Spin-offs Need Tough Love

A spin-off is merely a startup spawned by a mature parent (company), and conventional logic would dictate that it has a survival advantage over the lowly startup. Yet spin-offs seem to most often fail to launch in the real world. I was part of one myself a few years ago, and felt the pain, so the phenomenon has intrigued me ever since.

My first thought is that spin-offs are like struggling adolescents with over-protective parents. When companies spin off a division, they naturally want it to grow and succeed on its own merits, just as they have. But like protective parents everywhere, they tend to shelter it in ways that stunt its growth completely.

Before we look at my specifics, I should mention some of the reasons companies make the spin-off decision in the first place:

• De-consolidate—shed non-core functions to focus on core competencies. An example would be Time Warner spinning off AOL—to end a disastrous, dot.com-era marriage.
• Mingle and learn from the startup culture and new technology – without losing control. Foreign companies in the US like to use spin-offs to find expansion opportunities.
• Unlock shareholder value, which the spin-off can do as an independent entity. They may not be so constrained by monopoly fears and Sarbanes-Oxley controls.
• Grow faster, which a spin-off can do outside the parent company. Airlines, for example, have difficulty scaling up through mergers and acquisitions (M&As), but they can spin off their maintenance businesses and let the spin-off do the M&A in its own field.
• Grow in different dimensions from the parent company. Service operations such as call centers can grow far beyond their parent companies, especially if their services are relatively generic.

In retrospect, as in the case I was part of, I believe there were several areas in which the parent company consistently fails in their discipline:

• Rewarding without earning. The parent company guaranteed the spin-off a revenue stream and provided incentive bonuses based on artificial objectives, rather than competitive or market driven targets. The guaranteed revenue and incentives were only loosely tied—at best—to the spin-off’s performance.
  


• Fostering dictatorial leadership. Effective management skills in a startup are actually quite different from those in a large enterprise. The dictatorial leaders who survived and prospered in the enterprise parent, were ill-suited for the collaborative and highly adaptive spin-off and startup requirements. Yet they had “earned” the right to run an autonomous unit, and were not easily dislocated.
  


• Supporting them for too long. Parent companies provide services or infrastructure to the spin-off at below-market prices or for an excessively long period of time. In the reverse direction, this “support” carried the high overhead that is standard in the enterprise, but not financially sustainable in the spin-off.

In my view, fostering successful spin-offs, like raising adolescents, often requires tough love, embodied in the tough financial objectives and a firm timeline that startup investors impose on their charges. No free passes, and no bailouts.

But maybe I’m being too harsh in my assessment here. As I said in the beginning, I’m intrigued by the comparison of spin-offs to startups, but I feel like I’ve only scratched the surface on the analysis. If you know some good sources, or are willing to share your own insights, I’m all ears.

Marty Zwilling