From the February 2000 issue of Entrepreneur

Andrea Reisman had a problem--a huge, "Is this the end of my business?" crisis. Just a few weeks earlier, the 30-year-old co-founder and CEO of San Francisco-based Petopia.com, an online pet supply store, had been on top of the world: She had closed a May 1999 venture financing round that pumped $9 million into her start-up. But then came June 14, and her world tilted upside down when arch-competitor Pets.com announced it had closed a $50 million venture round that included cash from Amazon.com. Pets.com was simultaneously forming a strategic alliance with the e-commerce godfather. That meant visitors to Amazon.com would be peppered with continual reminders to buy kitty litter and 100-pound bags of puppy chow at Pets.com.

More aggravation came when Petsmart--a billion-dollar brick-and-mortar pet chain--announced it would merge its online outlet with independent online store pet.net, thereby transforming Petsmart.com into a formidable and slick e-commerce player.

Was it lights out for Reisman and her Petopia? It more than likely could have been, because in today's bullet-paced e-commerce battlefield, there's no nostalgia for yesterday's leaders. But Reisman pulled a fabulous rabbit out of cyberspace and, in July, closed a $66 million funding round including buckets of cash from pet store powerhouse Petco, which agreed to give Petopia exclusivity--Petopia would be Petco's only online retailing outpost.

"It's been a wild year," Reisman gushes. "The Petco deal enabled us to leapfrog over many competitors. It's really given us a head start."

Bigger and Better

Reisman's not alone. Now the big news in the dot.com arena is that branding is crucial--it takes a name and a sizable amount of consumer mindshare to win eyeballs, and getting there is an expensive proposition. The days when a little start-up could pretty much go it alone the way Yahoo! and Amazon.com did are waning, and a new philosophy is taking hold: "If you're a small dot.com, you have to build alliances with bigger companies. You have no choice," says Philip Anderson, an associate professor at the Tuck School of Business at Dartmouth College in Hanover, New Hampshire. "You need to build share fast, and that means you have to leverage more resources than you can get your mitts on by yourself."

Jim Datovech, 45, president of ComVersant, an e-commerce consulting firm in Gaithersburg, Maryland, adds, "Speed to market is critical today, and that's why alliances make so much sense. An alliance brings more strengths together."

Back at Petopia, Reisman heartily concurs because, besides providing money, the partnership with Petco transformed Petopia into an online bruiser overnight. "This partnership gives us so many advantages," says Reisman, who ticks off a few:

  • "We get better pricing on products because we're pooling our procurement with theirs.
  • "Every Petco store will feature marketing materials for the Web site, and we'll have access to its database of five million customers.
  • "We're using [Petco's] distribution centers, so we can get products to customers more efficiently.
  • "We're doing our media-buying in conjunction with Petco, so we'll get better deals on advertising."

The ironic punchline to Reisman's good fortune in snaring Petco as a partner is that she didn't even seek out Petco; it came to her. "They'd retained [investment banker] Morgan Stanley to help them select an online partner, and Morgan came to us."

She didn't spurn the overture. And, very quickly, the conversations got down to the nitty-gritty of how much money Petco would put into the business and what it expected in return. The deal took three months to finalize, but when all the papers were signed, Reisman says she got just what she wanted: "We remain an independent company," she says. "Petco's share is less than 20 percent of the equity, so we can sell different products at different prices. They are a partner, not the owner. We retain complete freedom to run this business. Petco is good at bricks and mortar; we're good at the dot.com space, and its management knows that."

Everyone's Doing It

Reisman is just one of countless entrepreneurs rushing to embrace large partners in the dot.com world. Another case in point: Last August, Toysmart.com, based in Waltham, Massachusetts, closed a deal where Walt Disney Co.'s Buena Vista Internet Group took a controlling interest in the dot.com start-up. Exactly what Disney paid for its slice of the virtual toy store is undisclosed, but, says Toysmart.com's 34-year-old president and CEO David Lord, as important as Disney's money is, it wasn't the deciding factor. "We had a great venture capital syndicate put together that was ready to fund us," says Lord. "Money wasn't a problem for us. We decided this based on other factors."

Like what? "The Disney brand is powerful, and, with Disney, we're getting premium [advertising] space on its Web sites that we couldn't get if we weren't part of the family. We fit into Disney's strategic vision, and that will help us really grow this business."

