When the Berlin Wall came down in October 1989, the world sighed its relief from the combat-ready tension that history calls the "Cold War." US companies that depended on Department of Defense procurement contracts for their livelihood, however, felt relief mingled with a new concern. How would they survive with demand for the tools of defense on the decline? ESL Inc, a TRW company, came up with an answer.

ESL's post-Cold War economic survival was not a pressing question when Arthur L Money became company president in January 1990. The company was financially healthy and still had plenty of defense work to keep it going. But the question was a haunting one, invoking the specter of slow financial starvation as ESL's customers inevitably reduced their defense spending.

To dispel that specter, Money envisioned his company as still healthy and viable in 2020, augmenting defense revenue with a new line of commercial businesses. Focusing on this 2020 vision, Money and ESL developed a system for generating businesses within ESL--businesses that would convert the company's defense expertise into civilian products.

Picture One

ESL's movement into commercial ventures began in 1992 with an attitude adjustment. The company started sending its employees to lectures by futurists and management gurus. The idea: to stimulate thinking outside the typical defense-industry paradigm. More than 120 of ESL's employees attended those lectures during the year.

Next, the company grouped people into idea factories. Their task was to brainstorm ideas for markets and products toward which ESL could turn its talents. Jeffry W Phillips, managing director of TRW Wireless Communications (one of the first spin-offs from the new-venture system), recalls that the idea factories took a while to catch on. Once they did, however, they really caught on. "People came in with all sorts of ideas," Phillips remembers, "and some of them were off the wall. But some of them were pretty good."

By the year's end, the company had given serious consideration to 18 of those ideas, and six became the nuclei for new businesses. In addition, the company developed a formal system for evaluating new-venture ideas (see box, "Hatching a new venture") and staffed a new-venture incubator facility for helping employees refine and strengthen their initial concepts. Further, it set a firm goal: 25% of the company's revenue must come from nondefense business by 2000.

Hatching a new venture

To find profitable civilian outlets for its skills and capabilities, defense-contractor ESL Inc developed a process for evaluating and nurturing new-venture ideas. The process includes periodic evaluation by a director-level review board and nurturing of promising ideas in a new-venture incubator. The incubator is both a place and a staff to help idea proponents refine venture proposals and validate their market potential. The process has proven successful at ESL and has inspired other defense companies to follow suit. An industry group dedicated to helping its members survive defense budget cuts, the Silicon Valley Defense/Space Consortium, has recommended the ESL process as a model for its own members' conversion efforts. Fig A shows the overall flow of the ESL new-venture incubation process. The process begins with an idea, which anyone at the company is free to propose. Along with an idea, however, the proponent must provide a list of potential customers and initial answers to other questions that explore the idea's fit with the company. As with other entrepreneurs, the work to develop the idea comes out of the proponent's personal initiative. The incubator's resources are available, however, to help the proponent prepare the idea for review. The review board meets every week to examine new-venture proposals. They ask six critical questions: What is the idea's fit with the company's core competencies and strategic goals? What is the market for the product or service; that is, how large is the market, who are the customers, and what is their motivation to buy? How does the product price compare with its cost to create, its value to the customer, and competitive products? What is the product's production cost, and what margins will the product generate? What investment, in personnel and finances, is needed to bring the product to market? What is the venture's five-year forecast for finances and return on investment? If it approves the proposal, the board authorizes funding for the proponent to validate Question 2's answer: the proposed market. Working with the new-venture incubator's team, the proponent can now spend company time refining the venture proposal--but only some company time. These in-house entrepreneurs still need to make a personal investment. "They are working more than 40 hours a week," notes Catherine A Kitcho, director of ESL's new-ventures program, "but compared to creating their own start-up, the risks are a lot lower." The market-validation phase takes about a month. If the proponent demonstrates to the review board that there is a sizable and valid market for the proposed product, the board funds a venture team to create a business plan. At this point, the project begins to more closely resemble a start-up company. The venture team must prepare the same type of business plan that venture capitalists in Silicon Valley demand before providing funding. The team may even build a demonstration system or perform proof-of-concept experiments. Finally, the venture team presents its plan and market analysis to the review board and the company president. Acting as its own source of venture capital, the company approves the proposal and begins funding for a venture launch. The venture team begins acquiring personnel, supplies, and facilities. A new business unit of TRW/ESL has hatched and is ready to grow.

Establishing its new-venture process was not an easy task at ESL. One of the first problems the company had to overcome was its narrow defense-oriented mindset, which focused on technology because the customer's needs were already well defined. "In a defense company, you have a tendency to think internally," says ESL's New Ventures Director Catherine A Kitcho. "It's very tempting to live inside your own intellectual world." To broaden its horizons to encompass the commercial world, the company had to shift its thinking away from technology. "What we found works," says Kitcho, "is to get people to think of market needs first, rather than starting with the technology and trying to fit it in."

Recognizing its need to acquire market savvy, ESL hired business consultants and marketing experts. It also found its people lacked basic business skills. Highly technical people needed to learn the fundamentals of marketing, finance, and business operations. So ESL retrained its staff.

Once the employees began generating new-venture ideas they wanted to pursue, the company ran into another problem: conflict of priorities. Project managers were sometimes resistant to new-venture proposals. The venture might be a good idea, but the managers didn't want their projects to lose key personnel to the venture. "This is where support and commitment at the top make a difference," says Kitcho. And, at the beginning, some conflicts did go all the way to the top for resolution. Now, Kitcho notes, managers understand the new ventures' importance to the company and work out compromises.

