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New Breed Of IT

With IT startups struggling, the time may be right for corporate software spin-offs

The Royal Dutch/Shell Group runs a highly successful business exploring the world for natural resources. For more than a century, the $149 billion London producer of oil, gas, and chemicals has tapped the planet for the energy that makes business possible. Now Shell is discovering that its mining skills are useful in the virtual world of data as it looks inward for resources that will help fuel the company's future growth.

Shell found one such resource in Kalido Ltd., a unit Shell spun off in February as a wholly owned London subsidiary to market and sell data warehousing applications developed for internal use. With five years of development and more than $30 million invested in Kalido, Shell hopes the new company, with U.S. operations in Houston, will continue to develop E-business apps and become profitable before the end of next year.

The idea for the Kalido spin-off stems from Shell's desire to better leverage past investments in an internally developed software application. The software standardizes data across different countries in which a company operates. Its architecture lets distributed databases be linked so they function as a single data warehouse with compatible data categories and definitions. Shell's decision to spin off Kalido makes sense, considering Shell isn't in the business of selling software.

"It's really difficult to play at being a business if you operate within another company," says Kalido CEO Andy Hayler. "If you have some really interesting application and plan to sell it, being part of a larger, more diverse organization won't work because you need dedication and support for your product that might not be available within the greater corporate structure."

Leveraging existing IT resources to generate added revenue by marketing technology products and services isn't a novel idea. Last year, long-term care provider Extendicare Health System Inc. spun off its IT unit to provide outsourced IT operations to other nursing homes. The utility Progress Energy Inc. created Statusgo.com, an application service provider that offers asset-management services it perfected administering its own large power plants and other facilities.



Hayler, CEO of Kalido, believes in securing outside funding and customers.

But Kalido is different-symbolic of a new breed of IT spin-off that could attract funds from other companies at a time investors are still licking their wounds from ill-advised investments in failed dot-coms. During the dot-com craze, venture capitalists and others invested on promises and dreams that, for the most part, never materialized. Today, investors seek assurances and favor proven technologies. Technologies with proven track records emanating from IT shops are obvious choices.

Within weeks, Kalido is expected to unveil an investment from an outside company. Many recent IT-department spin-offs were variations of online business, ASPs, or E-marketplaces that sought to take advantage of a quick return on investment that most didn't accomplish. Not so with Kalido. Its genesis is internally designed data-management software for solving a specific business problem; the thought of profit came later. Such an approach could prove attractive to outside investors, including venture capitalists.

"We're interested in companies with got-to-have, rather than nice-to-have, products and services," says Steve Baloff, general partner with Advanced Technology Ventures, a venture-capital firm focused on communications, Internet infrastructure, software, services, and health-care investments.

Given the economic climate, which has made technology investing a dangerous game, investors want to ensure they spend on a business rather than a standalone product. "What makes good companies is not just the technology but the people that know how to manage the product and a startup company," Baloff says. Three primary criteria must be met before a company should consider spinning off its IT department or even a portion of its IT assets: good technology, strong market demand, and a great management team.

Hayler, a former Shell IT executive, chose to hand-pick his management team and employees from the software industry rather than raid Shell for talent. Kalido's marketing director hails from IBM, its sales director from Cognos, and its chief technology officer from Oracle. "This was done to make sure we had the right skills to build a commercial software product and run a company," he says.

Kalido's pedigree may help it succeed as an independent company. It benefited from a long incubation period, dating back to its formation in 1996 within Shell; not all IT departments have such an easy job of projecting success, says Henry Feinberg, a venture partner with Technology Crossover Ventures. Large global companies such as Shell have more resources for turning IT costs into revenue.

Smaller companies have to be more judicious about their capital because they don't have the excess capacity to offer IT resources to other organizations, says Mike Morris, CIO of Vitamin Shoppe Industries Inc., a $34.3 million North Bergen, N.J., retailer and marketer of vitamins and nutritional supplements that spun off an online version of the company in October 1999, only to bring it back in-house 18 months later. Vitamin Shoppe wasn't in a position to generate revenue through IT, says Morris, who's been involved in discussions throughout his career about how to generate revenue from IT resources.

The goal is generally for the parent company to make money within three years of spinning off IT assets. This approach has its pros and cons, says Morris, who has worked as a technology executive in the pharmaceuticals and financial-services industries. On the positive side, the parent company wants to get the cost of running an IT unit off the books. Spinning off an IT operation turns it into a fixed monthly expense rather than a capital investment. "If you're devoting a lot of your resources to forming this venture, you're also asking IT professionals to take on more business and entrepreneurial issues," he says.

