The second article in the our guide on building corporate incubators explains the theory behind incubators. What is the core mechanism powering incubators? How are they structured? Who participates in the programs?
Underlying Theories Supporting Incubators
Understanding the theory behind incubators is essential if companies and startups are to prove the concept worthwhile. In a 2012 white paper, Mathew J. Manimala and Devi Vijay of the Indian Institute of Management Bangalore present seven theories that explain and conceptualize incubator functions.
Structural Support Theory
The structural support theory proposes that new ventures can overcome the problems associated with startups, such as being new and small, if the cost of their infrastructure and overheads can be reduced. According to this theory, “pooling resources, as occurs in an incubator context, leads to efficiencies because the central pooling of resources can significantly reduce overhead costs and thereby increase operating efficiencies.”
Structural support can include office space, communication technology, managerial assistance, access to laboratory and equipment, research facilities, and expert staff. According to this theory, the venture stands a better chance of survival if support in these areas is pooled.
The cluster theory was developed by Michael E. Porter and described in The Harvard Business Review in 1998. The theory places incubators within a broader ecosystem with other entities. Clusters are “geographic concentrations of interconnected companies and institutions in a particular field.”
The clusters are composed of industries and other linked entities important to competition. Fundamentally, they are networks and include, for example, component providers, machinery providers, services suppliers, and providers of specialized infrastructure. The advantage of being part of an incubator within a cluster is that it is easier to access resources within this environment, which increases efficiency and productivity.
According to Manimala and Vijay, the cluster theory builds on structural support theory and suggests that high-tech firms with similar characteristics in the same value chain cluster to stimulate faster knowledge dissemination and synergistic growth using each other’s capabilities.
Social Network Theory
This theory posits that the effect of internal and external network connections and social networks increase the client firm’s network density and positively affect the development and growth of the startups.
“[S]ocial networks and contacts,” according to Manimala and Vijay, “facilitate access to capital, credibility and respectability because of the association with the incubator and its sponsor institutions, and they provide techno-managerial assistance through the incubator’s professionals and/or network.”
New Venture Creation Theory
This theory posits that network access and community support for entrepreneurs increases their legitimacy and increasing the chances of venture funding and survival.
A 2004 study by Neck, Meyer, Corben, and Corbett found that incubator organizations, spin-offs, informal and formal networks, physical infrastructure, and the culture of the region where the incubator is located interact to form an ecosystem conducive to high-technology entrepreneurial activity. Additionally, greater rates of new venture formation were found following critical moments in the life of incubator organizations.
The Resource-Based View
This theory states that incubators provide both tangible and intangible resources to client firms. These resources – knowledge sources in the form of universities, for example – or market proximity spur growth through a community effect. This is not unlike the cluster theory in that incubators benefit from proximity and access to networks and logistics.
Gassmen and Becker used two levels of analysis in 2006 – the resource flow between the corporate incubator and the technology venture and the resource flow interface between the corporate incubator and the technology venture – to develop a model that can determine “how corporate incubators function as specialized corporate units that hatch new businesses.” They emphasize that tangible resources are all visible and easy to measure, whereas intangible resources such as tacit knowledge and branding are more difficult to quantify and assess.
The concept behind this theory is that entrepreneurs “operate in an inter-dependent co-production dyad” where business assistance is provided by the sponsor. According to Hackett and Dilts (2004), incubation co-production stimulates developmental assistance in independent incubator-client dyads.
This co-development is of mutual benefit and increases the likelihood that startups survive and that the sponsor and regional economies benefit.
Real Options Theory
Real options theory borrows concepts from the finance literature. The theory states that the selection of startups or entrepreneurs for the incubator creates an option, and the injection of required resources, monitoring, and assistance are also options. The real options methodology was initially applied when evaluating technological assets such as R&D.
In 2004, Hackett and Dilts used real options theory to predict whether new ventures will survive the early stages of development. The incubator is conceptualized as an entrepreneurial firm that sources and manages the innovation process within emerging organizations. The incubator is the unit of analysis while incubation outcomes, measured in terms of startup growth and financial performance at the time of incubator exit, provide indicators of success.
“For incubators to live up to their full economic potential, they need to overcome two pitfalls: they need to provide real value, not just office space, and they need to measure success in more than just outside funding.”
— Harvard Business Review, 2013
The figure, below, summarizes the rationale for business incubators, highlighting the value derived from networks in terms of knowledge resources, access to financing, and community support.
Source: Smartcompany, 2015
There are various models and types of business incubators. The U.S. Department of Commerce separates them into incubators “with walls,” which provide a separate space and location for projects, and incubators “without walls” (or “virtual incubators”) which house the incubator within the corporate environment and use the existing infrastructure and communication systems.
Corporations have taken these models and adapted them to their their needs. Evangelos Simoudis, founder of Synapse Partners, describes four incubator models in his piece “Using Corporate Incubators and Accelerators To Drive Disruptive Innovation.” We outline this models below.
The Incubator/Accelerator Model
This model includes both intrapreneurs (entrepreneurs within a corporation) and entrepreneurs. The incubation period for this type of model is typically between four to 18 months. Teams, if deemed of a high standard, are invited to join the corporation, or “spin in” as some say. They are retained for longer with additional sponsor investment to keep them going, or they are required to work outside the corporation, a “spin out,” with an investment from either the sponsor’s VCs or perhaps in conjunction with external VCs. Alternatively, the teams can be left to raise their own funding from external VCs or other funding sources.
