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TMCNet:  THE EVOLUTION OF OPEN INNOVATION: AN INTERVIEW WITH HENRY CHESBROUGH [Research Technology Management]

[September 30, 2011]

THE EVOLUTION OF OPEN INNOVATION: AN INTERVIEW WITH HENRY CHESBROUGH [Research Technology Management]

(Research Technology Management Via Acquire Media NewsEdge) Henry Chesbrough talks to James Euchner about how open innovation has evolved and expanded with the advent of open source and other models.

Henry Chesbrough coined the term "open innovation" with the publication of his book by that title in 2003. Since that time, there has been a fl urry of experimentation with different styles of open innovation at companies as diverse as P&G and Hewlett Packard, and Chesbrough has extended his research to business model innovation and, most recently, services innovation. In this installment from my conversation with him at IRI's Member Summit in October 2010, Chesbrough discusses the evolution of open innovation, what it takes to succeed at open innovation, where it might not gain traction, and how it compares with open-source innovation models.


James Euchner [JE]: The fi rst thing I'd like to ask you about is the evolution of open innovation over the four or fi ve years since you published your book. P&G has famously organized a major part of its innovation program around open innovation. Intermediaries like InnoCentive and Nine Sigma that seek to enable open innovation have been formed. People have experimented with a variety of different types of open innovation in different situations. Under what sort of business circumstances, from your perspective, does open innovation work well? Henry Chesbrough [HC]: Let me start with how it's evolved. When I wrote the book, I did a Google search on the term "open innovation," and I got back a couple of hundred page links to things like "Company X opened its innovation center in location such and such," not really in the spirit of what we think of as open innovation today. I did that same search about three months ago now, and I got 13 million responses. So it's gone hugely viral in the last seven years, which is a great delight.

In the beginning, I think what grabbed people about open innovation was the idea of making greater use of external technology in their businesses. That was the fi rst insight that stuck with people, and companies really started putting it into practice. The second insight was that, if you're going to [bring technology in], you had better worry about the intellectual property. And that means that intellectual property has got to be much more connected to the innovation function than it had to be historically.

A third insight is just getting established now, but it's still not widespread. That is that you should let your own unused ideas go outside for others to use in their business; in other words, open innovation is really about both sides of the R&D market. Just as companies can look for external sources of technology, they can also become contributors to others as external sources. This, I think, is emerging, but not yet well established.

I'm writing now about how all this works when we get to a services context. One of the things that I have found is that, when you start to add services to products and technologies, you inevitably change the business model [of the company]. So the business model becomes a really integral part of innovation. As you get more and more of your revenue from services as opposed to traditional products, all kinds of things change. Things that used to be bundled in with the product for free now have a price tag associated with them. Or instead of selling the product as a lump-sum purchase to the customer, maybe the customer rents it or leases it or has some sort of use by the unit or by the drink so that you get a recurring revenue stream over time rather than a one-time lump sum.

So all of these things in the business model start to shift when you move into the services domain.

JE: I guess this is especially true if you're not already a service business, but you're in a product business that's becoming more of a service business.

HC: Yes. And ironically, companies that are service businesses often fi nd that it helps to create products to standardize and systematize parts of their work process so they can scale more effectively. So that's a case where services innovation may involve a certain amount of product development, precisely for the scaling.

JE: You talked about the evolution of open innovation from the perspective of acquiring technology. It seems that some companies, like Proctor & Gamble, are seeking to fi nd whole solutions, not just a technology that might fi ll a gap that they have. Do you see more of that? Is that another part of the evolution? HC: Certainly, in the consumer product space, I see that. P&G was an early adopter and, even today, I think, is one of the leading companies practicing [that form of open innovation]. They have moved from [using open innovation] to plug fairly specifi c, narrow gaps to pushing more of their business issues into the open innovation domain. They are making that part of what they're looking for in external partnerships.

