Operating out of a building once owned by Apple Computer, a Japanese company has taken on the role of a mentor, funder, and friend to a flock of young Northern California startups. The company is Matsushita Electric Industrial Co., best known in the U.S. for its Panasonic brand. The startups, eleven of them at this writing, all have an Internet focus. They range from 2Roam, Inc., which helps deliver Web content to wireless devices, to MagicBeanStalk.com, which is building a business-to-business vertical exchange for other Internet startups. This process, in which an organization attempts to nurture startups as a gardener might seedlings, is called "incubation." In business parlance, Matsushita has taken on the roll of business incubator.

Matsushita's original idea was to build a Silicon Valley research and development laboratory. But Paul Liao, a U.S. researcher for the company, disliked the idea. "I basically refused." Liao told the Wall Street Journal. He felt that Matsushita wouldn't attract the best engineers, who, in the entrepreneurial spirit of the Valley, would soon leave to start their own companies.

Instead, Matsushita followed in the footsteps of Silicon Valley companies like Cisco and Sun by establishing a venture capital fund that invests in startups with the hopes of nurturing new technology---in effect, using the startups as a kind of external R&D lab. But venture funding is relatively hands-off. You make your investment, put somebody on the board of directors, and act as an informal mentor. By contrast, business incubation is a full-time job, and fewer companies take up the calling.

Matsushita's incubator is called the Panasonic Digital Concepts Center and is based in a 27,000 square foot building in Cupertino, which houses the support staff and six of the 11 incubated companies. (A second office opened recently in San Francisco.) The building has a digital entertainment center in the lobby, with the headquarters for the startups upstairs. There are common areas, room for support staff, and scattered couches, which are sometimes used by late-working engineers to take a quick snooze. On some days, the entrepreneurs gather for informal lunchtime lectures from attorneys, venture capitalists and other gurus. And on most days, you can find people brainstorming around the center's many whiteboards, many of which are placed in hallways, thereby inviting comment from passersby.

The structure of Matushita's incubation effort is a bit complicated. The Panasonic Digital Concepts Center is an umbrella organization with three divisions. One is Panasonic Venture Capital, which manages Matsushita's direct investments into its incubator companies and other venture backed companies. The second is the Panasonic Internet Incubator, which provides the incubator services, including the leasing, the brown bag lunches, and the assistance in finding the first institutional round of financing. A third group, Panasonic Global Networks, helps the companies navigate their way within Matsushita.

Leading the operation is Managing Director Charles Wu, who has been involved with 33 technology investments, ranging from online gaming to LCD flat displays, acting as a principal on 20 of them. He came to Matsushita via Vertex Management, a global venture capital operation. Before that, he was a project manager at RSA Data Security, the data encryption company.

Wu grew up in Ohio, immersed in computer technology. His parents immigrated from Taiwan in the late 1950s---among the first to come to the United States after this country lifted a ban on Chinese immigrants. Both worked as computer scientists at Bell Labs, "back in the days when a computer scientist was a programmer of telephone switches," Wu recalls. "That's one of the reasons I went to MIT---to figure out what my parents did for work." He majored in computer science as an MIT undergraduate, became an engineer at Raytheon E-Systems, specializing in the speech processing and artificial intelligence, and then went on to business school at Stanford.

Wu became an investment banker in handling some mergers and acquisitions for CS First Boston. "I'm an engineer at heart. I like to build things, and venture capital gave me the opportunity to build companies as opposed to just doing transactions." At CS First Boston, Wu noticed he had a competitive advantage when working with Asian companies, because there weren't that many other Asian technology investment bankers. He noticed, for example, when he was selling a monitor company to the Taiwanese that he already had connections to Asian money sources.

The incubator's Matsushita veteran is Associate Director Dr. Satoshi Kabasawa, who has been with the company for 18 years. Kabasawa has a background in speech, natural language and document processing, and comes by way of Matsushita's R&D division and the Panasonic Information and Networking Technology Laboratory in New Jersey. He holds a bachelor, masters, and doctoral degree in telecommunications engineering from Osaka University.

Kabasawa acts as the principal go-between, explaining Silicon Valley culture to Matsushita executives, and Matsushita to Silicon Valley entrepreneurs. One big difference is the way decisions are made. "Japanese companies traditionally take a long time," he says. But while decisions in the Silicon Valley are made more quickly, "they are very tentative, tending to change every half hour. Of course, any change of any kind usually has a good rationale, but Silicon Valley people always seems to be struggling to find out what's the best. That's a good attribute, but a different one."

Wu argues that slower decisions come with larger size. "Once you get to a certain size, it's hard to be nimble," he says, citing companies like Xerox and Nokia. "They all have problems with their internal culture." Nevertheless, Matsushita can still surprise him. Sometimes, the mother company is ready to jump before he is.

