial gains
or both. The initial intent of these investments was always more centered on the strategic
benefits that could be achieved from them. In the absence of technical benefits, however,
Analog would opt to buy low and sell high to profit from the investments,
if possible.
Photodyne, the best ADE investment financially, was sold to 3M in 1988 for a 35% compound
rate of return. Unfortunately,
Photodyne did not yield the technical benefits and synergies
ANALOG
DEVICES
ENTERPRISES,
1980-1988
425
that were hoped for. On the other end of the scale, Gigabit has had sales increases of over
100% every year for the past three years, and it produces all of the microchips on a Gray
3 supercomputer.
Gigabit was considered a financial success, possibly becoming the best
investment in the portfolio. Analog expected to market Gigabit products in 1991 and 1992.
BIT was also a success strategically, producing chips that are contained in ten Analog
products and also boosting the value of the ADE investment by 50% in dollar terms.
But if new ventures need “patient” money, ADI’s results in 1986 showed that patience
is a luxury. An external change put more pressure on Analog to emphasize the financial
side of its newstream investments. In 1986, AD1 experienced its first year of stalled growth.
The 1986 annual report warned that “so far we have been able to maintain our investments
without unduly comprising our bottom line, but looking ahead we know we cannot continue
to increase expenses without a commensurate increase in sales.” The financial reports for
1986 and 1985 showed expenses of $4,356,000 and $3,016,000, respectively, related to
ADE investments.
These expenses came about as a result of a change in accounting, dictated by the SEC.
Analog Devices had been employing the investment method of accounting for the ADE
investments. Though the accounting rules for corporate venture capital investment are vague,
the SEC felt that a modified form of the equity method would be more appropriate.
This requirement introduced an unpredictable and uncontrollable element into Analog’s
income statement. To reduce this effect, Analog began to seek more investors in each deal.
A consequence of this move was a likely reduction in the ability of Analog to realize strategic
benefits from its investments.
Furthermore, Stata stated, if the SEC’s position had been
known before ADE was founded, ADE would never have been born, for the new requirements
put the long-term goals of ADE directly in conflict with the short-term goals of ADI. It was
only a matter of time before the existence of ADE was questioned.
In 1987, Analog’s CFO concluded that “from a financial viewpoint, ADE has been
very painful financially and will continue to be for some time,” though he pointed out that
“if all we ever do is make money on this by buying low and selling high, then the program
will not have met its goals.” If technical benefits cannot be produced, a financial gain can
relieve some of the disappointment.
However, by 1988, the future of ADE was very uncertain, and Analog was retreating from its commitment to the venturing arm of the company.
Each key actor derived a different lesson from the poor performance of ADE, ranging
from the strategy itself to the level of expectations set forth. Some felt that the problem was
not ineffective technology or market forecasting, but rather, management. Another thought
that perhaps the matter of diversification would be better left to the divisions, though he
later said that divisions may not want to diversify because of their focus on the base business.
Still another cautioned patience, stating that “you’d better be prepared to go ten times longer
funding than you expected.” Finally, Sullivan stressed relatedness. In his eyes, the deals
that will prove workable are those in which investments are made in companies with complementary technologies that can be exploited by Analog’s core business. The future focus,
he contended, should be on obtaining leverage through marketing rights, joint R & D rights,
and technology transfer options. A final thought was that it might be concluded that Analog’s
investments into divergent businesses just don’t work.
IMPLICATIONS
The very factors that create success for a venture capital operation can compromise its ability
to serve the parent company’s diversification objectives (Hardymon, DeNino, and Salter
426
R.M. KANTER ET AL
1983). For example, there can be a conflict between the organizational independence required
to make good investments and the ~imi~t~ons on the kinds of companies to be invested in
that are presented by the parent company’s business strategy (i.e. I the desire to find synergies
with existing businesses). Some anafysts have argued that me objective of a corporate venture
capital program is generally strategic rather than financial, and that the possibilities for
synergy include acquisition possibilities, marketing rights, and technology windows for the
established corporation as well as capital, credibility, and marketing channels for the new
venture (e.g., Winters and Murfin 1988). Indeed, the promise of such synergies could serve
as an argument for the greater potential of corporate venture capital over inde~nd~nt venture
capital to nurture successful new ventures, as corporations can bring more to the party than
simply financing.
However, the Analog case and related research suggests a different conclusion. Achieving synergies requires active management of the interface between the funding coloration
and the new venture, not simply a statement of the theoretical “fit” (Kanter 1989). However,
autonomy is often found to be a condition for effective start-ups as well as for effective
corporate venture operations. A survey of 52 corporate venture capital groups found that
higher performance was achieved by groups run by managers with greater autonomy than
by groups highly controlled by corporate management (Siegel, Siegel, and MacMillan 1988).
Autonomy tends to undermine the connections, relationships, and trade-offs required to make
synergies work, as the tensions between the internal Analog division and the ADE portfolio
companies showed.
Thus, as in the case of Analog Devices Enterprises, an established corporation that
begins by viewing its venture capital investments as a part of corporate strategy, expecting
transferable benefits, may find venture autonomy an unstable situation. As a venture takes
its own course, diverging from the direction of the co~oration’s mainstream, or as the
absence of hoped-for synergies make financial returns loom larger as the rationale for
investment, the company may respond by moving in one af two directions. It could pull
the ventures closer to the corporation (through acquisition or tighter management, presenting the risk of harming the fragile venture, if not appropriate to its embryonic state,
but also the potential for improved performance-with new management and greater mainstream linkages); in that case, the corporate venture capita1 group has changed its focus.
Or, the company could loosen its strategic objectives and tighten its purely financial ones,
moving toward becoming only an arn~‘s-length investor. Then, as other investments look
more at&active, because of changes in industry conditions (as happened to Analog’s hightechnology investments in the 198Os), or as external changes influence strategic choices
(e.g., the accounting rules changes Analog faced), the company can move away from
venture capital attogethcr as a source for news~eam d~ve~opnl~nf.
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Galbraith, J. 1982. Designing the innovating organization. Organizational Dynamics 10(Summer):5-
l‘z
ANALOG DEVICES ENTERPRISES, 1980-1988
427
Hardymon, G.F., DeNino, M.J., and Salter, MS. 1983. When corporate venture capital doesn’t
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428
R.M.
KANTER
ET AL.
APPENDIX 1. THE PORTFOLIO COMPANIES
(AS OF OCTOBER 31, 1986)
TAU TRON, INC.
An early investment of $1,547,000 in Tau Tron, Inc., a manufacturer of high-speed digital
signal communications
test-equipment,
was sold to General Signal for $1,933,750 in June
1982. The proceeds were reinvested in the portfolio.
SIGNAL PROCESSING
CIRCUITS INC. (SPCI)
The first ADE investment occurred in 1980 after a group of Utah engineers approached
ADE for seed capital. ADE quickly invested $700,000 after a panel of Analog marketing
people and engineers reviewed the venture. The agreement gave Analog the option of later
acquisition, which was actually done in October 1983. This investment-along
with an
internal investment to develop digital signal-processing
circuits, based on the high-speed
process developed by SPCI-led
to the current Digital Signal Processing division of Analog
Devices.
NUMERIX CORPORATION
Larry Sullivan and Robert Boole searched nationwide for a maker of array processors,
computer components that increase the speed of number crunching for minicomputers. After
a year of searching, they saw an advertisement in a trade periodical for a firm called CNR,
Inc. CNR was developing an array processor that looked very promising. Sullivan conceived
of a very complex deal under which the key people and the array processor project were
spun out of CNR into a new company, Numerix. Analog invested $1.5 million in Numerix.
The chief technologist (who was also the founder) had been working on array processors
that might have significant applications for Analog’s customers. For example, in May 1983,
Numerix began marketing a 32-bit array processor that is three times faster than the market
leader and nearest equivalent. This device can be used to improve computer-aided design
(CAD) systems by making complex sets of calculations almost instantly. As part of its
investment deal, ADE picked up the right to acquire Numerix. This option effectively made
AD1 the sole supplier of Numerix capital needs. Numerix’s subsequent fast growth and its
need to fund follow-on products to its first products required AD1 to invest another $8 million
by the end of 1986.
INTERNATIONAL
IMAGING SYSTEMS (IzS)
In 1981 Boole and Sullivan sought a means of participating in digital image processingusing computers to interpret medical images, natural resource mapping, and landsat photographs. A phone call to Milpitas, California, put Boole in touch with the president of
International Imaging Systems, Inc., a six-year-old, six-million-dollar
company. The president was trying to figure out how venture capital could solve the cash flow problems for
this producer of image-processing
hardware and software. ADE invested $3 million in 12S
in June 198 1, receiving about 45% of the equity in return and a long-range option to acquire
12S.
ANALOG DEVICES ENTERPRISES, 1980-1988
429
JUPITER SYSTEMS
ADE learned about the importance of high-re~lution graphics in its dealings with IS. Boole
and Sullivan therefore went in search of complementary businesses. At a Boston computer
graphics trade show in the summer of 1982, Boole discovered Jupiter Systems. At the same
time, Jupiter was getting short of funds and the president was seeking new sources of
financing. ADE invested $2 million in Jupiter Systems, receiving about 20% of its equity
and the option to acquire the company in the future. It was believed that this product line
would complement Charles River Data System’s micr~ompu~rs and 12Simage processors.
