An ecosystem innovation fund, or “EIF,” is a seed fund for startups. EIFs are a hybrid of corporate venture capital and the US government’s Small Business Innovation Research grant program, or “SBIR.” EIFs combine the best from both models to create a new vehicle for large companies to invest in innovation in their digital ecosystems.
How does an EIF fit into corporate innovation initiatives?
My book, Innovation Casino, explains that you can fit a company’s products and services under two labels: core and non-core.
Core: Core offerings are at the center of your company’s skill set and reason for existing. Like the Apple iPhone or the Amazon Web Services platform, core products can become platforms for other companies to extend. You should focus your resources for research, development, and acquisitions on refining and transforming your core offerings.
Non-Core: Non-core offerings are not at the center of your company’s skill set and reason for existing. Non-core products may drive demand for your core products, which can make it temping to devote teams and budgets to them. However, Innovation Casino proposes you fund promising non-core ideas with an EIF, which uses capital from outside investors to fund startups in your digital ecosystem. EIFs are like the 2010 iFund for iPhone apps: Kleiner Perkins put up the capital and managed the iFund while Apple provided market research and support.
In summary, EIFs give promising non-core ideas a way to get built without diffusing your team’s focus or eating into your budgets for research, development, and acquisitions.
Are the corporate innovation strategies in the EIF model practiced today?
The closest examples to an EIF today are corporate venture capital funds such as Salesforce Ventures, Google Ventures, Microsoft Ventures, and the Amazon Alexa Fund—all of which prefer to fund startups that build on their platforms. Here is where the EIF model differs: EIFs are for investing small amounts of money in more companies than venture capital.
To invest in more companies, the EIF transfers the investment selection approach of SBIR. SBIR has been around since 1982 and has catalyzed nearly 70,000 patents. SBIR is a better model for investing in lots of companies than venture capital, which likes to make large bets on a few companies. Like SBIR, you would fund startups that meet your corporate innovation objectives.
What the SBIR model is missing are straight-forward ways to recoup principal and generate a return on capital. For this piece of the puzzle, we look to venture capital, which makes equity investments. So, like venture capital, your EIF would buy equity in the startups it funds.
Your EIF should look nothing like the SoftBank Vision Fund, which made enormous investments in a handful of unicorn companies. Instead, your EIF would be most compatible with a new generation of startups called “zebras.” (See section on zebras below.)
Why would a corporate venture capital fund need to invest in lots of startups?
Since the financial crisis of 2008 and 2009, borrowing costs and taxes have remained low. When borrowing costs and taxes go up, companies with too much debt may not be able to refinance. This has not happened yet. However, if a critical mass of companies could not refinance their debts, asset prices would go down, and it would become difficult to sell non-core assets without incurring permanent losses. The remaining option would be to spin off non-core assets into their own companies.
Digital ecosystems present an elegant solution for divesting non-core products and services while maintaining a consistent client experience. This can be done by turning non-core products into “apps” that customers can access and by organizing these apps under new companies. Employees who manage the apps would move to the new companies to do their same jobs—this time, with less bureaucracy and more control over their work. Divested apps could remain revenue sources for their former parent companies through ecosystem-related commissions and other equity arrangements.
Your corporate innovation strategy should account for the possibility that your company’s growth could become linked with your success in creating a digital ecosystem.
In a world where large companies are creating digital ecosystems in every industry, customers and developers will wonder whose digital ecosystem they should choose for the long run. BlackBerry launched their app store called “BlackBerry World” within a year of Apple’s. However, developers and customers didn’t believe that BlackBerry World would catch up to the Apple App Store. BlackBerry World was eventually shut down. Your corporate innovation strategy should account for the possibility that your company’s growth could become linked with your success in creating a digital ecosystem.
How do you become more like Apple than BlackBerry? For starters, your large firm will need to attract developers to build in your digital ecosystem versus that of the competition. This is where the EIF model, with its ability to invest in many companies, can help. The EIF model makes the following offer to the companies it funds:
- Startups get total control of their companies with Founder Friendly Standard investment terms (as opposed to less control with VC) and a little money in the door (as opposed to a lot of money from VC).
- This is in exchange for building products and services on your platform.
The above trade would not work for “unicorn” startups that aspire to grow rapidly and unprofitably. Instead, your EIF would be most compatible with a new generation of startups called “zebras,” which are resourceful and aspire to grow profitably.
Why are “zebra” startups a match for EIFs to fund?
Your EIF will probably fund a new type of startup called a zebra. The term zebra was introduced in 2017 by Zebras Unite, an organization calling for a more ethical and inclusive alternative to venture capital culture. Zebra startups focus on serving a niche. Many of the companies on the Inc. 5000 list are zebras.
Zebra startups differ from unicorn companies, which venture capital culture tends to focus on: companies such as Facebook, Instagram, Twitter, Uber, and Airbnb. Unicorn companies often grow quickly and unprofitably with the hopes of raising prices down the road. As a result, unicorn companies rely on an ample amount of investment and luck. Unlike their unicorn cousins, zebras are startups that aspire to grow sustainably from day one. Zebras often try to dominate a niche, not an entire market. This makes zebras a mismatch for venture capital and a match for your EIF, which needs niche solutions to execute your corporate innovation strategy.
Where can I read more about EIFs?
My December 2020 book, Innovation Casino, introduces the idea of an EIF. The term “innovation casino” is a metaphor for the odds of generating financial returns from corporate innovation. The book takes an odds-based approach to show how companies using an EIF to fund non-core innovation can get higher returns from their investments than companies using internal teams to tackle the same initiatives. Innovation Casino is available on Amazon in kindle, audiobook, and paperback formats. You can also read a chapter-by-chapter summary of the book on this blog. And be sure to check out my August of 2021 interview about ecosystem innovation funds.