The Dawn of the Marketing Venture Capitalist

In may 2005, Coldplay's single 'Speed of Sound' went straight into the top ten of the US charts – the first time a British group had achieved this feat since the Beatles with 'Hey Jude' 37 years before. For Coldplay's record company, EMI, it marked a return to the glory days when the Beatles were guarantors of its US sales. For the British music industry, it brought to an end a long era of transatlantic famine.

For the industry worldwide, the event represented a celebration of its distinct model for cultivating success: ten years ago Coldplay were a student band at University College London, before being discovered in 1998 playing at a music festival in Manchester by a record label A&R (Artist & Repertoire) scout, Debs Wild.

The music industry reflects what we will call the 'discovery' model of innovation in its purest form. In this model new ideas and new talent are predominantly 'found' not 'made', the commercialisers of ideas tend to be different to their originators and success is nurtured by a diverse, vibrant and self-sustaining ecosystem where talent and ideas bubble up from the bottom.

Significantly, in music there is a recognition and acceptance that success is fundamentally a percentages game: to win big you are going to have to be prepared to lose frequently and that is fundamentally OK. Management and investors may cavil about the risk and earnings volatility, but the model has proved durable. As Sony BMG Records CEO Andrew Lack said recently, 'My responsibility to the shareholders is to say: “Look, you're in a casino – if I place a bet ten times, then once or twice my number will come up.”'

THE GROWING INFLUENCE OF THE DISCOVERY MODEL

While the discovery model is epitomised by the music business, it is by no means unique. In industries such as pharmaceuticals and software, the large global players have been successful in 'talent scouting' externally among independent R&D labs or hotshop code warriors in pursuit of the next hit molecule or application.

Beyond the traditional corporate world, the growing influence of private equity as an alternative ownership model has demonstrated the virtues of a discovery-based approach to creating value.

The private equity model is different to that of the traditional corporate and depends less on interventionist management skills and more on the ability to skilfully identify and then arbitrage undervalued assets. The focus of the private equity investor is on the blending of these assets with management talent and powerful incentives to foment success.

Just as in the music industry, private equity investors recognise that they have to play the percentages game: late-stage investors typically work on a 40/40/20 ratio of big successes, middling successes and relative failures. In early-stage investing the odds are longer: more like 20/40/40.

Nonetheless this has proved to be an effective model. For example, in the consumer space in the UK, niche brands such as Molton Brown, Simple skincare, Wagamama and Hobbs have all been acquired and then resold by private equity owners, usually with spectacular returns.

While the discovery model has been the dominant force in industries like music, pharmaceuticals and private equity, the consumer goods industry has not traditionally embraced it. Instead consumer goods firms depend primarily on the 'invention' approach. In this model new ideas tend to be made not found: originators and commercialisers are usually the same entity; and the flow of ideas is as likely to be top-down (driven by perceived new needs and segments) as bottom-up.

Fmcg majors bet big on the invention model. Almost all branded players conduct their R&D and NPD inhouse and are prepared to invest heavily behind success: R&D budgets typically amount to around 1–3% of sales. Behind these investments lie elaborate innovation management structures and intensive staged-gate development processes.

Viewed in the round, the model is institutional and deterministic: research the market – identify the need –meet the need. Ready-aim-fire as opposed to the almost gleeful ready-fire-aim mentality in the music business.

And yet – despite this commitment – managers and investors in fmcg are professing themselves disappointed with the returns on their investment in innovation (see Figure 1). Top-line growth remains elusive (and is scarcely higher than underlying inflation); the majority of new products still seem to fail and the fruits of the process frequently seem more incremental than radical.

So, to deliver against expectations, the majors have to maintain a relentless focus on costs, contemplate risky investments in emerging markets and/or continue to box clever in the ceaseless fight with the retailer.

Unilever's much-vaunted 'Path to Growth' strategy illustrates the magnitude of the challenge. Ruthless divestment of non-core brands and the admirable clarity of the reporting served only to illuminate the poverty at the core of the project: revenue growth among the company's 400 leading brands only briefly reached the declared 6% pa target and had fallen back to 2% or less by the time the initiative was abandoned.