Another company that has been very active in open innovation goes at it in a very different way, and that's Hewlett Packard. HP Labs has an open innovation lab as part of R&D and what they do is make an annual call for proposals from external sources on particular challenges that they have identifi ed. They have done the work to be able to say, "Here are the gaps we need to have fi lled." And they have established inside of HP ways they're going to use the outputs of those initiatives and plug them into the larger HP enterprise. So they're going at it in individual pieces [but with a larger perspective] through this call-for-proposals mechanism.

JE: Now some of these places have appointed Directors of Open Innovation, which is probably gratifying to you.

HC: And John Tau at Weyerhaeuser is the Vice President of Open Innovation. That's a great job title.

JE: One of the things that Laffl ey of P&G wrote about in his book Game Changer is that you can't just change one thing. You can't just create a center for open innovation and expect it to have a major impact. Can you comment on what's required in an organization to really make open innovation work? HC: I interpret Laffl ey's comment to mean that, if you really want [open innovation] to change your company's culture and become part of how you're doing business, you can't isolate it in one place. It's got to go everywhere. If you think back to the total quality management movement, we used to inspect quality at the very end of the process before we shipped. It was the last thing we checked before the product went out the door. And we've learned that, if you're really going to do it well, you've got to put quality at the beginning of the process, and it's got to go throughout the whole organization to really be effective.

I think there's something analogous going on in open innovation. You can start-and often you need to start- in a localized way, especially if you don't have the support of your senior management. You may want to stay below the radar during the initial demonstration projects and tests that you do, while you learn enough so that you're able to make a strong case for why [open innovation] ought to get bigger.

But once you get to the point where it looks like it works in your company, where you've got some proof points that demonstrate it, then it becomes time to get real resources to run with it. To do this, you're going to need senior management support, and you're going to need organizationally to not be confi ned to a particular unit. The initiative is going to have to spread across your organization.

JE: As you pointed out, it may have implications even for the business model, but certainly, for other functions. So if you're doing open innovation, it may require changes in the way you protect your IP. It may require changes in how you go to market. Have you seen big successes where companies have managed open innovation from a function, say from the research labs, and made it work? Or does effective open innovation require the more grandiose approach that Laffl ey talks about? HC: I have seen examples of individual projects from the research labs going through and becoming successful, but in terms of open innovation really changing the performance of an organization, its fi nancial performance, I think that Laffl ey is right.

IBM is another organization that has really changed its fi nancial performance as a result of moving to a much more open process. In IBM's case, and I suspect that this is true in P&G's case, there are still parts of IBM that are pretty closed. If you go to their mainframe business, it's not a whole lot different [in this respect] from what it was ten years ago. So that business has been pretty closed, pretty vertically integrated. If you go to the IBM software business, on the other hand, it's a whole different story. There they are much more open and energized [around open innovation]. You see the effect in the management of IP. In semiconductors, IP is very, very carefully protected. But in other businesses, like software, they have a very different, much more open approach. They're very collaborative, and they're not worried about licensing; they're looking only for freedom of action, so on and so forth.

So even in a company like IBM or P&G, to say that the whole company has embraced open innovation [is probably not quite true]. In my experience, there are major business units within companies that have and are getting real results. But even in these companies, there are still pockets where they're doing business like they always have because, frankly, it's still working for them.

JE: Even P&G emphasizes that it's a complementary thing. You still have 9,000 researchers at P&G, and they're taking what they fi nd on the outside and augmenting it and developing it.

HC: Let me stay on the point [of internal R&D resources] for just a moment. I think that there's sometimes a misconception that open innovation can be used for outsourcing R&D and laying off internal R&D staff. I want to go on the record and do what I can to correct that for two reasons.

One is that the stuff that does come in from the outside rarely comes in ready to go. It often needs a lot more work before it can be combined and integrated with the rest of your processes to get something into the market. So simply starting something that was developed outside versus inside doesn't take away the need for a signifi cant R&D capability internally; you really do need to be able to do a lot of additional work [to be effective].

