Applying the Venture Capital Model to IT

(Stealing some ideas from VCs can create greater business value)

 Venture capitalism. The term conjures images of dynamic new companies that change the very face of their industries; of investors whose foresight and vision turn small experimental firms into the very engine of our modern economy. Their success in identifying and cultivating the best of the new ideas and firms that are continually forming their success in identifying, cultivating, and growing some of today’s biggest companies leads to a simple question…how the heck do they do it, and, more importantly, what lessons can we learn from how venture capital firms manage the selection, management, and sale of their investments? 

Two lessons stand out above all others. First, VCs manage the investment portfolio using a systematic approach that takes into account both risks and rewards. Second, VCs insist their start-up companies outsource all noncore activities, from accountancy to marketing. What does this mean for IT?

Managing the Investment Portfolio. Venture capitalists take a portfolio approach to investing not only because it enables them to cultivate multiple businesses, but because they can spread their investment risk. This same portfolio-investing approach allows the enlightened CIO to simultaneously incubate and develop numerous (and diverse!) projects, and then be more nimble and quick to market with those solutions that prove viable. This increases the likelihood that a CIO has a head start on a crucial business-changing solution.

However, as with any investment decision, there’s a bit more to it than simply green-lighting any idea that comes through the office door. Taking the portfolio approach dictates that CIOs:

Take many small bets rather than a few big ones. Diversity in the portfolio helps maximize the chances investments get commercialized. It also reduces the risk and potential cost that large projects will stall or not deliver to their potential. You don’t know what’s going to succeed before you try it, so why throw huge amounts of time or money at an idea that may not go anywhere, or whose time simply hasn’t yet come?

• Be patient and recognize that many of the bets won't work out. Failure is part of the portfolio approach; in fact, it’s the reason you’ve got a portfolio in the first place! However, the losses associated with any one failure are minimized because the initial investment is small, and the project is just one of many.  
• Value speed to market, responsiveness to market feedback, and adaptability over having the perfect set of features out of the box. What good is having the perfect product if your competitors are six months ahead of you? And how likely is it that you and your engineers are going to perfectly anticipate all of your customers’ needs anyway? Try a thought experiment. How likely is it that any of your suppliers are so knowledgeable about your business that they could offer you a new product or service that’s perfectly tailored to your needs, without you so much as first trying it out? IT managers following this model must emphasize rapid development, deployment, and refinement of successful technologies. 
• Have specific criteria, both market-driven and operational, to critically evaluate the development of projects to determine whether your company increases its investment, stays the course, or exits the project. Encouraging innovation is fine (actually, it’s essential!), but it falls to the CIO and other senior management to ensure that new projects support the company’s strategic vision and priorities.

In practice, this portfolio approach means that the "venture" portfolio of new, risky technologies and businesses is separated from the "core" portfolio of existing, mature ones. When a venture investment matures, its ownership should move into the appropriate infrastructure or business group. Why sequester things this way? Safety and innovation, both in equal measure. Your existing products and services power the company today; all the innovations in the world count for nothing without the revenue to keep the lights on! Keeping your experiments sequestered ensures that they don’t mess with your business model until they’re ready to be integrated. This separation however isn’t only for the good of the existing businesses. New businesses are by nature disruptive, and in almost any organization there’s going to be pushback, intentional or otherwise. Keeping the new ventures in their own space until they’ve matured and proven themselves thus gives them room to grow and experiment. So how do this look in practice?

The adoption life cycle of Linux is a good example of the migration from venture to core portfolio. Initially, Linux was confined to small numbers of advocates on the fringes of the corporate IT world. These advocates eventually consolidated into separate groups within their organizations supporting the Linux operating system. At this early stage, the particular strengths and weaknesses of Linux were still not fully understood from either a technical or management perspective. Over time, as Linux proved itself a low-cost and effective environment for Web servers, Linux groups became associated with the specific functionality they provided, like Internet application support. What was experimental technology without a specific technical application evolved into an efficient mechanism to provide very specific technical services.

Keeping your Organization Focused. To ensure that entrepreneurs focus on the task at hand, venture capitalists insist that the startups they invest in outsource all noncritical activities. This allows the startup to direct all of its energies towards its specific product or service offering, further enabling it to quickly scale projects up or down. So how does this translate to the IT space? Put simply, by outsourcing noncritical components of your projects, such as development work, you’re better able to focus on markets, customers, and key capabilities rather than technology and operational details in the early stages of the venture. Using offshore vendors can enhance these effects, because the lower cost allows you to both experiment more and tolerate more failures.

 So how does all of this work in practice? Take another page from the ways VCs operate to see the process in its entirety:

• Gather intelligence: Segment your IT portfolio and develop an investment philosophy.  
• Make investment decisions: Set up screening criteria and rebalance the portfolio as new investments are made.  
• Manage investments: Gauge risk and upside business metrics; implement a funnel review process for investments while running each investment as an individual business. 
• Exit investments: Create a system that enables rapid shutdown of projects, and link all investments to the needs of the stakeholders in each of your businesses. 
• Segregation: Classify IT projects in one of three ways:
  • Venture: linked to new business ventures with high return potential.
  • Customer Value-added: linked to existing products and operations to improve your service efficiency or effectiveness.
  • Enablement: linked to existing business lines with a focus on improving their technology or core processes.  

Limits of applicability. These techniques are best employed when the potential benefits are high but the likelihood of realizing them is subject to significant uncertainty. They provide CIOs with a systematic method of evaluating the factors behind this uncertainty; customer needs, organizational fit, feasibility, etc., at each stage of development, and of allocating more or less capital as appropriate, or even of exiting the business or project, if appropriate. Success in utilizing the portfolio approach relies on a disciplined governance process for evaluating and acting on investments, as well as experience in defining and managing outsourced activities.