That wasn't a problem for Shell, which has been nursing Kalido for five years. In 1996, Hayler, then Shell's global practice manager for information management, found himself with the difficult task of providing the Shell Lubricants division with an application that could give detailed data about the worldwide sales performance of its products. Hayler didn't see a commercial product in the marketplace that could meet his client's needs, so he tapped the parent company for the resources to build a customized application for the Lubricants division.

After securing about $1 million in funding from Shell in 1996 through Mark Pyman, executive VP of finance for Shell Services International, and Gerrit-jan Smitskamp, VP for management information within Shell Oil Products, Hayler delivered a prototype application the next year that allowed distributed data warehouses to be dynamically linked and function as a single entity-a key advantage for global companies with widely distributed IT systems. Shell Lubricants had had difficulty comparing data, particularly from German companies, which tend to create very detailed data classifications, and Korean companies, which generally create broader data categories, Hayler says.

"This is what enterprise resource planning applications promised but never delivered-standardizing the world," he says. "Shell Lubricants was never really able to get a sense of how the business was performing on a granular level." Kalido takes the opposite view, acknowledging that it's a complex and ambiguous business world.

Word of Kalido's success with Shell Lubricants spread quickly throughout Shell and helped Hayler secure more internal funding. From 1997 to 2000, Shell invested about $20 million in research and development into the Kalido product. The company kicked in $11 million as working capital before Kalido was spun off. Shell developed Kalido to work in conjunction with Oracle's databases but has since ported the technology to Microsoft SQL Server. Kalido plans to launch an IBM DB2 version by the end of September.

Adhering to the age-old dictum that oil and data don't mix, Kalido sought independence from Shell. As early as 1998, Hayler believed the best way to develop the Kalido product would be to attract outside funding and customers.

The biggest stimulus to spin off Kalido came from the success of the product in Shell's huge, complex oil-marketing business, where it achieved cost savings and strategic benefits. Though Shell wouldn't provide details, its executives say the savings came from not having to acquire new database software or repurpose existing database software. For example, the oil-products division uses Kalido to link 63 databases worldwide into a single data warehouse; its retail operation uses Kalido to manage a large data warehouse.

Kalido was destined to be independent. Working independently, a spin-off increases its potential to generate revenue by setting its pricing according to market demands. Customers want to know their product and service providers are investing in talent, sales and marketing resources, and infrastructure, rather than sharing revenue with a parent company. To show its independence, Kalido, couldn't favor Shell over other clients. Pricing, which begins at $300,000 for a single-server version of the application, has to be consistent across customers.

As a spin-off, Kalido benefits Shell as a software provider and an investment. Parent companies and their spin-offs generally don't share revenue since that tends to be a recipe for failure. If it's required to share a percentage of its revenue with the parent company, the spin-off isn't able to operate on a level playing field with competitors, says Wes Raffel, an Advanced Technology Ventures general partner.

Hayler plans to take Kalido public by the end of 2004, a time frame he hopes will let it reach business maturity. He won't speculate on the value of an initial public offering, but sees a move to the public realm more as a way to raise Kalido's visibility in the software market and give shareholders a way to cash out than as a way for his company to raise capital. Hayler reasons that, if he simply wanted to raise additional capital, he would seek venture-capital funding. He didn't pursue VC money because he wanted to avoid the 18-month fly-or-fail mentality employed by so many impatient investors.

The nascent state of Kalido hasn't kept it from attracting highly visible customers. Unilever plc, a British maker of consumer goods, chose Kalido's software because the startup understands the data-management needs of a multinational business, says Dave Waddington, Unilever's European-foods information-management architect. Whereas most other data-management apps address business as it is today, Kalido supports the process of change, particularly changing data categories. Unilever will use Kalido to provide a global master reference data repository system that Unilever designed and built using the Kalido software development kit and APIs. Unilever also will use Kalido as an enterprise data warehouse.

Waddington isn't concerned that Kalido is a start-up, primarily because of Shell's commitment to developing the database application over time and the oil company's continuing commitment to Kalido. Such customer faith could help guarantee success for Kalido and spur other companies with innovative, home-grown IT applications to offer them as money-making ventures.

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