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Graceful Exits and Missed Opportunities: Xerox's Management of its Technology Spin-off Organizations

  • Henry Chesbrough (a1)

The Xerox Corporation has devised several strategies for managing the numerous spin-off firms that independently commercialized many of its technologies. From 1979 to 1998, thirty-five technology-based organizations emerged from Xerox's research centers. Contradicting the common perception that Xerox “fumbled the future” by letting its technology walk out the door, in fact the company set in motion a series of deliberate initiatives to manage its spin-off organizations. After initially adopting a laissez-faire approach, the company soon turned to ad hoc methods, which evolved into a formal internal venture capital structure and culminated in a triage process, with the result that only companies perceived by Xerox as fitting into its overall corporate strategy were retained. By using spin-offs to withdraw gracefully from areas it considered to be marginal, Xerox for feited the potential to realize value from their research. Some, but not all, of the spin-offs obtained venture capital financing from outside sources and thus prospered independently. Their success demonstrated the opportunity that Xerox missed in managing its spin-offs.

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1 This is one theme in Chandler's seminal book, Scale and Scope (Chandler, Alfred D. Jr, Scale and Scope [Cambridge, Mass., 1990]). Chandler defines his research question in part as follows: “It then becomes critical to explain how and why the institution [of the modern industrial firm] grew by adding new units–;units that carried out different economic functions, operated in different geographical regions, and handled different lines of products” (p. 15). He then defines “economies of scope” as follows: “Economies of joint production or distribution are those resulting from the use of processes within a single operating unit to produce or distribute more than one product” (p. 17). Later in the volume, he includes the introduction of new products, based on internal research and technology, as one important aspect of this definition.

2 Qualitative indications of this pressure abound (see Buderi, Robert, Engines of Tomorrow [New York, 2000] for anecdotes from many leading industrial research laboratories). Quantitative evidence of this pressure has yet to emerge in the government statistics on R&D. The National Science Foundation Division of Science Resources, Survey of Industrial Research and Development (1998), Table E-1, reports that federal funding for R&D has fallen by over one-third in the past ten years in constant dollars. While company funding of research has offset this decline, most of that offset has come in applied research and development, not in basic research.

3 Rosenbloom, Richard and Spencer, William, Engines of Innovation: U.S. Industrial Research at the End of an Era (Boston, Mass., 1996).

4 The first work to attract significant attention to Xerox's activities in this area was a book, Fumbling the Future, by two McKinsey consultants, Douglas Smith and Robert Alexander (New York, 1988). It showed that many technologies that went on to become fundamental elements of the personal computer revolution originated in Xerox's labs at PARC. A recent book has reinvestigated these events (Hiltzik, Michael, Dealers of Lightning [New York, 1999]). However, there are limits and omissions in both accounts of Xerox's spinout company activity. First, the events recounted in both volumes terminate in 1983. Second, both accounts omit any consideration of spin-offs from other Xerox research facilities. Third, the venture capital industry was in its infancy back in the late 1970s. The enormous expansion of that industry has also expanded the hazards faced by technology companies, even as it increases the opportunities available to technically adept researchers.

5 Smith and Alexander, Fumbling the Future; and Hiltzik, Dealers of Lightning; also personal interviews with Mark Myers on l June 1998 at Xerox Corporate Headquarters in Stamford, Connecticut; with William Spencer on 26 Aug. 1998 at his office at the Haas School of Business in Berkeley, California; and with John Seely Brown on 10 Apr. 1998 at his office at Xerox PARC.

6 Kearns, David and Nadler, David, Prophets in the Dark: How Xerox Reinvented Itself and Beat Back the Japanese (New York, 1992), 86.

7 Pake, George, “From Research to Innovation at Xerox: A Manager's Principles and Some Examples,” in Research on Technological Innovation, Management and Policy, vol. 3, ed. Rosenbloom, Richard (Greenwich, Conn., 1986), 3.

8 Interview with Mark Myers, l June 1998, at Xerox Corporate Headquarters; with Robert Adams, 19 Apr. 1999, at his personal residence; with Richard Bruce at Xerox PARC, 9 Apr. 1998; and with John Seely Brown at Xerox PARC, 10 Apr. 1998. See also Weiser, Mark and Garmen, Andy, “Bleeding Edge Technology: From Lab Coats to Market Caps,” Red Herring, Aug. 1995, 52–8.

9 Interview with William Spencer at Haas Business School, 26 Aug. 1998; with Rafik Loutfy at Xerox PARC, 9 Apr. 1998; with Robert Adams on 19 Apr. 1998; with John Seely Brown on 10 Apr. 1998.

10 Interview with Ron Kaplan, Xerox PARC, 31 Mar. 1999.

11 Goldman, Jacob, “Innovation in Large Firms,” in Research on Technological Innovation, Management and Policy, vol. 2, ed. Rosenbloom, Richard (Greenwich, Conn., 1985), 3.

12 Selections of the research output of PARC during its first decade are contained in an edited volume by Lavendel, Giuliana, A Decade of Research: Xerox Palo Alto Research Center, 1970–1980 (New York, 1980).

