Growing Your Business: Spin-off or Start-up?

Spin-offs and start-ups can be growth opportunities for companies with strong core businesses because they create new revenue streams. Question is, when should you consider developing a spin-off, and when should you consider a start-up?

In strictly financial terms, a spin-off is a formal split of a company into two or more separate entities, while a start-up is a new brand entity created by an existing company. (A complete start-up, on the other hand, is a new entity created by an entrepreneur or investment group.)

It makes sense to develop a spin-off or start-up when the company’s future growth appears to have reached a plateau or has significantly slowed. Often, this occurs when a company’s product concept has matured.

Additionally, executives will need to have both the financial strength and the ability to leverage the assets of the platform company. Leveraging assets can provide economies of scale for the spin-off or start-up that, in combination with the knowledge base of the platform company, can help the spin-off or start-up succeed. While spin-offs largely leverage customer lists and brand positioning opportunities, both start-ups and spin-offs have the opportunity to leverage all key assets at management’s disposal.

Take advantage of what you’ve got
Executives should consider a spin-off when an opportunity exists for a company to extend its brand and product line to the same core customer. The ability of a spin-off to use the existing platform company’s customer files when developing circulation and contact plans, for example, gives the spin-off an advantage as it enters a new marketplace. Gap did this very successfully by developing Gap Kids.

Similarly, Talbots successfully introduced Talbots Petites, and Pottery Barn introduced Pottery Barn Kids. In each case, the core customer and positioning was maintained and the product extension worked by extending the brand into new markets.

Many factory outlet stores are examples of marketing to price-conscious core customers developed by established brands. In these instances many existing core company assets are used to build related brands with an often inferior, lower-priced product.

While the successful spin-off is likely to share the same core brand attributes as the platform company, the spin-off should seek to leverage all other key assets. In fact, the greater the number of assets the spin-off shares with the platform company, the greater the probability for success.

When the new concept and platform company have allied supply chains, the new concept can benefit from shared vendors. Similarly, being able to leverage the management expertise of the platform business can be beneficial to the success of the new concept, particularly when the expertise necessary to make a spin-off successful is “close-in” to management’s existing expertise.

In a retail-oriented company, for example, management can leverage store placement knowledge to determine locations for the spin-off’s new stores.

Finally, because the spin-off is a line or brand extension similar in concept to the platform company, the company can test the new concept within the platform’s stores to measure its potential and nourish the spin-off until it reaches a critical mass.

Danger signs
A spin-off is not always the best strategic option for a company, however. It is not in a platform company’s best interests to develop a spin-off when the company has other priorities in its core business, and the spin-off has the potential to dilute the brand or distract management’s attention.

Also, when the new concept cannot leverage the brand’s image and heritage or a platform company’s customers, the company should think twice. For example, Talbots Men’s could not leverage Talbots’ brand image and core customers and proved to be unsuccessful as a result.

The key to a successful spin-off lies in the similarities between the platform company’s and the spin-off’s customers and brand positioning. Sharing the same core customer values is a key ingredient for developing a successful spin-off, but not the only one.

When a start-up makes sense
If management believes that the company can either leverage assets other than the customer list or differentiate the potential new concept or brand from the platform company concept, then it may make sense to consider a start-up.
Specifically, when the company’s new concept is significantly different from the original company, establishing a new brand is a viable way to attract new customers and generate additional growth.

For example, West Elm, a successful start-up developed by Williams-Sonoma, occupies a similar category and leverages a similar supply chain as Williams-Sonoma Home, but sells to a trendier, more urban consumer.

Alternatively, if a company can leverage its supply chain and channel dynamics while exploiting general and administrative efficiencies, such as shared warehouse expenses, variable cost efficiencies and combined personnel responsibilities, it makes sense to consider a start-up.

Be warned, however: The platform and start-up company should not share key merchant positions. The merchants’ priorities are often tied to the responsibilities of the original company, not allowing them the freedom to focus on the start-up’s new concepts.

A start-up is not right for every company and is usually riskier than a spin-off. If the products are not differentiated enough, there is the risk of cannibalization.

Old Navy, a start-up introduced by Gap, differentiated itself by introducing a similar product at a lower price. Today, during challenging economic times, Gap struggles to keep its core customer who is trading down to the more cost-friendly alternative. This result, while better than losing Gap’s core customer to a competitor, compromises the health of the platform company.

Also, it is usually more costly to establish a start-up company than a spin-off. Start-ups require the development of a new brand—with the associated expenses of attracting a new customer, establishing a new brand image and developing a delivery system. If the platform company is not healthy enough to handle this financial risk, it should not pursue this strategy.

The value in the proposition
The value of developing a successful start-up or spin-off out of a platform company can be two-fold.

First, overhead expenses can be allocated over a larger revenue base, with general and administrative expenses as a percent of sales reduced. The expanded company can share one president and one CFO, possibly one warehouse, and can achieve a multitude of other economies of scale.

Second, the platform company can increase its growth rate and profitability if the spin-off or start-up is successful. Investors pay a premium for growth and growth potential. A successful spin-off or start-up increases the valuation and multiple potential of the platform business.

Ultimately, growth is essential for increasing a company’s value. As illustrated, a spin-off or start-up can generate this growth. However, when determining whether a spin-off or start-up is right for a company, consider timing first. Make sure the platform company’s core business is strong and self-sustaining. No company should sacrifice its core business for “the shiny new toy.”

Next, leveraging assets is crucial. Can brands, management expertise, customer lists and operational capabilities be leveraged?

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And, most important, when companies consider a spin-off or start-up, they must carefully weigh the potential positive effects the spin-off or start-up could have on the size and value of the business against the risks of investing in the new opportunity.