ADE hoped that Jupiter Systems could provide sales op~~unities for AD1 DSP products,
and that Jupiter products could eventually be used by ADI’s Measurement Control Systems
Division.
CHARLES RIVER DATA SYSTEMS, INC.
This firm was founded in 1973 as a supplier of DEC peripherals. The firm produced the
Universe 68, a microcomputer system used in scientific, engineering, and industrial data
transaction applications. “We decided to get involved in Charles River Data Systems simply
to learn about where the industry was going,” said Sullivan. “We knew this type of computer
would have an impact on our business. ” ADE invested $1 million in 1982 and invested $1.9
million in subsequent rounds.
GIGABIT LOGIC, INC.
Gigabit was a start-up working on gallium arsenide chips, a material that can be used to
make chips three times faster than silicon chips. Analog invested $1.5 million in seed capital,
for which it got the rights to market some gallium arsenide chips in the future and the right
to produce gallium arsenide chips for use in its own products that do not compete with
GigaBit’s. ADE had invested another $1.9 million in GigaBit by the end of 1986.
QU~~AT~
TECHNOLOGY
CORPORATION (QTC)
Boole and Sullivan discovered that users of array processors had special software needs.
Synergy in array processors and digital signal processing would be found if ADE could help
to satisfy this demand niche. ADE thus invested $500,000 in QTC, a start-up located in
Portland, Oregon, in 1982. To fund QTC’s growth and help launch a new product line,
ADE invested another $600,000 in QTC in 1985. ADI then picked up the right to acquire
QTC in the future.
BIPOLAR INTEGRATED TECHNOLOGY,
INC (BIT)
ADE invested $300,000 in this start-up in July 1983. In return, Analog got a joint-marketing
agreement and a technology-tmnsfer agreement. The seed capital, only a fraction of the
$10-11 million BIT would require to begin full-scale manufacm~ng, was treated as a loan,
with an interest rate of 10%. This would later be converted to common stock. The rest of
the funding was to be provided in a complex plan for three rounds of financing that would
carry the firm from bare bones start-up to expanded operations and first shipping to fullscale production. ADE invested $2.8 million in the subsequent rounds.
430
R.M. KANTER ET AL.
The goal of BIT founders was to produce the fastest bipolar chips for the digital signalprocessing and the data-processing
markets. The goal for further development of bipolar
technology, like complementary
metal oxide semiconductor (CMOS) and gallium arsenide
(GaAs), the competing technologies for chip manufacture,
was to lower the power consumption and increase the speed of chips. Miniaturization
was also a goal, and BIT has
developed the LBT (Little Bity Transistor), the smallest bipolar transistor. George Wilson
and several colleagues, the founders of BIT, had worked at Tektronix, where they knew
Barry Gilbert, ADI’s technologist in Oregon (hired away from Tektronix). While Tektronix
was committed to gallium arsenide technology, Wilson and his colleagues spun off to work
on their ideas for bipolar processes, which they believed could be used to make a fast and
dense chip. Although Analog discussed the possibilities of acquiring the firm at some time
in the future, Wilson et al. were definitely not interested. They preferred independence and
the chance to take the company public.
TEST SYSTEMS,
INC.
Test Systems in Tempe, Arizona, was developing the market for inexpensive test equipment
used to check circuit boards. This area complements ADI’s Component Test Systems Division, which works on methods of testing integrated circuits. Both seek to offer the market
more cost-effective methods of testing. Test Systems sought management and organizational
advice from ADE as well as help in shaping its market image and launching a sales program.
ADE invested $9 million in Test Systems in 1983 and received an option to acquire the
company at a subsequent date.
PHOTODYNE
ADE invested $1 million in this maker of fiber optic test equipment in 1982. The company
pioneered the use of fiber-optic sensing heads and specialized signal-processing
circuits for
use in their equipment. From its Newbury Park, California, headquarters, Photodyne has
achieved impressive sales in the United States and abroad, where 35%-40% of its sales are
generated. To fund Photodyne’s fast growth, ADE invested an additional $1.5 million in
Photodyne in 1985 and received an option to acquire Photodyne in 1989.
TIGRE
ADE discovered Tigre, a French firm, through I’S (Tigre and I* maintained
agreement). A $200,000 investment was made in 1984.
a joint marketing
INDUSTRIE IMAGERIE SYSTEME
ADE discovered this French company with the help of venture capitalists during visits to
several European countries to scout investments. An investment of $500,000 was made in
1984. AD1 worked out joint R & D and U.S. marketing agreements with the company as
part of the investment.
This portfolio company has been financially successful and has
recently started selling its products in the United States.