Thorkild Juncker

Isn't it all very new economy, jokes Juncker: tweed-jacketed and sprightly after an over-night flight from New York and a hectic morning of presentations.

Juncker is one of the key men behind Morgan's drive to create LabMorgan, an in-house incubator for e-commerce ideas that he is now unveiling around the bank. He later lets slip that he spent the previous evening discussing with one of the bank's equities executives what he described as potentially "a miracle idea" that had been suggested by a big client. Juncker worked on it during the flight to London, while staff in New York were refining the business concept and e-mailing ideas ahead to him. Juncker hopes to test out and validate the basic idea within two weeks. If it still stands up, LabMorgan will then accelerate development, build prototypes, demos and a basic company infrastructure around the business idea. That might take two months. Then comes the key decision whether to invest or not. If it still looks viable, JP Morgan might commit $10 million to $20 million into what began two and half months earlier as a chance conversation between Juncker and the equities man. In the internet arena, speed is of the essence.

That's not something the senior management of any big bank finds easy to grasp. Juncker recalls making a presentation to the executive committee of JP Morgan in late July 1999 on how he thought the internet might affect the bank's existing businesses and how the bank should respond. He used the honeycomb image to convey an idea of a collection of self-contained e-finance businesses that might stand alone and yet also fit closely together into a greater whole.

He drew a few blank looks that day.

A hive of creativity

Eight months later, JP Morgan is preparing to devote $1 billion of investments to new e-finance businesses in 2000, many based on ideas brought forward from employees of the bank and then screened, validated, built and launched by the 200-strong staff of the new LabMorgan, an in-house venture capital unit dedicated solely to business-to-business (B2B) internet-based finance ventures. The aim is to fill the cells of the honeycomb speedily by combining Morgan's established client contacts, market presence and solid brand with the new ideas and entrepreneurial flair of its own employees. These should be the first to spot ways the internet might allow the bank access to more clients, or to cut costs, or to do both at once.

If it works, LabMorgan will do much more than earn the bank income from its stake in thriving new e-finance businesses and capital gains from realizations. It will re-invent JP Morgan from within. "This is much broader than stand-alone venture capital. This is a transformation of the firm and its markets through innovation. There has to be a significant partnering with and impact on all our existing businesses, or we will have failed," declares Juncker.

From last September, the bank had been running a small-scale incubator, Lab60 (called that after the addresses of the bank's main offices in New York at 60 Wall Street and London at 60 Victoria Embankment), with about 25 people including web designers, programmers and business developers. Lab60 made its mark launching several internet-based ventures, including MarketAxess (see box) a multi-dealer bond trading portal; Cygnifi, a web-based independent derivatives services company; VolCenter, a portal for foreign exchange and precious metals derivatives traders, and several others. Lab60 became reasonably well known within the bank, but not especially prominent next to the main established business units.

The e-swat initiative

Nick Rohatyn

Now it has caught the attention of all the bank's employees. Juncker has spent the morning before meeting Euromoney briefing staff in London about LabMorgan. The bank couldn't find an in-house auditorium large enough - and it has some roomy ones - to accommodate the audience and many employees had to turn away frustrated at not being able to get into the meeting. LabMorgan has risen quickly from relative obscurity to very high profile. And lest anyone in the bank should not take it seriously, Nick Rohatyn, one of Morgan's most senior executives, who built its emerging markets business and recently oversaw the bank's credit businesses, has been appointed head of LabMorgan. It's a signal from JP Morgan chairman Douglas Warner that the new unit has serious clout.

In mid-December last year, Warner had contacted 75 JP Morgan staff ranking from senior management on down, told them to drop whatever they were doing and sat them together around eight or so large tables on one floor of an empty office building in New York. For six weeks they batted around various radical ideas for the bank and the internet, in a brainstorming session called e-swat, at once informal and intense, which ran on mercilessly through the holidays. Of the handful of action plans that emerged, the ramping up of LabMorgan is the most prominent. Many of the bankers from the e-swat team have moved into it.

Rohatyn, who had worked with Juncker on setting up Lab60 in 1999 and was part of e-swat, recalls how the thinking of top Morgan executives had changed at the start of 2000. "By January, the general thinking was that we needed to build something that was bigger rather than smaller and that JP Morgan needed an initiative that was more comprehensive and aggressive."

What are it's advantages? Most obviously, focus on a single area. While other internet incubators and venture capitalists might seek to fund all manner of internet ideas including business to consumer (B2C) and business-to-business, LabMorgan concentrates solely on ideas relating to wholesale finance. If an entrepreneur brings a new idea, LabMorgan can quickly test out the concept with the bank's own clients. Does it give customers something they badly need? Would they use it? How would they refine the business idea to suit them even better? Related to this, Morgan brings two components that are vital for many internet start-ups: content and brand. A portal for corporate bond research and trade execution remains no more than a good idea without actual research content and live prices. JP Morgan brings both. It also brings an established name. This might not be attached to a new company's name directly, but a flag on a website saying a new financial business is empowered by, or partnered with, JP Morgan lends it some serious credibility.

