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How many promising R&D projects are going nowhere at your company? Ten? Fifty? One hundred? Many organizations sit on a plethora of potentially valuable ventures that languish because they don't quite fit into current strategies or operations. And when times get tough, these noncore projects become obvious candidates for divestiture. By packaging them as stand-alone entities and spinning them out, companies can quickly tone up their finances while creating the potential for a cash windfall should the new business one day go public.
That's the theory anyway. In reality, though, spinouts rarely take off. Among the fifty or so we have studied in depth over the past seven years, two-thirds either fell short of expectations or failed outright. Some were ill conceived from the outset, having little or no market potential. Some lacked the right leadership and management teams. Some were cut off from their parent companies before they could develop the resources they needed to survive. And some were held too tightly by their parents, never getting the room to breathe on their own. Whatever the reasons, companies that go to the trouble of spinning out a business usually end up with little to show for the effort.
Companies that go to the trouble of spinning out a business usually end up with little to show for the effort. |
Michael D. Lord, Stanley W. Mandel, Jeffrey D. Wager |
But there are exceptions. In the life sciences, for example, the record is much better. R.J. Reynolds, the tobacco giant, recently spun out a pharmaceutical business called Targacept that is now well on its way to success as a separate company. Targacept's story shows that nurturing a successful spinout is not all that different from raising a healthy, independent child. Parent companies need to give their offspring the right amount of attention and care, but they also need to know how and when to set them loose. Learn to do that well, as RJR and Targacept discovered, and both the parent and the young company stand to reap handsome rewards.
The four spinout traps
Before looking closely at Targacept, let's consider why so many spinouts flounder. The general reason is simple: The parent company does not provide the critical strategic, organizational, financial, and legal foundations the young company needs to survive and thrive on its own. More specifically, we've found that most spinouts fall into one or more of four traps that doom them from the start.
The crown jewel trap
Some companies spin out ventures that simply are too close to the core of their main businesses. In effect, they sell their crown jewels. This was the case with Staples.comone of many on-line retail ventures born of the dot-com frenzy. Late in the process of spinning out Staples.com, Staples' executives realized that an on-line channel would have to be an integral part of the company's business going forward, and they put on the brakes. But even though Staples came to its senses in time, it paid a price for its misadventure: Shareholders revolted as the parent tried to buy back Staples.com executives' pre-IPO shares at what were viewed as vastly inflated prices.
The piggy bank trap
Sometimes a parent company is more concerned about quarterly earnings or other short-term financial exigencies than about sound strategic reasons for a spinout. It uses the spinout primarily to pawn off debt or expenses or to quickly raise external capital for itself. This is an easy trap to fall into, and one that is extremely tempting; after all, the capital requirements of funding a new venture can be large, the risk is substantial, and the payoff may be relatively distant. But as the story of Enron's off-balance-sheet partnerships makes appallingly clear, this kind of myopic financial gimmickry creates more problems than it solvesespecially if it's used merely to delay or avoid the pain and responsibility of making tough investment choices.
The one-legged stool trap
A company may try to spin out an area of its business that lacks one or more of the critical legs of a successful companya coherent business model, say, or a solid financial base. Consider some of the infamous retail spinouts of the late 1990s, such as Walmart.com or Kmart's BlueLight.com. Quickly slapped together during the Internet-retailing frenzy, these ill-formed business models could not support their own marketing, operations, finance, human resources, distribution, and fulfillment efforts. Both Walmart.com and BlueLight.com were spun back into their parent organizations less than eighteen months after being spun out, wasting millions of dollars. A single channel or patent rarely makes a successful spinout; it simply lacks the legs to stand on its own.
The umbilical cord trap
In many cases, parent companies are too tentative. They can't bring themselves to sever their ownership ties and give up control of their spinouts. Sometimes, the parents fear they'll lose out on some of the potential long-term financial gain. Other times, parent executives just can't turn the reins over to new leaders. Eventually, though, continuing entanglements with the parent interfere with the spinout's ability to make smart strategic and financial decisions. What's more, the close ties can spook key outside stakeholders, particularly potential partners and investors.
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Balanced leadership
The first hurdle the venture had to clear was getting the right leadership to champion the cause. To increase the odds of success, we've come to believe that a spinout candidate requires an "inside outsider" at the helm: an enthusiastic advocate who has credibility and clout within the parent company but who will fight for the spinout's right to exist independently. The leader also has to be a skilled negotiatorsomeone who can balance the needs of the infant company with those of its parent and its future partners and investors.
J. Donald deBethizy embodied those qualities. As an RJR vice president of R&Dand a former NRADP researcher himselfhe was both a respected scientist and an experienced R&D manager. He passionately believed that NRADP's discoveries could alleviate human suffering. By 1996, deBethizy had volunteered himself to be NRADP's active champion, even as he continued to hold his full-time job as head of RJR's overall product R&D efforts. In order to simultaneously manage his 165-person division and plan and implement the spinout, he recalls, "I had to start balancing a lot of different, competing demands. I started delegating the RJR work like crazy." Juggling disparate responsibilities and loyalties is a critical part of the spinout leadership process. RJR Tobacco's CEO, Andrew Schindler, knew deBethizy to be a capable R&D executive. But privately he wondered whether someone accustomed to big corporate budgets and long timeframes could adapt to the pace of an entrepreneurial venture. RJR could have followed the example of many parent companies by installing a hired-gun executive with more start-up experience to run the spinout. But despite his misgivings, Schindler decided to give the first-time entrepreneur a chance, trusting to deBethizy's passion and his strong management skills. Besides, to hire and bring an outsider up to speed at this point would cause too many delays and disruptions.
Early in the spinout process, deBethizy helped prove he was up to the job when he negotiated a life-support deal with Schindler. Operating funds for NRADP had nearly dried up, and many top managers within RJR were continuing to lobby to shut the group down. DeBethizy walked into Schindler's office to ask for more time. "I already knew that Andy would not give us another dime," he recalls. "He said 'Get out!' and threw me out of his office. But I knew Andy well enough to know that he changes his mind."
DeBethizy kept at Schindler and convinced him of the spinout's feasibility. The two men worked out a compromise: NRADP could continue to operate on the barest of support from RJR. But if the spinout could not fully finance itself by the end of 1998, it would be shut down.
Schindler could have been more generous, but he believed that it was in the fledgling business's best interest to be under financial pressure. "By threatening to shut it down, I was trying to spur it to the next step," Schindler explains. "This is the kind of pressure that a new venture needs to succeed." Without the assurance of internal funding, deBethizy and his team would have to work all the harder to gather outside investment. Some companies make the mistake, like many rich parents, of merely giving their spinout children money when what they need to foster is disciplinethe same disciplines successful start-ups employto learn to make it on their own. It was the formal disciplines of company building that deBethizy turned to next.