Milestone Group Quarterly: April 2007

Articles

• Face to Face: Mike Stonebraker, Founder and CTO of StreamBase and Vertica
• Investment Viewpoint: Jean-Louis Gasee, General Partner, Allegis Capital
• By Invitation: Don Tapscott, Co-author of Wikinomics: How Mass Collaboration Changes Everything
• Milestone POV: Synchronizing Time Frequencies Between the Large Enterprise and the Innovative Firm by Philippe Bouissou, Milestone Group Managing Partner

Milestone Group PoV:

Synchronizing Time Frequencies Between the Large Enterprise and the Innovative Firm by Philippe Bouissou, Milestone Group Managing Partner

What happens when a large corporation engages a smaller, innovation-focused business to develop a relationship? The answer can be found in the science of horology. It has been observed that a pendulum attached to another pendulum displays an amazingly rich dynamic behavior. In fact, physics proves that above a certain level of energy, the two pendulums exhibit a chaotic behavior, meaning that the trajectory of the end point is unpredictable. Even when the initial conditions are very close, the behaviors are very different.

This simple chaotic system is parallel to what often occurs when large corporations engage with smaller companies in technology innovation. Let’s view one of the pendulums as representing the large company, and using a natural time frequency of the business quarter (i.e., ticks four times a year) along with its mass as the number of employees. The pendulum of a startup, with its natural frequency of one day (a lot happens in 24 hours for a startup) features a much smaller mass, or smaller team. Often, a force behind the two entities is a push to find resources and expertise - technology innovation for the large company and sales, distribution, brand recognition and marketing for the start-up. While the link between both companies is the quest for bringing innovation into the marketplace, these two “pendulum swings” can results in an unpredictable relationship, one that often ends up failing as chaos theory sets in.

A large public company’s life is a highly regulated affair, from quarterly results, Wall Street briefings and comparing this period’s financial results to last year’s same quarter. For a small, nimble technology startup, things are happening at a much faster pace: there’s technical product development, getting new customers or partners on board, putting out press releases, bringing talent on board, preparing for the next monthly board meeting. This is driven by the goal of breaking new ground in pursuit of a large market or aggressively disrupting an existing one.

Google is a prime example on how fast a start-up can grow. The company was founded in September of 1998, and began generating $200 thousand of revenue in 1999. Revenue grew to $19 million the following year and close to $1 billion by the end of the company’s 5th year. This stunning growth is attributable to the technological advance of their search product coupled with an innovative business model, based on keyword advertising. In 2001, year-over-year revenue grew by 350 percent and by 300 percent the following year. As the company’s pendulum continues to gain weight, sales growth has slowed considerabl. And while Google is continuing to launch new technically innovative products, its revenue growth fundamentally comes from the same search product and is based on the same business model.

Some large companies have found a way around this “frequency coupling” problem by absorbing the embryonic company altogether.

Let’s look at an example of avoiding frequency coupling. On October 23, 2001 Apple unveiled a product that became one of the most popular consumer electronic products in history: the iPod. The original idea was conceived by Tony Fadell, who previously worked at General Magic and Philips. Fadell had tried to sell to the idea to RealNetworks in 2000, then to Phillips. When Steve Jobs saw Fadell’s demo, he immediately understood the opportunity and hired him. Tony led the product development and managed the critical and close relationship with PortalPlayer on their common reference platform.

Apple had previously failed on several consumer electronic products (including Newton and Pippin). In both of these cases, the development was internal and the other, smaller pendulum was the core internal team. Chaos resulted in the making and marketing of both products. A number of Pippin engineers left Apple to join WebTV, which was founded in 1995 by Steve Pearlman, also formerly of Apple. Ironically, WebTV was later acquired by Microsoft.

In no small part, Apple was successful with the iPod is because they hired the brainchild behind the product. Had Apple tried to partner with a larger company, chances are that they would have been less likely to succeed.

In the case of iPod, it was clear that innovation could not be produced internally, so Apple’s best move was to couple its resources with technology innovation from the outside world, while eliminating the wild swings of the start-up pendulum. In a similar way, it is also possible that Apple used Dan Fish’s technology for the two-finger user interface in the upcoming iPhone. Dan, who originally founded a company called Tactiva, was hired by Apple as a contractor a few years ago.

It’s not always the case that internal integration continues to yield technology innovation. Microsoft, for example, bought Lookout Software in July of 2004. The technology was finally incorporated in the recent release of Office 2007. It took several years for Microsoft to incorporate a desktop search application into its Office suite of products. In the meantime, Eric Hahn and Mike Belshe (the founders of Lookout) are doing something else and are not longer contributing innovation at Microsoft. Eric is now investing in startups at Inventures Group and Mike works at Google. Outstanding business and technical folks like Eric and Mike just could not synchronize their drive and passion for innovation and creativity with the (quarterly) ticking clock at Microsoft.

It is also interesting to note that large companies acquiring other large companies often display chaotic behaviors as well. Large combinations such as HP/Compaq, Oracle/PeopleSoft/Siebel/Hyperion, if they ever work, take a very long period of time to transition from chaos to order. The rules of physics also apply to startup merging together, although the time to go back to a predictable, orderly state is much shorter, as less energy is needed for the relationship to be productive.

Phillippe Bouissou is a Managing Partner at Milestone Group and heads up the firm's Emerging Growth Companies practice. Philippe has over 18 years experience in the software and Internet industries, having held both venture capital and operating positions in marketing, sales and executive management.

Prior to joining Milestone Group, Philippe has been involved with a number of software companies as Managing Director at Astra Venture Partners, a firm he co-founded and as General Partner with Ventech ($200 million) and for 5 years with Allegis Capital ($500 million).

Prior to his start in the venture business, Philippe was Director of Worldwide Internet Commerce at Apple, where he founded the online Apple Store and ran it from zero to $350 million. Before Apple, Philippe was Senior VP at Matra Hachette Multimedia, where he led US business development for electronic publishing for the $12 billion, high-tech and diversified media company. In 1991, Philippe founded and was the CEO of G2i, Inc., a Unix software company that was later acquired by Matra.