The second reason [you need to maintain internal R&D resources] is that, in order to be an intelligent consumer of what is around externally, you need to be active in the fi eld, up to date, current with who is who, which ideas have real staying power, which ones are fl ashes in the pan that aren't going to go anywhere. If you rely on your purchasing organization for buying your external R&D, you're setting yourself up for a terrible, terrible fall.

JE: That's a very good point. So pick a couple of instances where open innovation works very well. One that occurs to me is for companies (like P&G) that have a strong channel and a strong marketing capability; they can use open innovation to pull through new concepts. Another case is companies (like HP) that have specifi c needs for technologies that they can't source internally. Are there any other places where you think open innovation is particularly well suited to drive the growth of a company? HC: My new book is on service innovation, so I've been looking at companies in service businesses. United Parcel Service is an interesting one. They now offer to come in and take over the functions of the shipping department of your company, whether the parcel is going to go out through the US Postal Service or FedEx or UPS. UPS takes over all of the responsibility for these accounts for customers.

When UPS takes over the [shipping] facility, they badge the employees and put them on UPS's payroll. This gives them much more insight into what their customers are actually doing to generate the shipments; it gives them ideas for, let's say, working upstream in the supply chain to help optimize logistics that the shipping department didn't even know about; they were simply working from shipping documents on individual parcels to get them out.

That's an example where a company with tremendous logistics capability is partnering with its customers to help get shipments of its own products out to the market. But then, later on, as they learn more, they're working back upstream to optimize the supply chain as well.

JE: Are there instances where you think open innovation just won't work? [Maybe] the company has to make other changes before they can take advantage of this approach? HC: If a company is not open internally among its own employees, bringing in external stuff from the outside may not improve the situation at all. If you've got a newproduct development process that's very congested and it's taking a long time for a project to get into the market, it may not help to use open innovation to bring in a bunch of additional inputs from the outside; you throw those inputs into an already congested pipeline, and all you're going to do is create more congestion and slow things down even more. You've got to think about [open innovation] all the way through from the ideation stage into the market.

One way to use open innovation is to expand effective capacity for the organization by letting things that are stuck and not going anywhere internally go outside. Free up the resources tied up in those projects to be redeployed internally. Maybe you'll get some licensing revenue or some equity from the external licensing. But you also get those internal resources back to work on higher priority things.

Or if you've got programs that you think are going to have to focus on small applications initially but might turn out to have a bigger application later on, consider letting a partner do the work in the early market. You can then direct your efforts toward the larger, future application while you're learning from the initial area. You're getting some demonstration effect from proving the concept of the technology in the initial market, and maybe even some revenue from that market, so you can show your management that somebody else thinks the technology is worth something. And by the way, the real opportunity is not there; the real opportunity is over here.

We just had a company that spun out of Berkeley that exactly fi ts this description. It's called Amyris, a biotech company that partnered with the Gates Foundation to develop a biological way to produce hard artemisinin for antimalarial drugs. The initial marketplace was disease control in the third world using this synthetic biology technology. That application was licensed to a pharmaceutical company called Sanofi Aventis, and off they went.

But Amyris kept the intellectual property to the technology, which they reprogrammed to create biofuels, and they raised venture capital to pursue a technology that now had a demonstrated proof of concept [in the pharmaceutical space]. The technology was already in the pilot stage, so the biofuel venture was a less risky project. Amyris raised venture capital, and they had their IPO in Spring 2010. They are an example of using one market [together with partnering] to position yourself to get into a larger downstream opportunity.

JE: You mentioned that the latest stage of open innovation is companies taking assets they have and fi nding a way to spin them out to other companies of interest. Who is good at this? Do you have any success stories of a company that is able to profit by spinning out technologies? HC: I think Google has done a lot of spinning out of projects, particularly to nongovernmental organizations and to small start-ups. Once in a while, they might even buy them back later on, if it turns out that there is a real value that they didn't see the fi rst time around. Google has a very active alumni, you might say.