Corporate management alone can't resolve some of the problems ESL still faces. One of the most critical is the US government's procurement process. That process requires the vendor to obtain and fully document three bids on all parts and subcontract services in building a product for sale to the government. The result is a tremendous purchasing overhead that is inconsistent with the needs of a commercial venture. Government re- quirements on accounting procedures, security, and intellectual-property rights are also at odds with commercial practice. ESL and other defense companies are lobbying Congress to amend those requirements. In the meantime, they find themselves needing to duplicate departments such as purchasing and accounting to operate a commercial venture.

Along with problems, however, come answers, and ESL has learned valuable lessons along the path to defense conversion. Based on those lessons, ESL has a variety of suggestions for any defense company seeking to expand into commercial businesses. One of the first suggestions is to start while the company is still financially healthy. As Kitcho notes, "It's difficult to invest in new ideas while the company is downsizing."

Another suggestion is to be certain that the expansion effort has the full support and commitment of top management. Further, management needs to communicate that commitment. Otherwise, current projects can suppress the development of new ideas and products by hoarding personnel and resources, and the company's future gets sacrificed to satisfy current needs.

To recognize where new opportunities lie, companies need to identify their core areas of expertise. That identification includes examining the company's overall knowledge and skill base, not just the technologies it has developed. In ESL's case, that identification revealed expertise in digital signal acquisition and analysis as well as the handling and interpretation of large databases.

Along with recognizing core skills, companies need to identify where holes in their skill set lie. In ESL's case, those holes included a lack of marketing skills and ignorance of commercial business practices. Once they find the holes, companies need to hire the best available talent to fill them.

ESL also suggests avoiding head-on competition with commercial companies when cost is a major customer concern. Defense companies typically don't have the necessary experience in high-volume, low-cost manufacturing. Instead of head-on competition, ESL recommends that defense companies identify opportunities where their core capabilities give them a competitive advantage, allowing them to provide customers with products they need but can't obtain elsewhere.

For example, ESL's core expertise in signal acquisition and handling large databases, derived by developing electronic-reconnaissance and tactical-information systems, enabled it to create several such products. One is the VP8000 wideband signal-and-test system, developed to meet the needs of communications-equipment and medical-instrumentation developers who want to capture and synthesize wideband signals for testing their designs.

The VP8000 combines a 500M-sample/sec data-acquisition and signal-generation system with signal analysis and database-management software running on a host computer (Unix-based or Macintosh Quadra). That combination allows the VP8000 to act as a digital storage oscilloscope, a real-time spectrum analyzer, or a waveform synthesizer, all under software control. The unit holds 64 Mbytes of 8- or 12-bit sample data for analysis and display or for waveform synthesis. The host system holds additional data.

Designed for both defense and civilian use, the VP8000 employs a modular architecture to allow users a variety of configuration and cost options. The options include interface cards for general-purpose analog and digital signal acquisition and generation that are suitable for direct connection to CDMA/ TDMA communications networks. The price ranges from $50,000 to $90,000.

Another application of ESL's core expertise led to the PhonePrint network-access controller, developed to help control cellular telephone fraud. Fraud occurs because cellular telephones broadcast an identity code to the network to get a dial tone. Telephone pirates capture those codes off the air from legitimate calls, then program clone phones to use the stolen identity codes. The legitimate user winds up getting the bill.

The PhonePrint system uses high-speed RF-signal capture and analysis to create an electronic signature for each cellular telephone attempting to access the network. Because each legal cellular telephone uses a unique identity code, the code and the phone's electronic signature correlate. The system maintains a database of identity codes and the corresponding signatures. By comparing an incoming call's signature with one on file for the identity code the call used, the system determines if the call is legitimate or fraudulent.

When PhonePrint discovers a signature that doesn't match its file, it signals the telephone system to deny that caller access to the network. The process takes the PhonePrint system less time than the telephone system needs to establish a channel for the incoming call. Legitimate callers, therefore, gain access to the cellular network without additional delay. The fraudulent caller never gets a dial tone.

Both the VP8000 and PhonePrint illustrate use of ESL's core capabilities, derived from military experience and applied to civilian problems. Neither are old military products looking for a new home. It is that focus on applying capabilities, not reapplying product technology, that ESL believes will keep defense-conversion efforts successful.

According to Phillips, partnering is a key aspect of finding opportunities to apply a company's core expertise. Partnering allows a major customer to help refine a product proposal. "You need to link up with partners that have domain expertise," he says. That expertise provides the defense company with invaluable insight into the problems facing the customer's industry and helps ensure design of a viable product.

Finally, ESL recommends that de- fense companies start small with new commercial ventures and build them up as revenues increase. Starting small keeps initial expenses down and promotes among venture team members an entrepreneurial spirit and a tight-budget mindset. Most of ESL's new ventures, notes Kitcho, began with fewer than 20 people. The idea, adds Phillips, is to treat the new venture as a start-up company, not just another project within a large corporation. The start-up mimicry at ESL includes equipment and furnishings. "Even the building selection was made to mimic a start-up environment," jokes Phillips, gesturing at the cramped quarters and Spartan furnishings of ESL's new TRW Wireless Communications venture.

Following its own recommendations, ESL has come a long way toward realizing Money's vision of 2020. The company's nondefense businesses are generating in- come, promising to be 10% of the company's annual revenue this year. Meanwhile, the company's new-venture incubator continues to hatch business plans that should help the company attain its 25% nondefense revenue goal well before the target of 2000. ESL's new-venture incubation is its answer to the question of post-Cold War survival.