Perhaps none of this should be surprising: successful innovation is hard at the best of times and is exceptionally so in mature markets where jaded consumers, high rates of marketing investment and retailer power all conspire to elevate the barriers to success and breed risk aversion as a result.

CEOs have therefore tended to prefer the elixir of major acquisitions (despite evidence that the majority of these transactions destroy value) over the slower and rockier path to organic growth. For most consumer goods CEOs, innovation remains the great unsolved problem of how to drive success.

In their recent book, Fast Second, Costas Markides and the late Paul Geroski reached the conclusion that large corporates have a poor track record at primary innovation but a much better one at scaling innovative new products sourced from elsewhere. Their message is that firms need to make a choice between playing the role of 'coloniser' or 'consolidator' within their industries.

According to Markides and Geroski, 'Some firms are natural colonisers, able to explore new technologies quickly and effectively, making the creative leap from technological possibility to something that meets consumer needs ... Other firms are natural consolidators. They are able to organise a market, turning a clever idea into something that can be economically manufactured and distributed to a mass market.'

CHALLENGES FOR THE MARKETING FUNCTION

Faced with this choice, consumer goods companies need to think harder and sharper about how they are going to play the innovation game. Central to this decision is the need for firms to make a clearer choice about where and how to participate in the innovation 'value chain', based on an honest assessment of their real capabilities and advantages.

This in turn has implications for the marketing function and should cause marketers to ask themselves some profound questions about the role they can play and the contribution they can make to the corporate growth agenda.

Some 150 years after the industrialisation of the West and more than 50 years after the invention of marketing, we are still taught that the purpose of marketing is to fulfil 'unmet needs'. In the 1950s, when clothes were still predominantly washed by hand, floors were cleaned with a brush and the journey to work was on foot, by bus or by bike, the concept of 'unmet need' inspired a rich agenda. The implication was that consumer needs were both patent and identifiable, and that a guided programme of inquiry could identify fruitful opportunities and niches to be exploited by new products and services.

The result was that firms created substantial institutional structures and put generous funding behind NPD. When this started to have mixed success, an element of risk management was introduced by the advent of staged-gate innovation processes designed to weed out borderline projects on strict and transparent success criteria.

Despite these refinements, the traditional NPD model remains risky and the probability of success is low. But this should perhaps come as no surprise when we look around us. As a cursory walk around TriBeCa, Dubai, Notting Hill or even Shanghai would suggest, we are living in a world where consumption choices are being driven more by lifestyle preferences and status anxiety than by 'unmet need' per se.

As a result, the ability of the traditional model and structures to identify or anticipate new opportunities is weakening. In markets as big and diverse as alcoholic drinks, fashion, cosmetics and perhaps even cars and white goods, the obvious functional gaps that could reliably be identified by traditional needs-based analysis have long ago been filled.

Axiomatic to the needs-driven model is that marketers are in the driving seat of what is a primarily institutional and organic approach to innovation. The skill set of marketing is therefore rooted in consumer understanding, fuelled by significant investment in consumer insight. Most marketers see innovation as core to their role and most probably think that they are good at it: being 'innovative', like being 'strategic' or 'entrepreneurial' is something that few people like to admit to being bad at. Conversely, few if any marketers would be flattered to be described as 'consolidators'.

Marketers therefore tend not to exploit the talent-scouting qualities that seem to be serving the music and private equity industries so well.

A CHARTER FOR THE MARKETING VENTURE CAPITALIST

Marketing is labouring under a big limitation in that it tends to be viewed internally as the 'department of organic growth'. And only a modestly successful one at that!

As a result CEOs tend to view the real work of value creation as happening in the finance and mergers and acquisitions (M&A) function, where big issues like 'synergy' and 'consolidation' get thrashed out by the MBAs and investment bankers. Meanwhile marketers get busy with their line extensions and advertising campaigns.

The consequence is twofold. First, plenty of step-change acquisition and consolidation as the majors merge businesses, acquire 'strategic' brands and divest 'secondary' ones. Second, a frustrating lack of success in driving up organic growth and the rate of successful new product launches.

Meanwhile the middle ground of fast-tracking small but high-potential brand properties gets left to the start-ups and private equity players.

The time is therefore ripe for marketers to question their role and the contribution they are making to innovation-driven growth. This implies a new and different skill set and a more eclectic approach to driving innovation.

