Built to Flip - Where Do You Come Down?

Christina L. Darwall

Christina L. Darwall, 51, is executive director of the Harvard Business School California Research Center, Harvard's outpost in Silicon Valley. A former partner at McKinsey & Co. in San Francisco, she also cofounded ViewStar Corp., a document-imaging software company that is now part of Lucent Technologies. She has served on the boards of several technology startups.

Flipping is a very real phenomenon. It happens all the time, and it often represents a very profitable strategy for those who are involved in it. In many cases, it is also the right strategy from the standpoint of economic efficiency. Most of us connect "long-term" with "good" and "short-term" with "bad." But I'm not convinced that making those connections is meaningful anymore. In fact, I think that it can be quite destructive.

Increasingly, successful businesses will be ephemeral. Instead of being built to last, they will be built to yield something of value -- and once that value has been exhausted, they will vanish. Their very evanescence will be a source of competitive advantage. Sheer mass and mere momentum will be predictors of failure, rather than signs of benign persistence.

Just look at what's happening in business today. At open-source software projects like Linux and Apache, large numbers of nonemployees are working disparately to develop products that do not owe their existence to any one company. Contributors come and go. There is no master plan, and there is very little formal structure. Strategy is amorphous, depending both on the talents of various contributors and on the demands of a constantly shifting market.

At many technology companies, old boundaries are blurring. Employees, suppliers, customers, and partners communicate -- every day and in real time -- via intranets and extranets. Enlightened executives, such as Meg Whitman and Pierre Omidyar (both of eBay), worry as much about the culture of their user community as they do about the culture of their employee community. The tendency of employees to move more often and more easily between employers has fueled this dynamic.

At the same time, the technology economy is becoming more and more modular. Think of build-your-own PCs or plug-and-play software components: Soup-to-nuts companies -- companies that integrate fully up and down the value chain -- are yielding to virtual organizations that rely on partnerships and joint ventures.

Cisco Systems is a classic example. Cisco is best viewed as an extremely efficient sales-and-marketing machine. Its research-and-development strategy largely entails identifying and buying small, single-product companies just as a particular technology is beginning to prove itself. As a result, Cisco can eliminate much of the guesswork that would otherwise go into its research function. The selling price is often high, but what may seem like an outrageous valuation for an untested startup is actually a bargain for Cisco.

That strategy works well precisely because many of the companies that Cisco acquires and integrates are built to flip. Buying such a company -- one that has focused almost exclusively on the creation of a new product or service -- involves overcoming relatively few barriers. In this model, the acquired company is generally young. It has few ingrained beliefs about "the way we do business around here," and so it is more adaptable to the culture of the acquiring company. And because it has not focused on building strong sales and distribution capabilities, its employees welcome what the acquiring company brings to the party.

Is it wrong for Cisco to spend hundreds of millions of dollars on such a strategy? Is it wrong for entrepreneurs to create single-product companies that they can flip to Cisco? Not at all. In my view, that's a very creative and compelling strategy. In any case, it's hard to argue with Cisco's performance over the past few years.

Of course, it's one thing to reap profits by pursuing a smart strategy -- and another to fuel a culture of wealth entitlement. And clearly, we are witnessing episodes of excess on a grand scale. Many VCs now press companies to go public after just two or three years, rather than waiting five to seven years (as they might have done in the past). In some cases, that's appropriate. But I know several CEOs of young Internet companies whose backers have asked them to hit the IPO market well before they're ready. These CEOs are in a tough spot. "I can't predict revenues, let alone profits!" they say. But neither can they just ignore what their backers say.

Why are VCs doing this? First and foremost, the capital markets allow it. The investing public is more than willing to fund companies that are really just thinly disguised projects, and with that willingness comes high risk -- as well as the potential for high gains. For better and for worse, greed will always be with us.