U.S. multinationals are looking to small companies and startups for the next big ideas.
As companies in Asia and Latin America transform themselves from low-cost manufacturers to competitive innovators, many U.S. multinational corporations are confronting a strategic dilemma: Although under pressure to stay ahead of their often-flush global rivals, these multinationals are being forced to revisit their R&D budgets — a consequence of weak sales at home, where consumers are nervous about spending.
Some companies have responded by offshoring design and engineering to drive down costs. IBM, a well-known example, has invested significantly in its presence in China and India. Others have adopted open source policies that encourage collaboration, such as Procter & Gamble Company's "Connect + Develop" platform, which lets P&G and external product and process designers share technologies and know-how. But another option is growing more popular. Called "ecosystem investing" by some innovation executives, it refers to the increasingly complex network of suppliers and innovators supporting large companies.
In this model, well-established U.S. companies are creating strategic partnerships with startups and small companies whose technologies and skills can help the large companies expand their own capabilities. Longtime ecosystem investors such as Johnson & Johnson (J&J) and Intel are driving existing ventures toward advanced breakthroughs, and companies such as General Electric, General Motors, and Google have adopted the approach in earnest in recent years. The goal of the incumbents is to systematically target emerging technologies and "harvest" ideas without having to take on the risk of acquiring the smaller companies. Sometimes the large company takes an equity stake, and its top executives may sit on the small company's board or mentor its top management. Alternatively, it may seek to license the small company's technology or buy its products and distribute them to global markets. In all these arrangements, the strategy is to use external partnering to tap into startup sectors, for example, genomics and biotechnology, advanced robotics, lithium ion batteries, semiconductor manufacturing, and nanotechnology.
As many as 12 drugs in J&J's stable of products resulted from ecosystem investments, says Garry Neil, vice president in charge of the company's science and technology office. To find potential partners, Neil's office scours biotechnology clusters in cities such as Boston, San Francisco, and San Diego. "The secret sauce for the United States is the research universities and institutes, which are unparalleled in their ability to innovate, and to attract the best and the brightest from around the world," says Neil. The company is not trying to push the frontiers of knowledge as much as it is seeking to find technologies that can be commercialized. Adds Neil, "We focus less on winning Nobel Prizes and more on trying to come up with something that people are willing to pay for."
Neil has money earmarked in his budget to invest directly in startups, and if necessary he can seek additional funding from the Johnson & Johnson Development Corporation, an internal venture capital fund. "The idea is to make the wall between [J&J's] R&D unit and small, academic companies porous," he says. In 2006, for example, Ortho-McNeil Inc., a J&J division, invested the modest sum of US$40 million in Metabolex Inc., a privately held biopharmaceutical company based in Hayward, Calif., so the two companies could collaborate on the development of compounds used to treat type 2 diabetes. The arrangement paid off for both firms. Metabolex enjoyed a vital infusion of capital at a time when it was circling the "valley of death" — what venture capitalists sometimes call the period when many small companies are spending heavily on up-front research but have not yet begun to reap the rewards. And J&J obtained access to a technology that could arguably be developed faster and more cost-effectively at a small company than through its own R&D pipeline. In June 2010, Ortho-McNeil received an exclusive worldwide license to commercialize several Metabolex drugs, including the diabetes compound, for about $330 million. That's far less than the $1 billion a pharmaceutical company typically spends to develop drugs internally, and far more than Metabolex could have expected to bring in on its own.
Intel's ecosystem investment strategy is housed in Intel Capital, the company's venture capital arm, which acts as a technology scout, seeking smaller firms that could help the chip maker achieve clear goals, such as upgrading its manufacturing systems every two years. Often, the beneficiaries are companies in technology clusters in California, Oregon, New Mexico, or Arizona, where Intel's fabrication plants are located. "That's the real locus of people doing innovation," says Intel Capital Managing Director Keith Larson.
At least one of Intel's ecosystem investments played a critical role in safeguarding its network of suppliers. In 2005, it took a stake in Crossing Automation Inc., a small firm in Fremont, Calif., that makes specialized tools for the semiconductor industry, among others. When Intel supplier Asyst Technologies Inc. ran into financial difficulties and faced bankruptcy in 2009, Intel Capital guided Crossing Automation into buying Asyst, ensuring that Intel's domestic supply chain would not be disrupted.
Intel was able to dramatically increase the clout of its ecosystem investment strategy recently when it teamed up with 24 other venture capital (VC) firms as part of the company's "Invest in America" alliance, Intel's commitment to promote U.S. competitiveness by supporting technology development and creating jobs for college graduates. Intel put up a mere $200 million of its own money, but the VC firms pledged to match that investment, for a total of $3.5 billion over several years.
GE is a relative latecomer to large-scale ecosystem investing, but it is now dedicating significant resources to the effort. An apt example is GE's investments in A123 Systems of Watertown, Mass., a promising lithium ion battery researcher born out of an MIT engineering lab. As of April 2009, GE Energy Financial Services and GE Capital's Equity unit (two separate investment arms of GE) had poured $70 million into A123, taking a 10 percent stake in the company and setting the stage for its IPO in September 2009. (Since the IPO, GE's stake has been diluted.) With GE's backing, A123 is working to expand the use of its batteries in powering hybrid and electric vehicles and also in stabilizing utility power grids, an industry in which GE is extremely active. As part of the arrangement, Mark Little, GE's director of global research, serves on A123's board, affording GE a hotline into the future of lithium ion batteries and lending A123's management a much larger company's expertise on how to expand sales.
What appears to be motivating GE in this deal and dozens of other recent ecosystem investments is the desire of CEO Jeffrey Immelt to bring the 133-year-old company back to what made it great in the first place. Since succeeding former GE chairman and CEO Jack Welch (who retired in 2001), Immelt has refocused GE on innovation, even more so since the financial crisis. Moreover, Immelt is hungry for new green technologies in support of his Ecomagination agenda, which was implemented to meet environmental challenges such as wind, solar, and geothermal power generation. In December 2010, the GE Energy Financial Services unit said its portfolio of renewable energy investments had reached $6 billion.
For U.S. multinationals that are feeling the pressure from increasingly sophisticated global competitors, partnering with up-and-coming startups at home enables them to increase their competitive edge with targeted investments, rather than undertaking costly in-house R&D efforts. For small U.S. companies, it provides a means to bring innovations to market, and to escape or even bypass the valley of death. Which means that in today's post-recession, hyper-globalized world, it's an increasingly rare win-win.