And, of course, Morgan provides capital.

LabMorgan does many of the basic things that all incubators do for budding internet entrepreneurs. In the initial two- to four-week validation phase, it brings technology experts, business people and at least one professional doubting Thomas to work with the entrepreneur. It tests the basic idea out with clients. In the acceleration and building phase, it brings in website designers, provides premises, helps recruit key staff such as a chief technology officer and a chief financial officer. It helps build the company. "We do all the things a typical incubator does during the time-to-market phase and we probably do them at least as well as any incubator," says Juncker. He goes on: "Where we are unique is in the time-to-value phase, that is in taking the new venture from launch to critical mass, to making it a real player. We excel here because of our client reach and knowledge of the underlying financial markets." He mentions a couple of internet-based bond trading vehicles which were launched earlier than MarketAxess but which since then have been treading water while they tried to bring in leading dealers as partners. JP Morgan can provide that content immediately.

Finally, and as important in an age when speed to market is crucial for new e-businesses, the bank already knows very well the main sources of its new ideas: its own employees. Unlike outside venture capitalists, it doesn't have to spend time on background checks and due diligence on these people.

The LabMorgan folks call Morgan staff who bring them ideas their "intrapreneurs". LabMorgan also expects to develop ideas brought from outside the firm from former employees, from clients, from people who simply know and respect the bank. It calls this source the bank's affinity network. It may even benefit from other incubators that recognize they lack expertise in wholesale finance and might pass ideas on in return for B2C ideas generated by Morgan staff. But most will come from the intrapreneurs.

All this raises obvious issues of internal politics and the extent to which new businesses might cannibalize the old. What happens when a senior manager, or perhaps even worse, a junior executive, in an established business comes forward and asks LabMorgan to fund and develop a business that might compete with or even destroy an established JP Morgan unit?

There are two answers. The short answer is that this is a subtlety that the present business environment leaves no luxury for worrying about. If a bank employee comes up with an internet-based idea that might compete with an established business, the biggest risk is not developing the new idea. Because it's a sure bet that a competitor soon will. Better for the bank to joint-venture the idea with the employee.

"There may be some concern that JP Morgan could lose business to a new venture from LabMorgan. But our model is to partner with our existing businesses and we expect many of the market-innovating ideas to come directly from them," says Dina Pruzansky, a vice-president at LabMorgan. "They help design the innovation, retain an equity stake in the new venture and keep their people here doing the highest-value work."

Pruzansky says she is an example herself. After several years at the bank she had intended to leave and do something internet-focused until she saw an internal recruitment notice for Lab60. She was delighted to stay with the bank and still work in the internet area. "It [LabMorgan] feels like a start-up - we're working closely with entrepreneurs - but with huge resources behind us."

To the extent that a new venture from LabMorgan depends on content from an existing Morgan business unit - say something in the bond markets area that relies on bond indices or prices from the banks' researchers and traders - then the Morgan business unit supplying that content will be allocated a portion of the bank's equity in the new venture.

This distinguishes Morgan's approach from the internet development efforts at many other large banks. On a blackboard Juncker draws two roads angling towards a meeting point. The top road is the established JP Morgan with all its brand, content, market presence and client contacts. The bottom road is LabMorgan, which emphasizes new ideas, speed, focus, technology and the ability to partner quickly with entrepreneurs and even traditional competitors to Morgan. "Many firms keep those roads running in parallel and separate because they think the old and the new cannot meet. But to me the most interesting point is the intersection." With a flourish he draws a third wider, larger road leading away from the intersection and writes the word "value". He says: "That value could be simple efficiency, EVA, or market value-added to JP Morgan."

If JP Morgan can indeed negotiate the traffic snarling around that particular junction, it will have pulled off quite a trick.

Rohatyn finds another virtue in managing LabMorgan as an integrated part of the bank, rather than a separate unit. "Since our efforts relate to the on-going businesses of the firm, we have more ways of getting paid than a traditional venture capitalist. We can set things up which simply grow a certain market for us or bring efficiencies but which don't hold out the prospects of separate equity up-side. We look at things which a venture capitalist might ignore."

Secondly, Rohatyn adds that while some new businesses like MarketAxess might indeed compete with Morgan's traditional fixed-income business, they can also help drive useful changes in the existing business. "By bringing automation, it should free up our salespeople to work on more valuable strategic ideas with clients."

