Incubators: The Blueprint for New Economy Companies.

By now we've all heard the huge explosion heralding the entry of the incubator into the new economy. Building on the success of such ventures as Idealab!, founded in 1996 by Bill Gross, the business incubator has become the hot new way to get your idea to market fast, to give budding entrepreneurs the access they need to critical Internet time, while providing their less "creative" functions like office space, technology infrastructure and back office accounting.

Once the domain of not-for-profits like universities and local economic development agencies, incubators have suddenly surfaced as a great way for the for-profit sector to tap into the riches promised by the entrepreneurial fever of the new economy. Over the past few months alone, more than 40 new for-profit incubators have taken form in California, 16 of them in Southern California. All are promising the critical edge essential to new companies: speed to market.

And, from all accounts, it works. Companies that begin their lives in this nurturing environment have a startling 87% success rate, compared to a dismal 80% failure rate within the first five years for startups that take the traditional route. Inspired by the success of incubator "babies" like E-toys and GoTo.com, both products of Pasadena-based Idealab!, entrepreneurs are flocking to a growing number of incubators hosted by venture capital firms, bankers, consulting firms, and other Internet successes like Scott Blum founder of buy.com and now ThinkTank.com.

So what does this mean for the big, successful old economy firms who've built their business brawn on the traditional staples of bricks, mortar and capital but have so far singularly failed to share in the Internet explosion? Are the longtime giants - such as Time Warner - headed for a future that necessitates mega-mergers with Internet "clicks" - like AOL - to ensure that they get a piece of a new economy pie and a path to its huge market?

For some, the answer is a resounding no. And the somewhat surprising reason is the incubator.

Taking a step beyond the traditional, some big time companies have discovered that you don't have to lose your best and brightest entrepreneurial spirits to the temptation of stock options. Instead, you can give them the space - and the technology and the capital - they need, all under your own roof. In short, the incubator has become a blueprint for the new economy company, even inside the traditional corporate structure.

Witness the success of Channelware, a 1996 brainchild of two employees at telecommunications giant Nortel. Instead of packing their desks and heading to the nearest venture capitalist, these two entrepreneurs took the unheard-of path of bringing their idea to their boss. Four years later, Channelware is a successful spinoff with four offices (including Los Angeles, San Francisco and New York), 60 employees and customers like Barnes & Noble and Sprint Communications. Many other leading edge corporations such as IBM and Tektronix are testing similar programs.

How does it work?

First, you have to realize that to succeed in this new economy both existing and newly forming enterprises must structure - or restructure - themselves around seven organizational imperatives:

* An entrepreneurial environment that facilitates quick, informed and creative decision making

* Significant ownership opportunities to retain key people

* Access to the capital markets that will enable growth in stock value and allow for continued acquisitions and strategic alliances

* Strong credibility or backing that opens doors to investors and strategic partners

* Access to a high-quality infrastructure to support rapid growth

* Guidance and oversight from people with experience in successful new economy companies

* Access to scarce first-class information technology resources

With these critical elements in place, you are on track to create the new economy "Virtual Enterprise." Like Nortel, successful companies who take this path will provide all the support needed to enable their incubated ventures to grow, including the priceless ability to use the existing company's name -- and reputation -- to open doors for strategic partners.

In order to retain the entrepreneurial spirit of the start-up, they will treat small creative groups as separate, individual ventures. The company will provide the management guidance, infrastructure and financial support to "incubate" these ventures. And, when the venture reaches the IPO stage, a portion of its capital will be sold to the public, generating value to the nurturing parent company as well as significant upside to the creative team that built the venture.

The outcome is a clear win-win. Existing companies stem the hemorrhaging of top talent to Internet start-ups, while profiting from the high multiples investors are willing to pay for a share in Internet ventures. (For example, just think of 3Com's recent $874 million IPO of just 5.2% of its subsidiary Palm Pilot enterprise.) And entrepreneurial employees get the challenge -- and the profits - of creating their own "companies" with little of the risk they would face on their own.

Of course, these Virtual Enterprises rely on a number of strategic partnering and outsourcing relationships for their non-core operations, such as finance and accounting or fulfillment. Firms like Arthur Andersen are partnering with these ventures to provide the services which constitute our core operations: technology, accounting and finance, management, back office support, and even walking them through their IPOs.

Without the distractions of these time-consuming activities, key executives are free to focus on the critical core areas of the business that create and sustain the entity's competitive advantage, and reduce their all-important "time to market."

And in this new economy, isn't that what it's all about?

David Cutbill is a Partner at Arthur Andersen.