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Content Guy's Note: The goal of "The Innovation Conversation" is to explore some facet of the fast-changing, technology-driven retail landscape and how it affects businesses and consumers. It is, we think, fertile territory ... and one that Tom Furphy - a former Amazon executive, the originator of Amazon Fresh, and currently CEO and Managing Director of Consumer Equity Partners (CEP), a venture capital and venture development firm in Seattle, WA, that works with many top retailers and manufacturers - is uniquely positioned to address.

This week's topic: Why retailers are creating funds being invested in start-ups, the importance of getting beyond legacy cultures, and why money isn't the most important factor when it comes to innovation.

And now, the Conversation continues...

KC: We've seen stories in recent weeks about major companies such as Walmart and Target putting money aside so they can invest in start-up companies that they see as helping them innovate.  Are there institutional and/or infrastructural reasons that it makes sense to take this approach rather than creating an in-house engine for innovation?

Tom Furphy:
For many established companies, institutional and infrastructural inertia is hard to break. Companies have been built over decades to operate a certain way, to deliver value to their customers and shareholders in a way proven to be repeatable. Factories, distribution systems, stores, people, everything about these businesses have been honed to deliver a consistent experience and a predictable financial return. Every year, budgets are rolled forward, incremental programs are added, some costs are trimmed and sales are expected to grow a rational amount. It becomes difficult to truly innovate from within. It is easy for the team to become complacent and/or make safe choices in the process. It’s very rare to see risk-taking rewarded. To innovate, you have to be willing to fail, and most people and companies are not.

So, for many companies, putting specific funds aside to engage with and/or invest in startups makes sense. Startups are unencumbered with legacy culture, processes and systems. They are nimble. Their core DNA is about doing things differently. This DNA does not exist naturally in most companies. I hear companies throw around buzzwords like “Vision 2020” and “we’re going to be where the customer is.” That is not innovation. Enabling customers to shop in ways they didn’t think they could is innovation. Breaking business models, developing brand new infrastructure and delivering shopper and shareholder value in completely new ways is innovation. Many times that DNA is easier to find in startups, outside the walls of the company.

KC: Agreed. In so many ways, the definition of the word "infrastructure" suggests something solid, physical, foundational ... something that does not move. And so, existing infrastructure is not built to accept the existence of something foreign ... in fact, the DNA is almost genetically engineered to reject it.

So let me ask you this. Is this something that more traditional bricks-and-mortar companies ought to be building into their budgets?  And is it a matter of just allocating X dollars - maybe taking the money out of a cap-ex budget - for such an endeavor? Because I wonder the extent to which cultural issues have to be addressed when undertaking such an initiative.

It definitely starts with the budget. All companies should set aside a dedicated pool for funding innovation, whether for partnering with startups or developing from within. The amount or how the budget is funded can range widely. Innovation does not have to be expensive. In fact, frugality and scrappiness can foster the best innovation. It forces you to build things that customers want, which they will pay for and that can provide financial return quickly. Putting together a test pilot, getting it in front a limited number of customers, gathering feedback and iterating can be quite inexpensive. Then, once the innovation is proven, scaling can be done confidently.

KC: It is funny how you say that "frugality and scrappiness can foster the best innovation." As I usually do, I'll go back to a movie metaphor. Jaws is a much better movie because Steven Spielberg did not have an unlimited budget, and CGI had not been invented yet. He had a mechanical shark that didn't work, so he had to shoot a movie about a killer shark that has relatively few shots of the shark ... he had to be creative and innovative about suggesting terror rather than showing the shark, and that makes Jaws far more suspenseful, and I think you can argue that it was the limitations that helped make it that way.

Absolutely. Regardless of the amount, it behooves every company (in every industry, frankly) to foster and invest in innovation. Perhaps it’s a small amount to make an equity bet on a startup or it’s some budget to put together a test pilot. Or maybe it’s a larger amount, such as the cost of a store or warehouse, once an idea is proven. The key is to establish a culture that rewards risk-taking and learns from mistakes. Establish a culture that is not happy with the status quo. The status quo has always been disrupted in business. Companies should endeavor to put their existing models out of business. Innovation and experimentation should be part of every employee’s performance review. This culture shift does not happen overnight. It happens through experience, failure, more failure and success.

Working closely with startups is a fantastic way to foster innovation. It doesn’t necessarily require an investment in them. But setting aside funds and staff time to engage in pilots and iterations on their offerings can return itself in spades, both to your company and to the startup. But I would warn companies to be transparent and to not drag the startups along when a project or pilot doesn’t look like it will move forward. Startups have quick cycles where they have to continue to prove themselves to get to the next milestone. They can’t afford to let a project linger if it is not going to launch live. Nothing is more damaging to a startup than customer indecision and the passage of time. Your company does not want to become known as a startup killer.

KC: Is this an approach that purely is the purview of big companies, or should smaller companies be looking of these sorts of opportunities as well, albeit on a smaller scale?

Smaller companies should definitely be looking to partner with startups. They are actually a better partner for these early companies because they are often more agile than larger companies. They can often execute test pilots and iterate more rapidly than larger companies. Their decision cycle tends to be shorter than larger companies, which is tremendously valuable to these startups who need quick iterations toward product and market validation. Then, once a smaller company finds a startup solution that works for them, scaling the solution companywide is often quicker than it is for a larger company.

KC: I have to wonder, to be honest, if some of these start-up companies are making a deal with the devil when they agree to be funded by a big company? It's like in Damn Yankees - Joe Hardy is willing to sell his soul to the devil in exchange for just winning season against the hated New York Yankees for his beloved Washington Senators, ignoring the learn term implications. It is all about short-term vs. long-term gratification. So, how would you advise such a start-up if they asked you about taking money?

That's the irony. Being funded by a large company, while very tempting, is a bad idea for most startups. Visions of a marquee retailer or manufacturer backing you and leading you to market domination are simply unrealistic. You risk becoming a captive solution, which makes it very difficult for you to build your product for the larger market. Your roadmap is dictated by your investor.

Also, we’ve seen that when one of these companies backs a startup, competitive retailers or manufacturers run for the hills. Then, down the road when there is no market left to sell into, the retailer or manufacturer ends up acquiring the startup and folding the technology into the IT group and the team somewhere else within the business. This yields a less than optimal outcome for the startup. And while the “acquihire” is initially good for the acquiring company, the employees end up leaving as soon as their earn-out is up. They’re entrepreneurs. The last thing they want is a corporate job.

There are ways, however, for startups to creatively accept financing from retailers or manufacturers, while maintaining their independence. It is most important that the startup is mindful to keep the playing field level, allowing investment to be made by any partner. The investment parameters can scale based upon performance metrics (i.e. number of stores rolled out or based on the deal size with the startup), which might give a bigger piece to a larger company. But as long as the field is level, and there is a meaningful program in which any partner can participate, it can work very well.

And the Innovation Conversation will continue...

KC's View: