The Scalability Dilemma

Start-ups and the Scalability Dilemma

In my earlier blog post, Innovativeness is a Matter of Perspective, I wrote about the need for greater granularity when we look at entrepreneurship, especially concerning entrepreneurs in the developing world and transition economies. In that post, I asked if the authors of the GEDI report looking for the right results with their criteria that they define as “innovative, market expanding, [and] export-oriented” and then expounded on their notion of innovation. In this post, I’d like to probe the second criteria for defining high-potential female entrepreneurs – market expanding.

When they say “market expanding,” I think the authors of the GEDI study are looking at scalability. Scalability is an important concept, because scalability is directly linked with sustainability. When I consider scalability, I think of two different companies with which I was intimately involved over a period of years: Payload Systems and Neurok Software.

How Payload Systems Created a Scalable, Sustainable Market Opportunity

Payload Systems was an MIT-spin-off company based in Kendall Square in Cambridge, Massachusetts that I had the privilege of working for in the late 1980s and early 1990s. Payload provided engineering and integration services for space flight, primarily for principal investigators who received NASA grants to perform microgravity experiments on the US Space Shuttle’s Middeck. In the immediate aftermath of the Challenger accident in 1986, the STS fleet was grounded, and Payload sought other microgravity platforms in order to survive. The only other option was the Soviet Mir space station. While companies like Planetary Resources have popularized the commercialization of space today, Payload Systems was the only firm really doing it in the late eighties.

By definition, the commercialization of space is market expanding: Payload was trying to create a market where one didn’t exist before. They identified the “best fit” market opportunity, which required long-duration microgravity as a research platform: protein crystallography. Protein crystallography was the rate-limiting step for rationale drug design in the (at the time) emerging biotech industry. Crystalizing a protein of interest and then performing x-ray studies enabled researchers to determine the three-dimensional (3-D) structure of the macromolecule. The 3-D structure was critical for understanding how it achieved its biological activity, which, in turn was critical to modifying or mimicking it through biotech’s rationally design method.

Through the marriage of biotech market opportunity and space-flight technical capacity with the grounding of the US Space Shuttle serving as an impetus, the Payload Systems Space Protein Crystallography (SPCG) Program was born. Payload Systems was the first foreign company to be granted an American export license and fly a commercial payload on the Soviet orbital platform.

I came on board at Payload to manage the program at the tail-end of the proof-of-concept phase. My focus was on engaging commercial customers on a contract research basis and managing the relationship with the Soviet providers of carrier services, Glavkosmos and NPO Energiya. My good friend and mentor, Vinit Nijhawan, who was Payload’s VP for Business Development, coined the term “micro-multinational,” to describe Payload Systems. It was a rare thing in the late 1980s for a small company to be so actively doing business internationally. Aside from the Soviet, Russian and Kazakh partners, Payload’s SPCG clients were based in Paris, Ottawa, and Tokyo and science advisors hailed from both the east and west coasts of the US.

The story of Payload, a global micro-multinational, is a great illustration of what I like to call the “scalability dilemma.” In the midst of the second SPCG mission, NASA funding started flowing again. Government and private-sector contracting can be notoriously unscalable, without an extraordinary intellectual-property driven core competitive advantage.

Cost-plus and other such procurement instruments are designed to avoid having the client overpaying the vendor. The commercial SPCG program (and other of Payload’s commercial initiatives) were scalable, but the USG contracting business wasn’t – they were the basis for linear growth. If SPCG added an engineer to do a job, the cost of that engineer could be billed against the contract, but her time couldn’t be double-billed to two clients, even if a single task were applicable to both of them. Similarly, there are rules against subsidizing commercial product and program development on the Government’s tab.

There are plenty of good companies doing consulting and contracting. However, if the enterprise is not managed to go beyond a linear growth business model, it won’t achieve a leveraging effect. It is always a sign of trouble when a VC-funded biotech company starts offering “collaborative research services.” That means the company is moving away from its aggressive product development push and is leveraging its other assets, such as skills and equipment, to generate cash flow.

A testament to its success, Payload was acquired by Aurora Flight Systems, another contractor, in 2007. However, in 1992, Payload’s overhead and its general and administrative expenses associated with the contracting business rendered the commercial SPCG program non-viable within Payload proper. I had to spin it out through licensing, in order to proceed with a mezzanine proof-of-concept with paying, commercial customers. The SPCG program had the potential for exponential-growth scalability.

How Neurok Software Achieved Scalability Through an Intellectual Property Concession

Later, in the mid-1990s when I was based in Moscow, I had the honor of working with a great innovator-entrepreneur named Oleg. At the time he was the head of a department at the All-Russian Scientific Research Institute for Technical Physics, commonly abbreviated, VNIITF, in the Chelyabinsk region of Siberia. The meteor that spectacularly lit up the early-Spring skies of the tundra earlier this year hit the Earth not too far from VNIITF.

I started out working with Oleg on a sponsored research agreement with a major multinational oil company (MNC), which needed a mathematical solver for a computationally intensive modeling problem related to seismic data. Oleg’s team had formerly been responsible for modeling complex data from underground nuclear testing. Having worked on applied research problems with predefined milestones and deadlines, Oleg and his team was well positioned to develop a solution to the MNC’s problem.

What made this contracting-type business potentially scalable, however, was an intellectual property (IP) concession that I negotiated. MNC would own the rights to the project results for the energy industry, but VNIITF would retain rights in other fields of use. This opened up the opportunity for generating revenues at an accelerated rate, as the start-up company Oleg founded, Neurok Software, did. Neurok Software started customizing its solver based upon the same core for another MNC in the consumer products business.

The company later moved from its original home in Troitsk in the environs of Moscow to the U.S. Neurok continues to develop core IP and customize the solution for clients including major MNCs, as well as U.S. National Laboratories and CERN.

Having achieved a solid track record for top-notch solutions for industry and government big data problems, Neurok Software is now poised to achieve the next level of scalability through productizing its offerings. It took over a decade to move up the value chain to this point in the growth curve when Neurok may have a business proposition that includes a risk-reward equation appropriate for VCs.

High-potential is a Matter of Time

With such a long incubation time, should companies like Neurok Software and Payload Systems and their founders be discounted from being considered “high potential” entrepreneurs? Both the Payload SPCG venture and Neurok Software were high potential ventures, but it took time for them to develop and mature the market because they were ahead of their times.

Both enterprises were scalable at different levels and at different times with different types of business activities. And yet, they are important examples of the missing middle in entrepreneurship. There are a lot of gray areas. Just because a company is on a linear growth trajectory doesn’t mean that the company won’t scale on a steeper curve when the time and market conditions are right.