Building an Idea Factory: A Guide to Creating an Incubation Studio
Creating an incubation practice is a daunting one. And yet the upside, if you can get it right, is massive. A working studio that can incubate and spin out new products or companies at scale is perhaps the best engine for value creation imaginable.
A recent study of 415 companies created inside of studios found that only 9% failed and the rest either had exited or were still active. And the average company in that study was generating over $1M in annual revenue.
That is a big part of what Manifold does, both for ourselves and for our clients. For us, it provides our investors with an engine for perpetual value creation. And with many growth initiatives our clients embark on, incubating new businesses often is the end result.
In this series, we'll explain our methodology for identifying opportunities at scale. We'll talk about how we validate them as quickly and cheaply as possible. We'll discuss how we staff them as they earn more resources. And we'll discuss how we leverage emerging technology and tools to rapidly bring them to market and drive early distribution.
It's important to note at the outset that our process is constantly evolving. As we learn more, we refine our process. New tools and techniques are coming out constantly, and we regularly make use of them when relevant. I would expect this process to look different in many ways a year from now.
Our hope is that this post and the ones that follow will give you a good window into what an incubation practice can look like in your own organization. As you'll see, there's a lot there. But each step of the process is relatively simple to implement. The only real secrets are consistency, discipline, and a bit of luck.
Of course, if you've been wanting to stand up an incubation practice inside your own organization but need help, we'd be happy to talk.
Our Philosophy: Think Like a Venture Fund
Perhaps the biggest lesson we learned, both in talking to other studios (successful and failed) and in standing up our own, was the importance of thinking like a venture fund. While corporate teams certainly have domain expertise very few other organizations possess, the practical reality is that the most likely outcome for any one idea is failure.
While we do our best to mitigate this and earn a higher batting average (using many of the techniques you'll learn in future parts of this series), there are dozens of variables impacting an idea's potential. This could include, but is not limited to:
- The way the idea is presented to the market.
- The degree to which customers have the problem identified (such that they're willing to actually change behavior, create new habits, and pay for something new).
- The market size and its characteristics –– how price elastic they are, how much they talk to each other, their tendency to be brand loyal vs transactional, etc.
- The thousands of micro-decisions baked into the product that can have an outsized impact on activation, retention and referral.
- Broader macroeconomic issues –– whether you're in the middle of a crippling pandemic, for instance.
You can either try to pretend these variables don't matter, or in an act of hubris think that you can easily overcome them.
Or you can do what venture funds do, and simply make more bets.
Focus on Number of At Bats
Venture funds are routinely staffed with brilliant analysts, skilled operators who know how to build companies, and visionaries who can see 10 years into the future.
And yet despite their intelligence, pattern recognition and robust diligence processes, most of their bets fail.
They mitigate this by making more bets. They've learned that for every 20 investments they make, 1 or 2 will be likely to have meaningful outcomes. There will likely be some soft landings for others - acquihires, sales that return capital, etc. But those couple of larger outcomes will ideally return the fund. The rest effectively go to zero.
Interestingly enough, several of the failed studio models we've talked to in the past were actually created by venture funds. If anyone should have internalized this logic, it should have been them. And yet while they had the discipline to look at 100 deals for every one they invest in, the studio would often pursue opportunities that the GPs thought made sense. They would push those ideas through, fail to follow a similar diligence process that they use on the venture side, and be shocked with the outcomes didn't match up.
This is particularly surprising because the opportunity cost of pursuing an opportunity in incubation is so much higher than in venture investing. While in venture investing you're looking to add value as much as possible, will often sit on boards and make intros, the amount of human capital spent post-investment simply doesn't compare to the amount of horsepower required to get a new company or product off the ground. If anything, the threshold for incubation investment should be higher than venture.
In some ways, enterprise organizations are actually better equipped to build an incubation studio than venture funds who are mostly known for the practice. One major reason is simply resources - a typical venture fund operates under the 2 and 20 model. That makes providing all the resources necessary for success difficult or impossible. Companies (if they choose) don't have this constraint.
The Process in a Nutshell
We believe incubation teams should operate with this model. Specifically, we recommend:
- Placing lots of small bets, allocating a limited amount of resources to each.
- Utilize a strict stage-gate process to move opportunities through the funnel.
- As opportunities pass through stage gates, they earn more resources, eventually having their own team and the equivalent of a "seed" investment.
So how do you do this practically? That is the focus of the next few articles in the series. A preview of what to expect:
- Creating a thesis to drive ideation.
- How to find ideas at scale.
- The opportunity memo, and how to write a good one.
- Customer development methods.
- Cold market validation - where the rubber meets the road.
- Preparing a compelling MVP candidate deck.
- How to build v1 quickly and cheaply.
- Driving early distribution.
- Staffing and organizing for success.
All together, we believe this process will allow you to spread risk across a number of ideas, and only commit resources to the ones that earn the right.
You fail - a lot. But you fail quickly and cheaply. The end result is a machine for spinning up new opportunities and for generating rapid value creation.