In short, marketers need to start behaving less like an institutional salariat and more like venture capitalists. What marketing venture capitalism requires is root and branch reform of marketing organisational structures, skill sets and success models. But what would a charter for a marketing venture capitalist look like? There are four critical elements, highlighted in the next section.

WHAT NEXT? SOME PRACTICAL PRESCRIPTIONS

But what might this mean practically? What should firms wanting to travel this road do? And what needs to change in marketing? The following guidelines provide some starters for ten.

Assess Your Capabilities

Start with an honest assessment of your capabilities and develop a sense of where you do add value – and don't. This article is not trying to argue that there is no role for traditional in-house, organic innovation. However, it is almost certainly the case that there is too much of it about. Too many companies are deluding themselves that they have genuine capability in this area when their real skills lie elsewhere.

CASE STUDY 1: Apple - buying technology; not making it (see Figure 2)

The story of Apple is well known and the company is generally regarded as the sine qua non of what innovation is all about, with a stunning track record of successful new products such as the Apple II, Macintosh, iMac and iPod.

But what is really striking about Apple's strategy is that it has not depended on classic 'first mover' innovation. Instead the company started with a clear vision: to make the computer the 'digital hub' in the home and a facilitator of a new digital lifestyle around music, photography and video. Allied to this vision is a clear choice about where and where not to play in the innovation value chain: superb industrial and human interface design, 100% product compatibility and incisive branding and marketing. But not primary innovation. Apple didn't waste time re-inventing wheels but instead acquired the technologies it needed to fast-track to the digital hub proposition, as Table 1 shows.

CASE STUDY 2: P&G: 'Open Source' Innovation

By the late 1990s, Procter & Gamble, along with many of its fmcg peers, was struggling with the problem of driving top-line growth in what were its largely mature markets. Over-aggressive corporate restructuring and the diversion of resources from big brands into peripheral activities had sapped morale and the company needed new direction. CEO AG Lafley was appointed in June 2000 and announced a 'back to basics' strategy focused on getting the most out of core brands and categories. (see Figure 3)

Improved innovation performance was central to this strategy and in 2003 Lafley declared that his vision was that in future '50% of P&G's discovery and invention could come from outside the company.' At the time only about 20% of P&G's programme arose from this source. In fact, prior to Lafley's appointment, P&G was spending c. $200m a year (in excess of 10% of its total R&D budget) on internal 'skunk works' projects. P&G has now re-branded its 'research and development' function as 'Connect & Develop', recognising what is becoming a more open and eclectic approach to innovation.

Behind Connect & Develop is a highly directed but networked model. Extensive use is made of web-based sources. Search and visualisation tools are used to mine information about a wide range of developments in technologies, markets, competitor behaviour, social and political trends, etc. These are then brought to the attention of relevant managers by a team of 'gatekeepers.'

This search process is complemented by other ways of connecting – for example, an internet-based business (NineSigma.com), which enables client organisations 'to source innovative ideas, technologies, products and services from outside their organisation quickly and inexpensively by connecting them to the very best solution providers from around the world'. They also work with another website – InnoCentive.com – which provides an online marketplace where organisations seeking solutions to problems are brought together with scientists and engineers with solutions to offer. (see Figure 4)

P&G has also applied the Connect & Develop approach to internal idea generation. The company has a wide range of active communities around product groups, technologies, market segments, etc, which it leverages through intranets. An example is the 'Encore' programme, through which retired staff of the company – and potentially those of other companies – can be mobilised to act as knowledge and development resources in an extended innovation network.

The underlying approach is a shift in emphasis, not abandoning internal R&D but complementing it with an extensive external focus. P&G sees its task not just as managing 'know-how' but also 'know-who'. According to Nabil Sakkab, head of research and development at P&G's fabric and homecare division, the company's model for intellectual property formation has changed from 'the Kremlin to the Acropolis'.

The results have been encouraging. Under Lafley, the company is delivering organic revenue growth of c. 7% pa – excellent for a mature consumer goods business. P&G's new products are consistently ranked in IRI's annual table of top consumer goods product launches and, in recent years, have included the Swiffer duster (developed from acquisition of a Japanese competitor), the Crest SpinBrush electrical toothbrush (another acquisition of a nascent competitor) and Bounce, the world's first dryer-added fabric softener (based on technology acquired from an independent inventor).

