Open Innovation

Open innovation has been variously described as a process, a set of interfirm relationships, and a cognitive paradigm. As originally explained by Henry Chesbrough:

Open Innovation is a paradigm that assumes that firms can and should use external ideas as well as internal ideas, and internal and external paths to market, as the firms look to advance their technology. Open Innovation combines internal and external ideas into architectures and systems whose requirements are defined by a business model.

Henry Chesbrough, Open Innovation: The New Imperative (2003)

Prof. Chesbrough’s more recent (and preferred) definition is:

“Open innovation is the use of purposive inflows and outflows of knowledge to accelerate internal innovation, and expand the markets for external use of innovation, respectively. [This paradigm] assumes that firms can and should use external ideas as well as internal ideas, and internal and external paths to market, as they look to advance their technology.”

Henry Chesbrough, Open Innovation: Researching a New Paradigm (2006)

These are the two earliest (and official) definitions; subsequent definitions are given by an August 2007 posting in Joel West’s Open Innovation blog.

For a more expanded introduction, below is an excerpt from Dr. Chesbrough’s article “The Era of Open Innovation” which appeared in MIT Sloan Management Review; Spring2003, Vol. 44 Issue 3, p35-41.

Abstract

Today, in many industries, the logic that supports an internally oriented, centralized approach to research and development (R&D) has become obsolete. Useful knowledge has become widespread and ideas must be used with alacrity. Such factors create a new logic of open innovation that embraces external ideas and knowledge in conjunction with internal R&D. This change offers novel ways to create value. However, companies must still perform the difficult and arduous work necessary to convert promising research results into products and services that satisfy customers’ needs. Innovators must integrate their ideas, expertise and skills with those of others outside the organization to deliver the result to the marketplace, using the most effective means possible. In short, firms that can harness outside ideas to advance their own businesses while leveraging their internal ideas outside their current operations will likely thrive in this new era of open innovation.

Introduction

In the past, internal R&D was a valuable strategic asset, even a formidable barrier to entry by competitors in many markets. Only large corporations like DuPont, IBM and AT&T could compete by doing the most R&D in their respective industries (and subsequently reaping most of the profits as well). Rivals who sought to unseat those powerhouses had to ante up considerable resources to create their own labs, if they were to have any chance of succeeding. These days, however, the leading industrial enterprises of the past have been encountering remarkably strong competition from many upstarts. Surprisingly, these newcomers conduct little or no basic research on their own, but instead get new ideas to market through a different process.

Consider Lucent Technologies, which inherited the lion’s share of Bell Laboratories after the breakup of AT&T. In the 20th century, Bell Labs was perhaps the premier industrial research organization and this should have been a decisive strategic weapon for Lucent in the telecommunications equipment market. However, things didn’t quite work out that way. Cisco Systems, which lacks anything resembling the deep internal R&D capabilities of Bell Labs, somehow has consistently managed to stay abreast of Lucent, even occasionally beating the company to market. What happened?

Although Lucent and Cisco competed directly in the same industry, the two companies were not innovating in the same manner. Lucent devoted enormous resources to exploring the world of new materials and state-of-the-art components and systems, seeking fundamental discoveries that could fuel future generations of products and services. Cisco, on the other hand, deployed a very different strategy in its battle for innovation leadership. Whatever technology the company needed, it acquired from the outside, usually by partnering or investing in promising startups (some, ironically, founded by ex-Lucent veterans). In this way, Cisco kept up with the R&D output of perhaps the world’s finest industrial R&D organization, all without conducting much research of its own.

The story of Lucent and Cisco is hardly an isolated instance. IBM’s research prowess in computing provided little protection against Intel and Microsoft in the personal computer hardware and software businesses. Similarly, Motorola, Siemens and other industrial titans watched helplessly as Nokia catapulted itself to the forefront of wireless telephony in just 20 years, building on its industrial experience from earlier decades in the low-tech industries of wood pulp and rubber boots. Pharmaceutical giants like Merck and Pfizer have also watched as a number of upstarts, including Genentech, Amgen and Genzyme, has parlayed the research discoveries of others to become major players in the biotechnology industry.

From Closed to Open

Is innovation dead? Hardly, as punctuated by the recent advances in the life sciences, including revolutionary breakthroughs in genomics and cloning. Then why is internal R&D no longer the strategic asset it once was? The answer lies in a fundamental shift in how companies generate new ideas and bring them to market. In the old model of closed innovation, firms adhered to the following philosophy: Successful innovation requires control. In other words, companies must generate their own ideas that they would then develop, manufacture, market, distribute and service themselves (see “The Closed Innovation Model”). This approach calls for self-reliance: If you want something done right, you’ve got to do it yourself.