13 Hiltzik, Dealers of Lightning; Smith and Alexander, Fumbling the Future. This perception was confirmed in personal interviews with John Seely Brown, William Spencer, and Robert Adams.

14 Interview with John Ellenby, at his GeoVector office on 14 Apr. 1999; interview with Robert Metcalfe at his Boston residence, 1 July 1999.

15 Jacobson, Gary and Hillkirk, John, Xerox, American Samurai: The Behind-the-Scenes Story of How a Corporate Giant Beat the Japanese at Their Own Game (New York, 1986), 70–1.

16 Xerox's first research center, called the Research and Engineering Center, opened in Webster, New York, in 1960. The PARC facility opened in Palo Alto, California, in 1970. The Xerox Research Center of Canada in Mississauga, Ontario, opened in 1974. The Xerox Research Center Europe opened in Cambridge, England, in 1986. And the Rank Xerox Research Center opened in Grenoble, France in 1993.

17 To understand the processes that led to the formation of these firms, I sought to interview participants within both Xerox and the spin-off firms. To manage the inherent problems with retrospective recall and self-serving representations of events, I tried to uncover contemporaneous evidence of the ventures from public sources. Armed with these aids to memory, I interviewed respondents. I attempted to cross-check accounts of events with multiple respondents and omitted information that could not be verified with a second respondent. However, some selective memory and bias nonetheless remain in this account.

18 Interview with Robert Metcalfe, l July 1999.

19 Pake, “From Research to Innovation at Xerox,” 13.

20 Interview with Robert Metcalfe, 1 July 1999.

21 VLSI stands for Very Large Scale Integration.

22 This statistic, which measures revenue market share, comes from Jacobson and Hillkirk, Xerox, American Samurai, 71. Kearns and Nadler, Prophets in the Dark (pp. 134–5), report a share decline from 80 percent to 13 percent in copier installations, a measure of unit market share.

23 Interview with Brian Stern, president of Xerox New Enterprise, via telephone, 21 May 1999.

24 Kearns and Nadler, Prophets in the Dark, 237–56.

25 Goldman, “Innovation in Large Firms,” 7.

26 As Kearns and Nadler recount in Prophets in the Dark: “How bad off were we? If nothing was done to correct things, we would be destined to have a fire sale and close down by 1990,” p. xiv.

27 Ibid., 259.

28 As it husbanded its resources to fight back in the copier market, Xerox also began to evince greater interest in strategic partners in the nascent computer industry. For example, Xerox had made a minority equity investment in Apple and was eager to broaden its relationship with Steve Jobs and Apple. Hence, corporate executives at Xerox pushed PARC managers to “open the kimono” with Jobs—a presentation that would motivate Jobs to commercialize much of the Star workstation's concepts in a personal computer. This led to Apple's introduction of the Lisa, and later, the Macintosh. As Josh Lerner describes (“Xerox Technology Ventures,” Harvard Business School case no. 295–127, p. 2), Xerox had made a $1 million investment in Apple that would ultimately prove to be worth $50 million. The impetus for the detailed demonstration of PARC technology to Jobs came from the Xerox executive who was in charge of this strategic investment (Hiltzik, Dealers of Lightning 331–3). A second example, noted above, was Metcalfe's license from Xerox to commercialize the Ethernet technology that became 3Com, where Xerox was trying to partner with Digital Equipment Corporation and Intel.

29 Hiltzik, Dealers of Lightning, 377.

30 In particular, both Komag and Synoptics were able to take much of their lab equipment with them. In each case, some money was paid back to Xerox later for the equipment, but the ability to have immediate use of the equipment was beneficial to both companies.

31 Despite Spencer's efforts, some research staff were alienated, particularly after Spencer forced the departure of Robert Taylor from PARC. Taylor, who had been at PARC as an assistant director since its early days, had been a strong and effective proponent of a research-driven approach within PARC. Spencer's agenda to bridge the divide between research and development conflicted in many ways with Taylor's. (See Hiltzik, Dealers of Lightning, 1999.)

32 Interview with William Spencer at his office at the Haas Business School, at U.C. Berkeley, 26 Aug. 1998.

33 Most of the techniques had been developed by Scifres, who holds a total of sixty-six patents, thirty of which are related to laser diode technology.

34 Personal written communication from William Spencer to the author, 15 Aug. 2000. Spencer's recollection of SDL's initial structure is broadly similar to that of Scifres, but they do differ on details. Scifres recalls that Xerox did have to invest an additional $1 million, and that Spectra Physics invested an additional $3 million into SDL. Scifres further remembers that Spectra Physics held more equity than Xerox as a result of this larger cash infusion.

35 Ludwick's quote is taken from Charles Holloway, “Synoptics,” Stanford University Graduate School of Business case no. S-E-57 (July 1998).

36 Interview with Andrew Ludwick at his residence, 22 Apr. 1999.

37 Weiser and Garman, “Bleeding Edge Technology,” 52–8. See also Pake, “From Research to Innovation,” 10–14.

38 It also acted as something of a consolation prize for Adams, who was passed over for a promotion within Xerox's management, according to William Spencer. Interview at his residence in San Francisco, 17 Aug. 2000.