Source: P&G; FT; McKinsey Quarterly

The energy that goes into the creation and evaluation of new products needs to be balanced by a rigorous assessment of the last several years innovation answering the questions of what worked, what didn't, what went right, what went wrong, and what can and can't be fixed. Many will conclude from this exercise that they have been ill-served by the traditional model and need to find new routes to success.

Confront the Trade-Off: Should New Products be Made or Bought?

The weight and recurrence of R&D spend, the classic NPD process and the disconnect between marketing and M&A all conspire to suppress the question of whether to 'make or buy' new products. The so-called 'business development' function is almost exclusively concerned with M&A, while marketing is exclusively focused on organic growth. The two parties need to talk a common language of value creation. New structures and formats need to be created to bring them together and force the trade-offs.

Acquisitions are frequently criticised for failing to earn returns in excess of the cost of capital. But how often is internal R&D spending assessed on comparable rate of return criteria? Based on a set of typical ratios for an fmcg company, a firm needs to derive 5–10% of its annual sales from new products every year, in order to meet return on investment criteria on internally sourced R&D. This is a tough target in the context of the low success rate of new NPD and typical organic growth rates of c. 5%.

Make the R&D Budget Contestable

The logical consequence of the make or buy model is that the R&D budget should be seen as only one of a number of routes to securing growth. In other words, it needs to fight for its place at the table alongside acquisition, licensing or outsourced R&D as a solution.

Contestability could have a very significant impact on the shape of growth strategies, as significant value is locked up in R&D budgets: $10 billion turnover fmcg company will be spending c. $200m pa on R&D – equivalent to a capitalised value of c. $1.5–$2bn. Diverting even a portion of this sum on targeted acquisitions could be a source of real impact on the top line.

Bring Deal Origination Skills into the Mix

Marketing has traditionally been defined as a creativity and insight-driven function, based on the ability to listen closely to consumers and translate their needs into products. Marketers are not disposed to look outside the firm for new ideas. Nor do they tend to look through the lens of the business strategist or corporate financier around the opportunity to arbitrage undervalued assets.

The Marketing Venture Capitalist's Charter

• Shift the emphasis of new product and service development away from 'invention' and towards 'discovery'.
• Adopt a more diverse and eclectic approach to innovation, embracing approaches such as acquisitions, JVs and licensing as well as traditional organic methods.
• Define a new role for the marketer as investor – someone at the heart of the growth agenda who is skilled and empowered to take 'make or buy' decisions around innovation, based on rate of return criteria.
• Cultivate a new approach to risk management based on the notion of innovation opportunities as a series of real options, rather than the convergent logic of the traditional staged-gate process.

However, while financiers spend their lives trying to do precisely this, they do it from a mechanistic financier's perspective, distant from exposure to consumer dynamics that are the meat and drink of marketing. Marketers are therefore much better positioned to bring consumer insight and trend analysis to bear on acquisition scanning.

The problem is that many marketers are neither particularly analytical nor have had anything more than rudimentary finance training. A tall order to combine the two, maybe – but imagine the impact and influence of individuals who can both understand and divine consumer trends and link these to acquisitive growth opportunities.

Small companies with proven revenues can be bought for less than it takes to get many 'blockbuster' innovations to market. P&G secured the ultimate purchase of SpinBrush for $475million – equivalent to 2.3 times its previous year's sales and widely considered to be a steal.

CASE STUDY 3: Premier Foods - The Proud Consolidator

Premier Foods, which floated on the London Stock Exchange in 2004, is a large British food company with a distinctive heritage. Originally an MBO from Cadbury Schweppes in 1986, Premier was subsequently acquired by conglomerate Hillsdown and was then the subject of a second leveraged buyout by American Private Equity firm Hicks, Muse, Tate and Furst. Hicks Muse's strategy for Premier was to build its scale as a 'house of brands' comprising products that were regarded in some quarters as the walking wounded of the British food industry, among them Branston Pickle, Ty-Phoo Tea and Hartley's Jam.