Just a few simple questions

A large venture capitalist might see 10,000 business ideas in a year. LabMorgan, concentrating solely on e-finance, will see fewer, but still expects to measure them in thousands. It expects to launch from 20 to 40 new businesses in a year. What lessons has Juncker absorbed in the previous months that will serve the new LabMorgan through this process? First is that there are two types of internet ideas: the small and the big. LabMorgan is interested in the second kind.

And Juncker does not lack ambition for the ventures LabMorgan launches. "In Europe the entrepreneur behind the typical start-up is probably happy to launch his company and grow it to being a national player. What we offer is the ability to take the next step and access the regional or global markets quickly."

Although junior employees may come up with some interesting technology-intensive ideas, it is the top producers and business leaders who are the best sources of business ideas. Juncker has a few simple tests for these budding entrepreneurs. "We expect when people come to us with their ideas that they can answer a few basic questions. What is the unmet client need your business meets? Why is your idea unique? What is the size of the potential market? What technology is needed? Why are you best placed to make this work?"

And what are the rewards for people that can answer those questions? By the time LabMorgan provides the first round of financing, the founder who brought the idea might expect to still own from 15% to 30% of a business that is now worth in the region of $20 million. As the size of the business rises, so his or her ownership will be diluted, not least to accommodate outside business partners as investors. The group makes it clear that by the time the business gets to the IPO stage, the founder will likely own roughly 5%. But if things go well 5% of something now worth closer to $200 million than $50 million.

Any clues as to the kinds of businesses LabMorgan might launch this year? Precious few, although it is clear that Juncker is steeped in all aspects of internet lore and sees potential applications from the retail business to consumer world in the wholesale finance arena. He is interested in auction sites like eBay and the opportunities for exchanges to trade highly illiquid exposures. "If you can trade beanie babies worth $4 to $5, there are plenty of non-commoditized financial exposures - say a three-year commodity export finance loan - that you might potentially post and seek prices for."

Richard Mc Vey

The implication was stark and obvious. To meet this wish meant setting up a new venture outside JP Morgan with ownership and sponsorship from other banks, probably direct competitors. Through October and November 1999, McVey began looking for just such partners. He was put in touch with Lab60, JP Morgan's in-house e-finance incubator, which had been working in parallel on a similar idea. McVey now became its first client. Lab60, the forerunner of LabMorgan, worked on validating the business plan and exploring the capital structure.

McVey recalls the experience of being a test case for Lab60. "We had a goal to move quickly and the ability to draw on talented internal resources from Lab60 was crucial in two ways; first in things like website design and second, and even more importantly, in connections with partners working within the new economy. For example, Lab60 connected us with Moneyline, our technology partner, legal counsel and compensation consultants. Coming from the traditional financial services industry, we had little idea about structuring equity-based compensation for new economy workers."

McVey conveys strongly the urgency surrounding an internet start-up. To secure some form of first-mover advantage, Market-Axess announced itself in January, once it had agreements with two other partners - Bear Stearns and Chase - but before the technology was anywhere near complete. MarketAxess aims to start executing transactions in May.

MarketAxess will provide research, trading and ultimately new issues in corporate bonds, high yield, emerging market bonds, municipal and agency bonds. The three dealers and equity investors together reckon they have a 16% share of their target market, enough for critical mass. Potentially the three move up from the lower reaches of the top 10 to being part of a virtual bulge bracket bond firm.

Other partners and instruments could eventually be added on, though McVey is wary of technology problems delaying the scheduled roll-out of services. He says: "We have a great start and can execute the business plan with our current group of dealers. But like any internet start-up we'll be in a race for critical mass and that might lead to adding on dealers."

Meanwhile he points to another attraction for clients: "A huge advantage is that a platform like MarketAxess can bring electronic straight-through processing to markets which today are still heavily manual." If it felt it would help clients, Market-Axess could easily add government bond trading from any or all of its partners. But its not a main focus. "There are any number of platforms addressing government bonds and futures, but fewer in the credit markets," McVey says.

McVey never took his idea to another venture capitalist, seeing no point in stepping away from a major dealer with big share in the target market that MarketAxess would need anyway.

In any venture capital deal, a key potential conflict between the institutional investor and the entrepreneur with the business idea is over how much of the business each will own, each wanting as high a percentage as possible. McVey recalls: "Morgan identified independent experts and consultants to deal objectively with the issues."

McVey is now chief executive officer of MarketAxess, a firm which is planned to have a staff of 35. Reflecting on how LabMorgan might work he suggests: "Having a centre of expertise within a large firm but partnered with the existing business is a great way to capitalize on good business ideas that might otherwise be squandered. It's a way for entrepreneurs to be attached at the hip to Morgan and fulfil their interest in being part of the new economy."