Wu says that one distinct advantage of a Japanese-run incubator is the tradition of keretsu-like cooperation. "In the U.S. environment there is a natural fear by startup companies that the engineers of the parent company will steal the concept." But in a Japanese company that's not going to happen, he says, because of the emphasis is on relationships and people, not just ideas and technologies. Wu says that the very notion of companies helping each other out is foreign to many parts of the world. "I find it sometimes difficult to explain this concept to the Matsushita division in Europe, and sometimes even within the U.S. outside the Silicon Valley. But the Japanese understand the concept and, in that sense, the idea of business incubation come naturally."

Jim Robbins, executive director of Panasonic Internet Incubator and a long-time veteran of the incubation business says the Matsushita venture is one of the few corporate-funded, Internet-focused incubators. He estimates that of the 750 or so U.S. incubators, more than half of them are government-funded. Of the remaining, only about 100 are Internet focused, and of those, only about 10 are sponsored by corporations. But other companies may well follow. According to Wu, "some Japanese companies are saying that if this global giant, this icon of Japanese companies, has established an incubator in the Silicon Valley, there must be some value in it."

Looking for a few good startups

For startups, admission to the incubator starts with an online application form. Matsushita looks for companies that have strong marketplaces as well as good potential to be helped out strategically. "We also look for companies who could be funded by the Silicon Valley venture capitalist community, as well as contribute to and learn from the community we're developing," says Wu.

Applicants go through several screenings. Those admitted pay rent, although the terms are quite flexible, and Matsushita takes a miniscule one percent ownership in the company, mostly to help defray the long-term costs. "One percent ownership is not a lot," Wu says. "But we've run these models before and it more than pays for itself. Matsushita also has the right to invest up to 10 percent of the first institutional round of funding, and has taken that option with every company so far. "We also ask for the right to invest in the first round of financing, but we are partnering with the Silicon Valley venture community and we let the community decide on what companies to fund. They are leading the deals---we play a support role by providing some capital and legitimizing them. But at the end of the day, we are not trying to compete with our brethren on Sand Hill Road [the Menlo Park, California, street where many venture capitalist firms are based]."

Not all startups prosper, of course. Wu defines success as a significant partnership in which Matsushita either licenses a startup's technology or acquires the company whole. Such relationships are proving an economical way to fulfill Matsushita's original R&D goal. "If I want to start an R&D operation in the Silicon Valley, I could go out and hire 100 engineers at a cost of between $20 million and $40 million each year," Wu says. "By contrast, the net cost of the Center, including the assistance we provide, is much less than that. That in effect gives the corporation as a whole $20 million to $40 million to either license or acquire different technologies.

Among the Center's successes is an introduction made between Replay TV and Matsushita Kotabuki, the world's second largest hard drive company, resulting in U.S. distribution rights for the Replay product under Panasonic's ShowStopper brand. Another success is Evoke, a Web conferencing company that will soon be rolled out to all Matsushita employees as an internal conference call system. Wu is also happy with the success of 2Roam and its wireless Web display technology. Rumor has it that eBay, the online auction company, picked up 2Roam's software because the company had a clear Japanese strategy.

Of course Matsushita has no guarantee it will be able to out-compete other bidders, but as the incubator, it has a headstart. Says Jim Robbins: "This arrangement increases the chance that the strategic partnership will actually work because they are in effect living with us---or more precisely, we're living with them, and investing in them, as well." While there are pros and cons to this approach, the advantage is cost savings, he says. The longer you wait to invest in a promising company, the higher the cost. "In addition, you also run the risk of not getting a chance to acquire because you don't find out about the company in time."

For the incubated startups, a big advantage is the prestige of being allied with a $70 billion company. "If you are sitting in a Panasonic incubator and walk into any other Fortune 500 company, there's a perception that you are more than just operating out of a garage," Wu says. "You have an association with someone that has scrutinized you and sees the potential. The connection helps legitimize the company." Wu says that with the Panasonic brand name on his card, he can walk into almost any company in the world and get an audience with their top people. "We try to help our portfolio companies get into those places, as well," he says.

The alliance can also get startups an audience with Panasonic executives. An estimated 200 to 300 high-level Matsushita visitors have trekked across the Pacific to visit the Digital Center. While an ordinary visitor to the Silicon Valley might not get past the lobby, "this is a place where people can go, look, and see how actual Silicon Valley startups are operating," Wu says. "They can take a look at the structure and see what makes it tick, and ask why they made the decisions they made." The cluster of companies is also an advantage. "In creating linkages, it's like being a marriage broker," he says. "You want to make multiple introductions because you never know what sticks and what doesn't."