Lord also offers insight into the deal Toysmart negotiated, and it includes two crucial elements:

  • "We insisted that the deal had to be approved at the highest levels of Disney," says Lord. Why? Lower-level execs come and go; their clout rises and falls. If a little business is dependent on an executive who falls out of favor, it too can see its luster diminish in the eyes of the larger partner.
  • "Our contract says we only sell good toys. We do not sell all Disney toys, and there is no pressure on us to do so," says Lord. "We are passionate about what we're delivering to our customers, and that attracted Disney. It understands and supports our passion."

Does Lord have regrets about selling a huge chunk of his business? "You always have hesitations about going into a deal like this," he says. "Earlier, we had talked with Toys "R" Us and went down the path [toward a part-nering] fairly far with them. But we decided we couldn't live with the deal, so we walked away. With Disney, there weren't any deal-breakers. There were only signs telling us to go forward because it will really help us grow."

Another take on the benefits of partnering with a big company is offered by Michael Franz, 46, chairman and CEO of HotOffice Technologies, a Boca Raton, Florida, developer of virtual intranets for small businesses. Last August, Franz closed a venture round that included $6 million from Staples, plus an agreement by Staples to market HotOffice to its customers. "By ourselves, we're one thing. With a partner like Staples, we're a very different thing. Customers trust us much more because of our partnerships. It makes us seem more reliable."

It Works Both Ways

As good as some of the news may be about the partnerships proliferating throughout the dot.com world, like most things, there's a dark side, too. "Partnerships can be an incredible opportunity, but for the relationship to work, you've got to work at it," says ComVersant's Datovech, who cautions that often big companies put up their money but are unprepared to offer the smaller company anything more. "They're looking to learn from you but often aren't prepared to put much else into the relationship," he says.

And that's just the beginning of the negatives. "If you're not careful, the big company will `gut' you," says Ed Roche, a vice president with The Concours Group, a research-based management consulting firm in Kingwood, Texas. "They learn how to make your products then dump you. There is often very little a small company can do to fight back." Your best defense? Always remember to step very lightly when choosing a partner.

Dartmouth's Anderson points out another trouble spot: "Almost by definition, you're taking the larger brand where it hasn't been before. That's a recipe for conflict."

Chew on that because it's at the paradoxical core of most small-big alliances. The big company wants the little partner for its creativity, its innovation and its ability to plunge into terrain previously unexplored by the big fellow. But once the deal is signed and sealed, the risk aversion that is at the core of virtually all mega-corporations kicks in--and, suddenly, the partner is counseling caution and slow forward motion.

Some problems are even created by the small business itself. "It's easy for small-business management to take its eyes off the ball," says Larry J. Lenhart, a principal of Northern California High Technology Practice at Deloitte & Touche in San Jose, California. Bluntly put: Once an infusion of cash from a large partner eases the pressure to perform, some small business owners just get lazy or--just as bad--suddenly adopt the methodical "big company" thinking of their partner and lose the hard-charging drive to succeed that every entrepreneur needs to prosper.

A chilling potential by-product: "Often the little company's best employees will quit," says Roche. Why? They were initially attracted to the fast pace of a small business, but as more bureaucracy takes root in the aftermath of a partnership, they might just bolt.

One last thought to keep you gnawing: "The big company may acquire effective control of the little company but not formally," says Roche, meaning a straightforward acquisition hasn't been done. Instead, by taking command of key functions--accounting, say, or by assuming multiple board seats--the big company simply grabs control. "Small companies usually don't have the expertise to negotiate a fair deal. You absolutely need a third-party to assist you."

That recommendation is seconded by Ken Burke, 33, founder and CEO of Petaluma, California-based Multimedia Live, an e-commerce tool developer that brought in publisher R. R. Donnelley & Sons Co. as a sizable partner last September. It took eight months to negotiate that deal, which left Burke still in full control of the company's ownership. But the key for him, says Burke, "[was] hiring really good lawyers. They found many things in the deal we had to get revised or deleted. You don't want to negotiate that sort of thing alone."

The Happy Couple

In her bustling San Francisco offices, Reis-man must surely understand the downside of being in a partnership with a mammoth company, but for right now, hers remains the happy glow of a honeymooner. "This partnership has gone amazingly well for us," she says. "A key is that Petco knows we're building our own brand and own identity. They support us in this, and there's no way we could have come this far so fast without that level of support."

Doesn't she have any worries? Well, she admits, there are two concerns that have continued to win her attention. "A challenge for us is winning the support of management at the store level," she says. Top level management may have signed on to this deal with full enthusiasm, but that doesn't necessarily mean that store managers--who see both their income and advancement within the company as being directly linked to how much sales volume their shops generate--will instantly jump on board.