What's interesting, too, is how a company treats people who leave to pursue an opportunity. In the old days, such people were treated as traitors who were betraying the organization; they were shunned by the rest of the organization. These days, some companies look at them as alumni who know your culture very well, and maybe have had a certain degree of success in that culture. If they leave to try something and it doesn't work out, and they want to come back, companies can say, "Fantastic- we'd love to have you." The employees come back with a renewed appreciation for what they have, a good job in a stable company. But they also have had the experience of trying things on the outside, so they have all that learning experience they're bringing with them to the job. They can be very valuable employees.

JE: Shifting gears a little, can you connect open source to open innovation? Help us understand what is the same and what is different. How do you think about intellectual property differently, for example? HC: Open source, as you know, began as a software development methodology, which essentially meant that nobody owns the IP. Open source is really a participatory, voluntary community that comes together to create a great piece of technology that everybody can use and build on. Everybody wins because each of the contributors is taking advantage of the others' skills; together, they are building something that they collectively use.

In that domain, you don't really need or even want intellectual property, because it gets in the way of sharing. With the passage of time, we've actually come to see that there are open-source business models, and indeed, companies that are making profi ts on open-source technology. They're not making a profi t directly from the IP itself, which is held in this more common way, but they have wrapped elements around the IP or around the technology that allow them to make money. The obvious business models involve wrapping services around the core technology.

But there are more subtle business models, too. IBM, for example, invests a lot of resources in open source. Along the way, it invests in special tweaks to improve device drivers that make its hardware and software run better than they otherwise would in these environments. IBM Global Services also benefi ts from the existence of an open-source operating system, for example, which they can directly modify and use to reduce the support costs for the heterogeneous equipment from different vendors that they manage for their customers.

In that sense, open source simplifi es IBM's complex problem of how to manage different confi gurations of equipment. IBM stays true to open source; they're not trying to enforce IP against it, and they are contributing in the spirit of the community. But they're also making money in the process. IBM is a good example of what I think of as a company creating open-source business models. What distinguishes open innovation from open source is the idea that [with open source] the business model is a fundamental element in innovation.

JE: Thank you. Open innovation is a fascinating and dynamic world. Thank you for spending the time to discuss it with us.

HC: Oh, Jim, it's my pleasure. Thank you.

Henry Chesbrough, known as "the father of open innovation," explores the application of open innovation to services in his latest book, Open Services Innovation .

One of the things that I have found is that, when you start to add services to products and technologies, you inevitably change the business model. So the business model becomes a really integral part of innovation.

If you rely on your purchasing organization for buying your external R&D, you're setting yourself up for a terrible, terrible fall.

One way to use open innovation is to expand effective capacity for the organization by letting things that are stuck and not going anywhere internally go outside.

What distinguishes open innovation from open source is the idea that [with open source] the business model is a fundamental element in innovation.

Henry Chesbrough is executive director of the Center for Open Innovation at Haas School of Business at the University of California-Berkeley. Known as "the father of open innovation" for his authorship of Open Innovation (2003), Chesbrough has focused his research on the management of technology and innovation. He coauthored Open Innovation: Researching a New Paradigm (2006) with Wim Vanhaverbeke and Joel West and extended his analysis of innovation to business models with Open Business Models (2006). His latest book, Open Services Innovation (2011), considers open innovation in the services sector. Chesbrough has also published numerous articles in Harvard Business Review, Sloan Management Review, Research-Technology Management , and elsewhere. Prior to embarking on his academic career, Chesbrough spent ten years in product planning and strategic marketing positions in Silicon Valley companies. He holds a PhD in business administration from the University of California-Berkeley, an MBA from Stanford University, and a BA from Yale University. henry@chesbrough.com Jim Euchner is editor-in-chief of Research-Technology Management and a visiting scientist at the Massachusetts Institute of Technology Sloan School of Management. He previously held senior management positions in the leadership of innovation at Pitney Bowes and Bell Atlantic. He holds BS and MS degrees in mechanical and aerospace engineering from Cornell and Princeton Universities, respectively, and an MBA from Southern Methodist University. euchner@iriweb.org DOI: 10.5437/08956308X5405003 (c) 2011 Industrial Research Institute, Inc

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