02 Oct 2000  Research & Ideas

Networked Incubators: Hothouses of the New Economy

Are business incubators a fleeting phenomenon or a lasting way of bringing start-ups to fruition? Four HBS professors argue that one particular model—the "networked incubator"—is most likely to endure.

 

Editor's Note— Business incubators are a booming industry. Offering office space, funding, and basic services to start-ups, these organizations have become the hottest way to nurture and grow fledgling businesses. But are incubators a fleeting phenomenon born of an overheated stock market, or are they an important and lasting way of creating value and wealth in the new economy?

Morten Hansen, Henry Chesbrough, Nitin Nohria, and Donald Sull argue that one type of incubator, called a networked incubator, represents a fundamentally new and enduring organizational model uniquely suited to growing businesses in the Internet economy. It shares certain features with other incubators—mainly, it fosters a spirit of entrepreneurship and offers economies of scale. But its key distinguishing feature is its ability to give start-ups preferential access to a network of potential partners.

In this excerpt, the authors explain why access is the key and why networked incubators are emerging only now.

If networked incubators offer such compelling advantages, why are they emerging only now? The answer reflects a subtle aspect of the new economy: While there are tens of thousands of business plans and partnership proposals floating around, people have less time to consider and evaluate them all. A successful company like Yahoo! is inundated with business proposals from hopeful start-ups. When there is a wealth of opportunities, there is a poverty of access because so many entrepreneurs are chasing so few potential partners, all of whom are extremely busy. Networked incubators have sprung up now because of the critical need for access: The Internet economy is very much a network economy in which access and connections can help quickly launch businesses, increase the traffic at Web sites, and speed the diffusion of new technologies.

A networked incubator can provide tremendous value to a start-up team through connections that help forge crucial strategic partnerships, recruit highly talented people, and obtain important advice from outside experts. Consider three examples of start-ups that gained valuable networking benefits through networked incubators.

The first is Brainshark.com, a year-old company that got started in a Boston-based incubator called Reach Internet Incubator. A year ago, founders Joe Gustafson and Mark Yacovone faced the challenge of designing the architecture of Brainshark's Web platform for the company's business-to-business Web communications services. They wanted to move quickly to outsource the project, but first they desperately needed critical advice on the architecture of the platform. Fortunately, Reach Internet Incubator had an advisory board of external technology experts, one of whom was able to help them. Gustafson and Yacovone obtained the advice they needed without having to conduct a time-consuming search and without having to negotiate a contract up front. (Reach had already contracted with the expert to help the incubatees.)

Another example is CarOrder.com, an online auto seller that began in Trilogy Software's corporate incubator. According to CarOrder.com founder Brian Stafford, the critical benefit that Trilogy provided was rapid access to world-class human capital. "Before joining Trilogy, I started two companies," Stafford says, "but lack of talented people starved them both." The situation was dramatically different with CarOrder.com, which was able to hire approximately two-thirds of its technical employees through Trilogy's on-campus recruiting process, widely acknowledged as one of the most effective systems for finding elite technical graduates. In addition, CarOrder.com made use of CollegeHire.com, a Trilogy portfolio company that provides a sophisticated online service to place high-tech college graduates.

E-Loan's worldwide expansion represents a third case for the value of networked incubators. When E-Loan executives wanted to launch international operations quickly, they relied on Softbank's worldwide operations, which include incubators in Japan, France, the United Kingdom, Germany, Australia, and New Zealand. For example, E-Loan looked to @Viso, Softbank's European incubator, to help it forge a marketing deal with Canal Plus, the leading pay television company in France.

These examples highlight two critical characteristics of networked incubators. First, networking is institutionalized, meaning that the incubator has mechanisms in place that foster networking. Reach Internet Incubator established an advisory board of external experts committed to helping incubatees. Softbank partnered with strong local companies in various countries, allowing the newly formed E-Loan operations to use those connections to forge marketing deals. The mechanisms existed before the incubatees actually needed them, allowing the start-ups to take advantage of them quickly.

Second, the networking leads to preferential access, not preferential treatment—a subtle but crucial distinction. Preferential access means being able to call a meeting and receive the full attention of busy people. By contrast, preferential treatment means being guaranteed results from the meeting, such as a partnership deal. While E-Loan executives in Europe got a chance to pitch a business proposal to Yahoo!'s site in the United Kingdom, they did not get special treatment: Yahoo! executives first turned down the proposal, forcing E-Loan to come back with a better deal. Creating preferential access does not mean forging subpar deals; rather, it allows marketplace efficiencies to dictate decisions.

By institutionalizing networking, an incubator achieves scalability of networking benefits. Networking no longer depends on the personal connections of a few people and can be scaled up to include many mechanisms and managers networking on behalf of numerous companies. This advantage is important when comparing networked incubators with venture capital firms. A huge influx of cash in VC funds—$48 billion in the United States in 1999 versus $7 billion in 1997, according to the National Venture Capital Association—has attracted thousands of business plans. This sheer volume of funds to be invested and plans to be evaluated has strained the capacity of even the best venture capitalists. The same constraints apply when these VCs attempt to make introductions that would help a start-up. Silicon Valley legend John Doerr of Kleiner Perkins Caufield & Byers may have the most valuable personal Rolodex in the world, but he still has only 24 hours in a day to use it. In contrast, the institutionalized mechanisms of a properly designed incubator transcend any individual's capacity to network.

To summarize, networked incubators provide value through preferential network access while fostering entrepreneurial drive and offering economies of scale. Neither large established corporations nor venture capitalists consistently provide all three characteristics. (See the exhibit "The Advantages of Networked Incubators.") The chief distinction between a networked incubator and an established company is the difference in entrepreneurial drive. The key differences between a networked incubator and a VC fund are the presence of an organized network and the benefits of scale. For these reasons, well-designed networked incubators are uniquely poised to nurture and grow fledgling Internet businesses.

The Advantages of Networked Incubators
Networked incubators combine the benefits of two diverse worlds — the scale and scope of large established corporations and the entrepreneurial drive of small venture-capitalists firms. To this mix, networked incubators add enhanced network access to key business partners, making such organizations especially effective for growing start-ups in the new economy.
  Established Companies Venture Capitalists Networked Incubators
Scale and Scope
leveraging size and reach in order to lower costs by pooling resources and spreading them across units
High
Historically the key advantage of large global companies.
Low
VC-backed start-ups are left alone to obtain services and buy supplies.
Medium
Common services and pooling of resources ensure some benefits, especially time savings.
Entrepreneurial
Drive

stimulating individuals to pursue risky and disruptive innovations
Low
Red tape hinders new ventures; entrepreneurs are not rewarded.
High
Entrepreneurs are free to pursue ventures and own large equity stakes.
High
Entrepreneurs are free of red tape and own equity in ventures.
Network
Access

forging partnerships, obtaining advice, and recruiting people
Medium
Many established companies have some, but not extensive, contacts with Internet companies.
Low
A VC partner nay have an excellent personal network, but it doesn't go beyond the individual partner.
High
Organized and active networking among portfolio companies and strategic partners.
  Established Companies Venture Capitalists Networked Incubators

Excerpted with permission from the article "Networked Incubators: Hothouses of the New Economy" in the Harvard Business Review, September–October 2000.

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