If they don't? The promised in-store promotion just may not amount to much if banners are left in stock rooms at the back of stores and Petco customers aren't given the word about the Web site. "We recognize this as a potential problem, and we're trying to work on it," says Reisman. "Besides, most managers are Petco shareholders as well, and the value of their shares will go up with our success--and all the local managers know they're going to lose some business to the Internet, so they might as well lose it to their own company."

Speaking of share prices, that brings up Reisman's second problem: the timing of an IPO. She remains tight-lipped as to when it might occur, but certainly a buy-out by Petco is not her ultimate goal. Seem surprising? Not in today's dot.com world, where, increasingly, comparatively new Internet businesses accrue massive market valuations in just a few blinks of an eye. Pretty much all dot.coms see themselves plunging into the public markets, and, with that target in mind, Reisman can only smile: "In fact, we're looking for more partners with strengths in areas where our present partners aren't strong," she says. "In today's market, there's incredible pressure to produce short-term results, and partners are the key. There's no doubt about it: The fastest way to grow in the Internet economy is through partnerships."

Irreconcilable Differences

Don't pop the cork to celebrate a business alliance too soon: Fifty-five percent of alliances fall apart within 31¦2 years, says Los Angeles business consultant Larraine Segil, author of Intelligent Business Alliances (Times Books). Just why do these marriages unravel? Segil surveyed executives with alliance experience to get the answer:

  • 75 percent cited incompatible corporate cultures
  • 63 percent pointed to incompatible management personalities
  • 58 percent said differences in priorities contributed to their falling outs

That's why Segil tells small companies in alliances with big partners to ask themselves this: If the marriage ends in divorce, do we have the resources to recover? If you don't, get moving on developing a separation stra-tegy. It may never be deployed, but with more than half of all corporate marriages ending in quickie divorces, prudence dictates having a scenario on hand for survival without the larger partner. "Partnerships can prove life-threatening to small businesses that aren't prepared for the day when the wheels come off the alliance," says Jim Datovech, president of ComVersant.

More hard-eyed advice comes from Steve Patti, president of The Media Farm Inc., a content services agency in Dallas that has prospered from close alliances with Compaq, Hewlett-Packard and other mammoth tech businesses--but that's also seen its share of deals go south. His advice:

  • "Properly manage the big company's expectations. Don't let it tell you, `It's our way or the highway.' Don't appear too eager to do the deal.
  • "Protect your ideas--don't give away everything. Keep a few secrets. The more keenly the big company is aware that it needs your skills and know-how, the harder it will work to make the relationship a two-way street that's genuinely a win-win."

Pre-Alliance Counseling

Want to dig deeper into the benefits--and perils--of forming an alliance with a bigger business? If you're contemplating an alliance, you'd better do this due diligence because, quite plainly, there are more ways for deals to go sour than there are probabilities they'll prosper. These Web sites offer well-formed, incisive analysis:

  • "Dispelling the Myths of Alliances" (http://www.ac.com/overview/Outlook/special99/over_specialed.html) is a thoughtful article written by a couple of Andersen Consulting partners, who say that 30 percent of alliances are outright failures (compared to 39 percent that are deemed unequivocal successes). They offer tips for getting your alliances in with the 39 percent.
  • SmartAlliances.com (http://www.smartalliances.com), put up by consulting giant Booz-Allen & Hamilton, offers the firm's advice to clients considering alliances. Don't miss the "Chart of the Week", which offers at-a-glance visuals on how to do an alliance right (and how most have been done wrong).
  • "Mergers and Corporate Consolidation in the New Economy" (http://www.ftc.gov/os/1998/9806/merger98.tes.htm), a statement from the Federal Trade Commission (FTC) supported by rich statistical analysis, gives you the goods on alliances and the economy. The FTC, by the way, points to several factors as fueling the current trends: the need to be globally competitive, technological advances (deals often allow a company to acquire the technology it craves) and the ongoing wave of downsizing.

Made For Each Other?

Ready to dive into business with a heavyweight? Before you jump, make sure you know the answers to the following questions, from Partnering Intelligence: Creating Value for Your Business by Building Strong Alliances (Davies-Black Publishing) by Stephen M. Dent. The answers should be in line with your business goals and visions.

1. What is your potential partner's vision?

2. Where does it want to go as a business?

3. What are its values and ethics?

4. What kind of corporate culture does it have?

5. What types of relationships and partnerships does it already have and how well have they been working out?

6. What are its strategies to achieve its vision?

7. Has it conducted an internal assessment?

Contact Source

Robert McGarvey is Entrepreneur's "Staff Smarts" and "Web Smarts" columnist.