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The Incubator Economy

During the late 1960s, when the youth of America was protesting, a Berkeley student, named Mike Milken, was instead studying something called "junk bonds." Wall Street virtually ignored these instruments.

However, Milken made an interesting discovery. While the default risk was much higher than AAA bonds, the rate of return on junk bonds far outweighed the risks.

So, by the 1980s, Milken revolutionized Wall Street with his junk bonds, which eventually resulted in the buyout of RJR Nabisco.

Something similar happened several years ago. The new discovery was made by Bill Gross and David Wetherell, respectively. Both of them created high-tech incubators, Idealab! and CMGI (CMGI).

That is, an incubator invests in a variety of small companies. The incubator will then help them grow -- such as with strategic advice, drafting legal documents, the launch of the Web site, subsequent rounds of financing and so on -- and then take them public.

While venture capitalists routinely ignored investing in green start-ups, Gross and Wetherell saw that the potential returns were staggering -- dwarfing the risks. The result has been a string of IPOs, such as eToys, GoTo.com, GeoCities and Lycos.

Interestingly enough, while the IPO market has had problems lately, several companies have done quite well, one of which is an incubator: Internet Capital Group (ICGE). The company specializes in the hottest part of high-tech: business-to-business e-commerce (B2B).

Think of ICG as a vast knowledge bank. For example, the company has an Advisory Board, with such names as: Geoffrey Moore, the author of the seminal book on high-tech, Crossing the Chasm; Esther Dyson, the CEO of EDventure Holdings (which publishes Release 1.0); Sergio Zyman, the former Chief Marketing Officer at Coca-Cola (KO) and author of The End of Marketing As We Know it; K.B. Chandrasekhar, the Chairman of the Board of Exodus Communications (EXDS) , which he co-founded.

Unlike most Advisory Boards, ICG's is very active. In fact, ICG considers itself a partner. ICG provides comprehensive services, such as with day-to-day matters, like sales, marketing, finance, information technology and business development. There is also help with executive recruitment.

What's more, ICG strives to get its portfolio of companies to collaborate, creating synergies.

Checking in ICG's prospectus, I found a checklist of what it looks for in a B2B prospect:

1. Inefficiency: ICG looks for those industries that are traditionally inefficient and see whether e-commerce, community and other online vehicles can improve the situation.

2. Centralized Information Sources: ICG looks for industries that have an existing infrastructure of information resources, such as trade journals, catalogs and trade shows. Thus, ICG can support companies that digitize this information and make it interactive.

3. Management Quality: ICG wants a top-notch management with "overall quality and industry expertise."

4. Industry Leader: ICG only wants to invest in those companies that have the tools to become the leader in its category.

5. Profit Potential: ICG analyzes the particular industry, looking at the possible number of transactions and dollar value of each transaction. According to the prospectus, in a billion dollar industry, "incremental efficiency improvements present significant profit potential."


We will be hearing much more about business-to-business e-commerce over the next several years. According to Forrester Research, B2B e-commerce is expected to grow from $43 billion in 1998 to $1.3 trillion by 2003.

And the five principles stated above can be a great help in finding the winners.

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