Burn the Business Plan

by Carl J Schramm

  He had bet on innovation to revive a century-old product. Today, Pevco holds nearly one hundred patents and has built two factories, one in Baltimore, the other in Houston. A quarter of America’s 3,200 hospitals have installed Pevco systems to save labor and reduce potential liability related to mixing up specimens and drugs. In 2015, Valerino’s company installed the biggest system in the world, connecting six hospitals in Houston.

  From Outer Space to Shelves at GNC

  David Kyle worked in an industrial research laboratory at the aerospace giant Martin Marietta. A Ph.D. in biochemistry, like the scientists he worked with, he had turned down a professorship to work on cutting-edge science. His lab’s mission was to develop algae as a waste-disposal catalyst, a food supply, and a source of oxygen to sustain life on a space station.

  Two years into this research, Martin Marietta decided to return to its historic competency—building military aircraft. Its space lab was no longer to be part of the company’s future. Fearing that he would be out of a job, Kyle agreed to return to Cornell as a professor. Martin Marietta, however, had a different idea, one that changed his life. The company proposed that he and two colleagues transition their lab to a free-standing company. As Kyle remembers it, “Martin Marietta was giving us the nicest good-bye possible.” The arrangement included giving the trio all their lab’s equipment, and money to pay their salaries for a year.

  The hitch was that they would be starting a research laboratory with no customers and nothing to sell. Kyle and his partners would have to redirect their research to find an earthly use for algae, one that could make money. Each believed commercial products were possible but knew that their task, which would involve experimenting with thousands of strains of algae, would be enormous. Their entrepreneurial moment was at hand. The three pooled $25,000 from savings and incorporated Martek.

  Immediately, they focused on fifty algae strains that they suspected might have commercial uses. Their first research contract involved finding a way to convert fat molecules in chicken feed to produce low-cholesterol eggs. As a byproduct of their work on chickens, Martek came up with its first product, a vegetable oil many times more stable than the oil derived from petroleum. Selling for a few thousand dollars an ounce, it was used, among other things, for lubricating bearings on precision instruments like gyroscopes. Experimenting with fermenting one strain of algae after another with various mixtures of nitrates, phosphates, and carbon dioxide, they were soon making food colorings and fluorescing agents used in diagnostics.

  Initially, Martek scraped by making such specialty products and on research grants from the federal government. Using Small Business Innovation Research (SBIR) Awards, which are grants to help high-tech startups develop viable commercial products, Kyle’s team discovered how to generate docosahexaenoic acid (DHA), from algae. DHA, discovered in the 1920s, was the first of the “good” fats, necessary for heart health. Prior to discovering how to make DHA from algae, it was extracted from animal and fish sources, and invariably contaminated, so DHA’s benefits were compromised. The growing community of consumers wanting organic products opened a market for Martek.

  In order to produce DHA and other algae-based supplements at scale, the company needed large facilities to continuously ferment its products. Several venture funds provided capital, allowing the company to buy two abandoned breweries. In 1993, eight years after it was started, the company sold shares to the public. Martek became the world’s principal manufacturer of algae-based food supplements, supplying thousands of companies around the world. The company also developed its own supplement brands in conjunction with General Nutrition Centers (GNC) stores, and developed private label brands for other outlets, including Walmart.

  In 2010, twenty-five years after its three partners had put up $25,000, they sold Martek to an international ingredient company for $1.1 billion.

  Frustrated Corporate Innovators

  Ciocca, Valerino, and Kyle might not fit the popular image of entrepreneurs. To some they look like executives who, because of a shift in an employer’s strategy, had a chance to own a business that they already were running. Each could have ignored the opportunity, moved to another company, or, with a Ph.D., like Kyle, gone back to teaching. Instead, they all took up the entrepreneur’s challenge—developing a vision, creating an innovation, assuming enormous risk, and persevering to achieve scale. Starting small or lean was not in the cards for them. Ciocca was like David compared to the Goliaths of the wine industry; Valerino took over a business with a broken technology; and Kyle knew that the lab he had been given could never make money with the space station as its only customer.

  Ciocca told me, “I never thought of myself as an entrepreneur. When I started in business, the word just wasn’t used. I knew, though, that the people who made a difference—a lesson I learned from Ernest Gallo—were those who saw that risk-taking was necessary to success. It’s the hallmark of what entrepreneurs do. But, I think it takes a blend of knowing what the boundaries of your risk are and then trusting that your vision can make your business grow. To do that you have to keep pushing into the unknown, which means constantly inventing products that will define your company. So, like every successful entrepreneur, I managed risk by focusing on innovation.”

  Valerino’s recollection of his early days at Pevco parallel those of iconic entrepreneurs. He didn’t take a salary for three years. He burned up all his savings paying suppliers. He inherited a unionized workforce. “I had to pay the union dues on time, or else I got a visit.” He rented a tiny house as his office. Looking back, he laughs that his competitors showed pictures of his headquarters to dissuade potential customers. “If I wasn’t living the life of an entrepreneur, I don’t know who was. I bet the whole company on a dare that I could build a perfect system.”