Following its successful stock market float, Premier has continued to prosper and expand its portfolio. Its R&D ratio, at 0.1% of sales, is very low even by food industry standards. However, Premier has proved willing to grow via well-judged acquisitions. In 2005 it acquired Marlow Foods, the owner of Quorn textured vegetable protein, for £172m. Premier's share price rose by 7% on announcement of the deal. This was unusual for an acquisition as markets traditionally mark down the shares of the acquiror, implying strong endorsement of the strategy by investors.

And rightly so. What Premier apparently recognises is that their strategy is that of a pure – and proud – consolidator. It does not delude itself that its core skill is to be innovative and doesn't waste cash on R&D as a result. However it does it has confidence in its ability to deal with the UK grocery trade and to turn around tired and/or underexploited brands.

Sources: FT; company website

Think Differently About How to Manage Risk

Innovation is a risk that no amount of Bases II tests and staged-gate systems are going to eliminate. In fact, the culture of risk reduction may be having the opposite effect by inspiring either too much incrementalist, imitative innovation, or blowing shareholders' funds on too few failed big ideas.

Most new products are going to fail. They just are. Marketers need to start thinking about innovation opportunities as a portfolio of options rather than a converging funnel that leads to the single big idea. The imperative should be to get as many of these options as near to the market as is possible at reasonable cost. With the possibilities of viral marketing and the growth of the internet as a sales channel it's getting easier rather than harder to avoid the set-piece listing negotiation with the big retailer that has been the traditional hoodoo of the NPD process.

Challenge the Tyranny of the Boston Matrix

The current vogue for global branding and portfolio rationalisation is making marketers blind to the buried treasure that lies within the tail of their brand portfolios. The failure of a strategy like Unilever's Path to Growth should serve to make people leery of the false gods of global 'drive' brands.

At the root of the problem is too-slavish application of outmoded frameworks like the BCG matrix and pursuit of leadership positions in markets that are too widely defined. The consequences can be highly toxic for growth: everybody knows that the career fast-track is on the 'drive' brands; the secondary brands get starved of talent and investment and so decline.

As a result, entrepreneurialism and the potential to look afresh at opportunity get quelled. The perverse result is that arbitrageurs get to make huge returns while the majors struggle to make progress.

Shape the Organisation Around Consumer Segments, not Traditional Categories

A striking feature of the music industry is that, while its zest for global consolidation has been strong, care has been taken to preserve the identity and genre focus of individual labels. Record companies have appreciated that while there are substantial synergies available in manufacturing and distribution, artist and repertoire activities thrive on distinctive cultures.

Record labels have therefore kept their individual identities and physical locations, even though a global behemoth like Sony or Warner is running the back office and keeping an eye on the numbers. Instead of preaching the mantra of organisational restructuring, record company execs talk proudly of maintaining a 'myriad' of labels.

There are big benefits from the label model that fmcg majors can exploit. Foremost among these is that labels are targeted at genres, which are defined flexibly according to cultural, regional and ethnic preferences, among others. A recent example is Sony BMG's decision to create a new label, Music with a Twist, targeted at the gay/lesbian and 'gay adjacent' audience – a hugely important segment that has been under-recognised by traditional marketers. In contrast, marketing structures within fmcg tend to be defined by brands within product categories. The risk in this model is that it will tend to drive incrementalist innovation within the bounds of the existing category.

IN CLOSING

During the middle years of the last century the global fmcg industry was the cradle of marketing innovation. Yet during the last 20 years or so it has had to grapple with the challenges of maturity. Much has been achieved – in areas such as supply chain management and portfolio rationalisation – in order to defend profits in the face of burgeoning retailer bargaining power. But the end of that road is being reached.

However, fostering a similarly robust strategy for managing innovation has proved elusive. Diverse influences, from the music industry and private equity at one end, through to industry pioneers like P&G at the other, are illustrating new models of success. The time is right for contemplating radical change. This is a challenge that the marketing function can and must face. The dawn of the marketing venture capitalist is here.

This article featured in Market Leader, Spring 2006.

NOTES & EXHIBITS

FIGURE 1: ORGANIC GROWTH RATES (PER ANNUM) FOR THE WORLD’S LEADING CONSUMER GOODS COMPANIES, 2002–2004.

FIGURE 2

FIGURE 3

FIGURE 4

TABLE 1: APPLE'S TECHNOLOGY STRATEGY