For years, the logic of closed innovation was tacitly held to be self-evident as the “right way” to bring new ideas to market and successful companies all played by certain implicit rules. They invested more heavily in internal R&D than their competitors and they hired the best and the brightest (to reap the rewards of the industry’s smartest people). Thanks to such investments, they were able to discover the best and greatest number of ideas, which allowed them to get to market first. This, in turn, enabled them to reap most of the profits, which they protected by aggressively controlling their intellectual property (IP) to prevent competitors from exploiting it. They could then reinvest the profits in conducting more R&D, which then led to additional breakthrough discoveries, creating a virtuous cycle of innovation.

For most of the 20th century, the model worked — and it worked well. Thanks to it, Thomas Edison was able to invent a number of landmark devices, including the phonograph and the electric light bulb, which paved the way for the establishment of General Electric’s famed Global Research Center in Niskayuna, New York. In the chemical industry, companies like DuPont established central research labs to identify and commercialize a stunning variety of new products, such as the synthetic fibers nylon, Kevlar and Lycra. Bell Labs researchers discovered amazing physical phenomena and harnessed those discoveries to create a host of revolutionary products, including transistors and lasers.

Toward the end of the 20th century, though, a number of factors combined to erode the underpinnings of closed innovation in the United States. Perhaps chief among these factors was the dramatic rise in the number and mobility of knowledge workers, making it increasingly difficult for companies to control their proprietary ideas and expertise. Another important factor was the growing availability of private venture capital, which has helped to finance new firms and their efforts to commercialize ideas that have spilled outside the silos of corporate research labs.

Such factors have wreaked havoc with the virtuous cycle that sustained closed innovation. Now, when breakthroughs occur, the scientists and engineers who made them have an outside option that they previously lacked. If a company that funded a discovery doesn’t pursue it in a timely fashion, the people involved could pursue it on their own — in a startup financed by venture capital. If that fledgling firm were to become successful, it could gain additional financing through a stock offering or it could be acquired at an attractive price. In either case, the successful startup would generally not reinvest in new fundamental discoveries, but instead, like Cisco, it would look outside for another technology to commercialize. Thus, the virtuous cycle of innovation was shattered: The company that originally funded a breakthrough did not profit from the investment, and the firm that did reap the benefits did not reinvest its proceeds to finance the next generation of discoveries.

In this new model of open innovation, firms commercialize external (as well as internal) ideas by deploying outside (as well as in-house) pathways to the market. Specifically, companies can commercialize internal ideas through channels outside of their current businesses in order to generate value for the organization. Some vehicles for accomplishing this include startup companies (which might be financed and staffed with some of the company’s own personnel) and licensing agreements. In addition, ideas can also originate outside the firm’s own labs and be brought inside for commercialization. In other words, the boundary between a firm and its surrounding environment is more porous, enabling innovation to move easily between the two (see “The Open Innovation Model”).

At its root, open innovation is based on a landscape of abundant knowledge, which must be used readily if it is to provide value for the company that created it. However, an organization should not restrict the knowledge that it uncovers in its research to its internal market pathways, nor should those internal pathways necessarily be constrained to bringing only the company’s internal knowledge to market. This perspective suggests some very different rules (see “Contrasting Principles of Closed and Open Innovation” next page). For example, no longer should a company lock up its IP, but instead it should find ways to profit from others’ use of that technology through licensing agreements, joint ventures and other arrangements.

One major difference between closed and open innovation lies in how companies screen their ideas. In any R&D process, researchers and their managers must separate the bad proposals from the good ones so that they can discard the former while pursuing and commercializing the latter. Both the closed and open models are adept at weeding out “false positives” (that is, bad ideas that initially look promising), but open innovation also incorporates the ability to rescue “false negatives” (projects that initially seem to lack promise but turn out to be surprisingly valuable). A company that is focused too internally — that is, a firm with a closed innovation approach — is prone to miss a number of those opportunities because many will fall outside the organization’s current businesses or will need to be combined with external technologies to unlock their potential. This can be especially painful for corporations that have made substantial long-term investments in research, only to discover later that some of the projects they abandoned had tremendous commercial value.

The classic example is Xerox and its Palo Alto Research Center (PARC). Researchers there developed numerous computer hardware and software technologies — Ethernet and the graphical user interface (GUI) are two such examples. However, these inventions were not viewed as promising businesses for Xerox, which was focused on high-speed copiers and printers. In other words, the technologies were false negatives( n1) and they languished inside Xerox, only to be commercialized by other companies that, in the process, reaped tremendous benefits. Apple Computer, for instance, exploited the GUI in its Macintosh operating system while Microsoft did the same in its Windows operating system.