39 Lerner provides the general terms of the XTV structure. See his “Xerox Technology Ventures,” Exhibit 5.

40 Kearns's quote is taken from Armstrong, Larry, “Nurturing an Employee's Brainchild,” Business Week, 23 Oct. 1993, 196.

41 Interview with Tony Domit at his office, 19 Apr. 1999.

42 “A Walk in the PARC,” Economist, 10 July 1993, 68.

43 I heard many charges and accusations made “off the record,” and generally, exclude such criticisms from this account. I include this one for two reasons: first, that it was made by three separate individuals at different stages of the research; and two, it foreshadowed the later decision to terminate the XTV structure, despite its financial success. This last decision is difficult to understand, absent these sentiments.

44 Interview with Howard Shao, 17 Aug. 1999, at his offices at Documentum.

45 Interview with Larry Mansinter, 29 Feb. 2000, at his offices at Documentum. Mansinter had worked on software projects at PARC since 1973 and had been involved in the Docmentum spin-off process from the technical side of Xerox.

46 This perception is not shared by respondents from Documentum. While such a dispute cannot be adjudicated ex post, there was an organizational attempt by Xerox to utilize its document management technology more directly. About one year after Documentum was spun off, Xerox created an internal business division called Xsoft. Xsoft's products would compete in the same space as Documentum in document management software. In the words of Xerox president Allaire, “[B]y consolidating document software development and marketing [into XSoft], we can respond more quickly to the ever-changing needs of our customers” (Business Wire, 22 Aug. 1991). In the event, Xsoft's financial results were quite minimal, compared with those of Documentum. By 1995, Xsoft sold off many of its businesses, and others were broken off into separate Xerox New Enterprise companies in the fourth stage.

47 Some of the facts surrounding the failure of Live Works were unavailable to me because of the terms of a settlement of a lawsuit between Xerox and three of the outside professional managers (which did not include Bruce) of the failed venture.

48 The assumptions behind these calculations are detailed in Josh Lerner, “Xerox Technology Ventures: January 1997 Teaching Note,” Harvard Business School case no. 5–298–152, 1998. They assume that XTV liquidated its position at the end of the first day of public trading for Documentum and Document Sciences.

49 Under two scenarios of returns to Xerox after partners' fees, one from Lerner (see above) of $219 million, and the second from Adams's claim of $300 million, the three XTV partners would have received between $55 and $75 million as their portion of the returns from for the six years they spent with the fund. In addition, they would have collectively received 2 percent of the fund each year for salary and administration.

50 Interview with Rank Loutfy, then vice president, Corporate Research and Development, at Xerox PARC, 9 Apr. 1998.

51 John Seely Brown, director of Xerox PARC and chief scientist of Xerox, in Christina Darwall and Henry Chesbrough, “Inxight: Incubating a Xerox Technology Spin-off,” Harvard Business School case no. 699–019, 1999, 3.

52 Mark Myers, Xerox Chief Technology Officer, quoted in Christina Darwall and Henry Chesbrough, “PlaceWare: Issues in Structuring a Xerox Technology Spin-off,” Harvard Business School case no. 699–001, 1999, 3.

53 Myers's quote is from Darwall and Chesbrough, “Inxight,” 2.

54 Thermo Electron Corporation is a publicly held company that develops and manufactures products based on applications of thermodynamics. The company uses a variety of innovative techniques to foster entrepreneurship and has spun off a number of its subsidiary companies to the public stock market, while retaining 80 percent ownership of each subsidiary. See Carliss Baldwin, “Thermo Electron Corp.,” Harvard Business School case no. 9–292–104, 1992 and “Thermo Electron Corp. (A): The Spinout Strategy,” Harvard Business School case no. 1–897–067, 1997. See also Allen, Jeffrey, “Capital Markets and Corporate Structure: The Equity Carve-outs of Thermo Electron,” Journal of Financial Economics 48 (1998): 99124.

55 Interview with Steve Riser, former CEO of Chrystal Software, at his office at Chrystal, 20 Apr. 1999.

56 See Darwall and Chesbrough, “PlaceWare: Issues in Structuring a Xerox Technology Spinout.” This case provides an excellent overview of the PlaceWare spin-off process and issues.

57 Interview with Robert Kravacic at Xerox PARC, 12 Aug. 1998.

58 The commitment to publicly list the spin-off requires that the spin-off have sufficient size and momentum to qualify for listing, and be able to survive as a public entity. By contrast, XNE is spinning off early stage technologies into companies that, with the single exception of XES, are years away from qualifying for an IPO. For more on Thermo Electron's approach, see Allen, “Capital Markets and Corporate Structure.”

59 Interview with Richard Bruce, 31 Mar. 1999, at Xerox PARC.

60 Interview with Mark Myers, 1 June 1998, at Xerox Corporate Headquarters in Stamford.

61 For an introduction to real options, and their application to research projects, see Trigeorgis, Lenos, Real Options: Managerial Flexibility and Strategy in Resource Allocation (Cambridge, Mass., 1996).

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