This model is appropriate when a sponsoring business wants access to early stage innovations, is looking at the long term – ideally, seven to 10 years – for concept development and potential disruption, has appropriate metrics set up to measure the startup’s performance, and is open to the risks involved in mentoring and supporting an early stage startup.
The unique benefits of this model are that there is a long-term commitment to disruption, which is crucial. Concepts need time to be morphed into products, time to reach the market, and time for adoption, which means that there may be some delay before there is significant ROI. Another benefit is that entrepreneurs and intrapreneurs work side-by-side and may eventually join the sponsor’s business units.
But entrepreneurs should be aware of the downsides to the model. According to Wharton Magazine, the sheer number of incubators is increasing, and not all of them are up to snuff. Some have weak investor relationships, which means that fundraising for the startups might be difficult come demo day. In addition, new programs have not had sufficient time to build a reputation or a track record, which is not conducive to attracting investor funding in a competitive startup market.
Wharton magazine also suggests that the time that entrepreneurs must spend at social events, building networks and discussing initiatives with potential investors, is time taken away from engineering, experimenting, and problem-solving toward a better end product.
Samsung and Telefonica are examples of firms that have applied this model.
The Pay-it-forward Model
For this model, the corporate incubator provides facilities and training while the teams work with external entrepreneurial teams. The idea is to expose teams to real-world problems in the industry and to provide resources and experts to help them solve those problems. This type of program typically lasts from six to 12 months, and the sponsoring corporation receives no equity from the startup.
This model is appropriate when the corporation wants to expose its executives to startup thinking and practices, attract entrepreneurial talent, and access new ideas and early stage innovations from other resources to solve existing problems.
The unique benefits to corporations for this type of incubator are access to startup teams and their thinking and the creation of goodwill. A downside to this model that entrepreneurs might want to consider: there may be a significant bias toward the interests of the corporation.
Allianz and Turner have applied this model.
The Developing Intrapreneurs Model
LinkedIn, Google, and Starbucks use this model where entrepreneurial teams incubate innovative solutions and test business models. This strategy works for companies that could not pursue ideas using existing business units. This model fits when an organization is strongly committed to long-term innovation to achieve disruption.
The unique benefits of this model are that new products and business models can be rapidly developed. Resources are allocated to strengthen intrapreneurship and permit risk taking on out-of-the-box thinking.
One downside, according to Sean Silverthorne of Harvard Business School, is that if a startup is working on a product or service that competes in some way with the business of the company, the effort could be perceived as a threat to many inside the company.
The New Work Environments Testing Model
This model, applied by ATT Foundry and Standard Chartered Bank (SC Studio), describes creative work and the testing of new solutions or environments by the innovators.
The new work environments testing model is an incubator without walls. The sponsoring corporation does not offer on-site space for clients although they may have a central office through which to coordinate services, house the management staff, meet with clients, and perhaps even provide conference rooms for clients. This is a suitable model for a corporation that wants to test startups but does not want to assume the risk of creating an external startup team.
The unique benefits to the new work environments testing model are that the corporation can use existing structures, such as flat management and open communication tools, to experiment with innovations, which reduces costs and may lead to better performance within the organization.
The New Incubator – Soft Landing for International Programs
Although a goal of incubators has been to boost local economies and ideally the national market, not all are focused on domestic markets. Many startups now use the incubator environment to reach beyond domestic boundaries.
According to the U.S. Department of Commerce, a new form of business incubation program has recently emerged: international business incubators provide the same set of entrepreneurial services as a typical incubator, but they also provide a “soft landing” for international firms seeking to enter the U.S. markets.
These types of incubators often provide specialized services. For example, the University of Florida’s soft landing program helps both domestic and international firms integrate into the Central Florida business community. The program helps with short-term leased office space, networking with the Central Florida business community, domestic market research, and provides access to experts on legal, government, regulatory, and press and media matters.
The University of Toronto has partnered with the Chinese firm Diantou.net to help companies who are entering the lucrative Chinese market. According to The Impact Centre at the University of Toronto center, Diantou.net will “provide start-ups with legal, marketing and other support services” while the Toronto center will offer entrepreneurship course to Chinese students, researchers, and startups.
Other similar incubators offer translation services, language training, assistance with documentation such as obtaining business and driver’s licenses, cultural training, assistance with visa and immigration, and housing assistance.
Types of Business Incubator Tenants
Just as there are different incubator types and models, there are also different types of tenants who may or may not be viable participants in one or more of the incubator models. A lot depends on the support and the resources that the host company is willing or able to provide and whether the startup is in the same industry vertical as the sponsor.
Business incubator tenants can be characterized according to their maturity and readiness. Ernesto Tavoletti describes four types of incubator tenants.
Anchor tenants pay bills promptly and contribute financially to the incubator. They do not require input from the corporate host. Examples of this type of tenant include accounting companies, law and financial services firms, economic development agencies, or university offices.
Long shots are startups that require the input of the corporate host in terms of a nurturing environment. These entrepreneurs are aware that they lack resources in their early stages and require co-production efforts from their host to reach their potential.
Up-and-comers also have significant resource gaps that can be addressed through co-production. These companies are one step ahead of long shots and are operated by entrepreneurs who are aware of the gaps but are on the verge of being able to engage with resource assistance.
Superstars have matured beyond the up-and-coming stage, and they are ready to engage with minimal co-production efforts from the host. They have resolved problems, can withstand crises, and expect to imminently graduate from the incubator. These companies can act as role models for up-and-comers and long shots.
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West Stringfellow spent over 20 years launching products and leading innovation at corporate giants and startups, holding management roles at Target, PayPal, VISA, Rosetta Stone, GraysOnline and Amazon.
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