For the startups, these visits can provide connections that might otherwise takes years to develop. Consider Vistify, Inc., which is developing software for home network appliances. (Vistify is actually co-incubated: by Panasonic and the Women's Technology Cluster, located in San Francisco.)

"Seven senior people flew in from Japan specifically to meet with us," recalls Marketing Director Wona Chung, noting that the two companies are both interested in appliances for the networked home. Chung echoes Wu's contention that business relationships go to the heart of business incubation. "They've invested in us because they see strategic partnership potential. The company believes strongly in R&D and we're like an additional research arm, smaller and perhaps more nimble, that can investigate areas that they might have overlooked. Their guidance has been great. We've gotten far more content than we could have developed on our own and we think it's been a good two-way street."

Incubating the incubators: An Interview with Dinah Adkins

Diane Adkins has been involved in the incubator business since its infancy. Today, she is the executive director of the National Business Incubation Association in Athens, Ohio---an incubator of incubators---which provides education, training and research for some 1200 business incubators. She also serves on the advisory board of Panasonic Digital Concepts Center, as well as the Nidus Center for Scientific Enterprise in St. Louis---a life sciences incubator started by Monsanto.

Let's start with the basics. What's your definition of an incubator?

A business incubator is a comprehensive business assistance program targeted to startup and fledgling companies to improve their chances of success. That assistance might include management team development, business planning, marketing, technical assistance, education, facilities, accounting, funding: all of the things a business needs to get started and be successful.

Why would a business sponsor an incubator, rather than just establish a venture capital fund or acquire the companies they like?

Because they may want to spend the time looking at the company and determining whether they want to work with them. It's not always apparent which technology is going to succeed or where the market is going to go. In addition, surrounding a startup company with all of these services improves the chances that your investment is going to be successful. In other words, money itself is never the solution. Very few people start companies with the sufficient experience, contacts and technology to make it on their own. A huge number of startups die out---and not always because they have bad ideas.

I've heard it's three out of four.

Nobody knows. The U.S. Small Business Administration says that 61 percent of companies starting out in any particular year are not in business six years later. But the dissolution rate could be affected by many things: the owner wasn't making enough money, or got a better offer, or got sick, or couldn't sell the business. It's not always bankruptcy.

So mentoring is the missing key here?

Yes. You don't learn to be an entrepreneur unless you have done it before. Nobody teaches it in school: universities are only starting to pay attention to this area. You can't work in a corporation and learn how to be an entrepreneur. In fact, the children of entrepreneurs have a much greater chance of starting a successful business because they've actually seen a role model. They've seen how to do it. That's the whole point of incubation: to increase a business's chances of success.

Has anyone tracked the success rate of companies that have gone under incubation?

We reported on it in a study published in December 1997. We did random samplings of incubators, their tenants and graduates, and found that 87 percent of the clients that had been served by the incubators were still in business. But you have to understand that, unlike the Small Business Administration, we don't include restaurants [which as a sector have a high failure rate]. And the phrase "still in business" doesn't indicate how long a company has in fact been operating.

How many different kinds of incubators are there?

There's two if you look at it in terms of for profit and not for profit. Not for profit incubators have a public goal---such as job creation. These might be funded by government or through a variety of partners. For example, Rensselaer Polytechnic Institute Incubator Center [in Troy, New York] is a university incubator, which has been around for 20 years. Students work in the incubated companies, graduates get jobs there; and students, graduates and staff participate in developing the companies. The for-profits currently fall into a couple of different models. One is a corporate incubator. Their bottom line is more like a partnership or an alliance that will lead to a product that will serve the core needs of the company or support the company's product. And so they are not looking necessarily at investing in a company---it's more for the synergy.

Almost an extension of the R&D?

Exactly. Startup companies are a lot more efficient per investment dollar per employee than big companies. There's a whole problem with big companies, with the "not invented here" syndrome, and with the fact that it's very difficult for big companies to support discontinuous innovation. If they support IBM mainframes, they will probably miss opportunities for PCs. So one way to keep up with the pace of change is to look outside the company, to try to have a window on all this technology, and find the deals that are going to be most useful to them. So that's one kind of for-profit. The other just aims for a good return on equity, and in that sense, is more like a venture capital organization.

Are incubators mostly a U.S. phenomenon?

Mostly, but it's spreading. Panasonic is a Japanese company. These companies get access to Panasonic businesses all over the world.

Has Panasonic or another Japanese company thought about doing an incubator at home?

I don't know. The Japanese culture has not been favorable to entrepreneurship, an issue they are well aware of and are trying to address.