  Kyle saw Martek’s challenge as making a commercial product by using his team’s incomplete but cutting edge knowledge about culturing algae. There were enormous manufacturing risks involved in buying old breweries to ferment at scale. Martek took twelve years to become profitable. “Many nights, falling to sleep, I thought about how simple and secure my life would have been if I’d gone back to teaching.”

  For Ciocca, Valerino, and Kyle, their entrepreneurial opportunity was not of their own making. Like all companies, Coke, Diebold, and Martin Marietta constantly weigh the strategic importance of various parts of their business relative to changing circumstances. Whether right or wrong, they dispose of business units they believe are peripheral to their futures. Every year, large companies sell thousands of operating units, many times to employees.

  The same large companies produce even more of another type of spinout entrepreneur: employees who leave to immediately begin work on an innovative idea that they had while working at the company, but in which they couldn’t provoke any interest, or sometimes even elicit any response, from management. Entrepreneurs who resign their positions to start new companies often are frustrated that their employers could not appreciate the growth potential of their insights and innovative ideas for their employer’s future.

  Innovation Must Find a Home

  Two of the best-known frustrated innovators, who valiantly tried to persuade two employers to leverage a discovery into explosive growth, were Robert Noyce and Gordon Moore. Both began their careers at Bell Labs, perhaps the best known industrial-research facility in history. There, they worked for William Shockley, the Nobel Prize physicist who invented the transistor. Overnight, the vacuum tube, which had made radio, television, radar, and computers possible, was obsolete. Noyce and Moore left Bell with Shockley, joining his startup and believing that he was committed to advancing and manufacturing semiconductors. After two years, it became apparent to them that Shockley was more interested in further research than in grabbing what Noyce and Moore saw as the golden ring in semiconductors.

  The pair turned to Fairchild Camera Corporation to bankroll a new company, Fairchild Semiconductor, that would make transistors and assem
ble them into microchips. Located in Mountain View, California, they were surrounded by other startups working on applications of microchips to all kinds of new devices, including computers. Noyce and Moore came to see that the demand was much bigger than even they had imagined; they forecasted that it would double every two years. As they saw it, their company could produce huge profits for Fairchild Camera if it would build a big enough factory. Fairchild Camera, however, wasn’t interested; it refused to take the risk involved. Noyce and Moore quit once again, this time to create Intel, which became the world’s largest manufacturer of microchips—the “inside” of many of the world’s personal computers. Intel is now seventy-five times bigger than Fairchild.

  Another ubiquitous technology that is part of all of our lives evolved in much the same way. Gary Burrell, the head designer at the King Radio Company in Kansas City, hired Min Kao, a newly minted Ph.D. in electrical engineering. Using semiconductors, together they were designing new communication and navigation systems for small airplanes made by King’s customers, Cessna, Piper, and Beechcraft. When AlliedSignal (now Honeywell) acquired King, the pair was tasked with continued development of top-secret guidance systems for missiles carrying nuclear warheads. These systems were being redesigned to use newly available satellite signals to pinpoint the locations of potential targets that might be anywhere on earth.

  Burrell and Kao came to understand that the global positioning system (GPS) used to guide missiles could be used to improve navigation for airplanes and ships. Try as they might to explain the market potential of GPS signals in such commercial applications, AlliedSignal believed its future success was tied to building weapons systems for the Defense Department. In 1989, when the government permitted civilian use of satellite-positioning signals, Burrell and Kao left to start a new company.

  Garmin, a combination of their first names, introduced its first product a year later, at the 1990 Marine Technology Exposition in Chicago. The GPS 100, a navigation aid for ships, was an instant success. They left the convention with five thousand orders and a conviction that their next product should be geared to a mass consumer market. Burrell and Kao set to work on a hand-held GPS device, the Garmin eTrex H, introduced in 1991. Garmin grabbed headlines, and a huge market, when news spread that U.S. servicemen were using their personal “Garmins” in combat during the Gulf War. Today, all of us have Garmin technology in our lives, supporting the mapping applications on our mobile devices, telling us that our missing luggage is in Brazil when it should be in Tulsa, and showing how many feet above sea level we are on the mountain we’re climbing.

  Before Starting Your Own, Work for Another Company

  Nearly ninety percent of all entrepreneurs have worked for other employers before starting their companies. Embryonic entrepreneurs cannot help but absorb lessons working for established companies that can prove useful as they start their own. If you are an aspiring entrepreneur, what should you do to get the most from such an experience?

  Work for an Innovative Company

  Ewing Kauffman delighted in knowing that many new companies, at least fifteen, were created by former employees of Marion Labs. He viewed his company as a nursery for other entrepreneurs. He also believed that, as long as people were leaving with great ideas for new companies, provided they didn’t compete with Marion, his company was fostering the entrepreneurial spirit that he tried to preserve even as his company grew.

  Learn the Innovation Process

  But being in an innovative environment is not enough. An aspiring entrepreneur needs to pay close attention to the process by which companies develop new products. How does the company’s research shape new products? How does market feedback from the company’s sales force inform evolving product design? How does the company decide to spend capital on new machines or plants?

  Also, you should study the pace at which growth is happening among various products within the company. As innovation accelerates in one product line, those products or divisions with slower growth or higher risk often are sold off. Ciocca and Valerino found themselves in just such situations. If they look, employees in big companies get to see the tug and pull of how companies decide to advance one product at the expense of others. Spinout entrepreneurs often can seize opportunities arising when companies shift their production mix.

  Appreciate Scale

  Many entrepreneurs without the experience of working in big companies unconsciously limit their ambitions regarding how big their startup might become. One reason is that many have never even seen a big factory or the inside of a huge warehouse, venues that serve as reference points for scale.

  As a young Wall Street banker, Jeff Bezos, founder of Amazon, which now owns giant warehouses in nearly every state, had visited companies, toured factories, and seen complex and large-scale logistics at work. Bezos had analyzed financial reports that described the scope and scale of really large companies. This experience allowed Bezos to imagine Amazon becoming a giant company even while it was a startup.

  Acquire Industry Knowledge

  Very few spinout entrepreneurs start companies outside of the industries in which they work. The obvious reason is that they have acquired specific industrial knowledge. After ten years of experience working for Gallo and running Coke’s wine business, Ciocca knew every detail of growing grapes, making wine, running a bottle factory, and distributing and selling. When the opportunity appeared, he had the necessary experience to buy and run The Wine Group as a startup.

  Industries are defined by products, the technologies related to making them, and the customers who buy them. Competitors use the same raw materials, processes, and, mostly, the same sales channels. People who have worked in one company for a long time learn not just the ways of that company but the rules of the industry. Executives within an industry often move from one company to another. They are not hired because they bring a competitor’s secrets, but because they know the common culture of the industry. Someone working at Macy’s may be valuable to Target because he knows the general operating rules for retailing; he doesn’t have to learn the business.

  This is the same reason that entrepreneurs starting companies hire people with industry experience. If you start a candy-bar company, someone who has worked at Mars comes knowing how to source cocoa, make candy at scale, the idiosyncrasies of candy wholesaling, and how effective marketing can bring customers to your product.

  Develop Industry Networks

  Working in a big company inevitably produces a wide set of contacts and friends in the company and industry. These networks are valuable to spinout entrepreneurs in many ways. Ciocca knew people everywhere in the wine industry when he started The Wine Group, from grape farmers to liquor store owners. When he left Coke with his new company he could draw on the goodwill he had amassed. Ciocca told me, “Without industry connections I wouldn’t have had much of a chance of even buying grapes.”

  Valerino fondly remembers the suppliers that he had used at Diebold extending Pevco credit when he couldn’t pay for parts. Burrell and Kao, because of their connections in the defense industry, had presumed credibility when they approached shipping companies who, seeing the advantages of using geopositioning technology, were ready to buy their new navigation products.

  Business Planning and Spinout Entrepreneurs

  Every big company has teams of MBAs working on strategy. Coke, Diebold, Martin Marietta, Fairchild, and Allied Signal had up-to-date written business plans. Each contemplated leveraging the company’s past successes, its core competencies, into future growth. None, however, anticipated the events that led Ciocca, Valerino, Kyle, Burrell, and Kao to break away, several becoming bigger than their parents. AlliedSignal, for example, could not see the potential of what Burrell and Kao described—it was outside their strategy of weapons research and production.

  The president of a publicly traded company once told me, “Of course, we have a business plan. If an acquirer shows up, I’m ready. But, I keep it locked in my desk. If I
circulated it inside the company, people would work toward its goals at the expense of seeing all the opportunities our customers keep presenting to us. And, I never want someone here to think that they would have to start their own company because we wouldn’t treat their idea as a potentially transformative innovation.”

  What Employers Can Learn from Spinout Entrepreneurs

  Most spinout entrepreneurs never intended to start companies. Most were loyal employees. Their arguments on behalf of expanding their product lines or developing a particular innovation genuinely were motivated by wanting to see their employer become more successful and profitable.

  Economist Albert Hirschman, in an attempt to understand why some firms don’t grow as fast as others, studied the behavior of employees who saw the future of their firms differently from their bosses. In his book Exit, Voice, and Loyalty, Hirschman argued that many people who left companies were frustrated that their former employer couldn’t see how bright its future would be if it embraced the vision or innovation that they had proposed.3 Hirschman saw them as disappointed that their work could not contribute to their employer’s future success.

  Valerino’s loyalty to Diebold continues all these years later. He still recalls how reluctant he was to leave. “Diebold was a great company. I should have made all this money for them.” He continued, “All it took was faith that pneumatic tubes had a big future in hospitals.” Ciocca recalls with a tinge of regret, “Coke just couldn’t see wine as its future. It could have been the biggest wine company in the world.” In retrospect, Ciocca, Valerino, Kyle, Noyce, Moore, and Burrell and Kao, all were innovation scouts, trying to find the path for their former companies. In reality, they each were becoming entrepreneurs in the process.