Open Innovation, page 9
It provides an outside path to market for technologies that might otherwise sit on the shelf within the labs. This brings in additional money to Lucent, creates additional options for its research staff, and frees up resources to hire new researchers.
It forces technology to move faster out of the lab. Whenever the NVG identifies a candidate technology for spin-off, this starts a clock within the company’s businesses. If the company doesn’t commit to use that technology itself, then the NVG gets the opportunity to spin it off into a new venture. This creates a forcing function to pull technologies out of the lab at a faster rate.
Lucent’s NVG ventures provide an experimental setting for the observation of Bell Labs’ technologies in different uses in different markets. As a result, Lucent acquires valuable feedback not available if the technology had stayed bottled up in the lab. By getting the technology out to the market sooner, Lucent learns more quickly about customer needs, trends, and new opportunities.
Customers also have important information that can be vital to open innovation. The most advanced, most demanding customers often push your products and services to the extreme. In doing so, they themselves attempt to create new combinations with your offerings as part of the building blocks. In a real sense, they are innovators themselves, what Eric von Hippel calls lead users.13These experiments may again yield new knowledge. People may use your technology in ways you never expected. In the process, customers’ experiments often yield new features or requirements for what you build yourself. If you respond to these required changes, then a new round of learning can begin.
This process of innovation and discovery seeks out these iterative loops of learning. Before, companies chose to wait until the technology was “ready” to ship to customers. The mind-set was “We know what they want, and they’ll wait until we say it’s ready.” Open Innovation companies invite the customer into the innovation process as a partner and coproducer. Here, the mind-set shifts to “Here are some of our thoughts,and here’s a product that features them. What can you usefully do with it? What can we do to help you do something even more useful?”
Open Innovation and Managing Intellectual Property (IP)
Many companies relegate licensing decisions and patent protection to their legal department. To the extent that IP is part of a company’s technology strategy, it is usually managed so as to preserve the design freedom of the company’s internal staff. Open Innovation companies regard IP as an integral part of technology strategy and insist on managing it at a strategic level within the company. Not only are these companies interested in selling IP; they are motivated and informed buyers of IP as well.
These firms accept that rarely can a company exclusively control an important technology for an extended period. The forces that diffuse knowledge are so many and so strong, that the wiser course is to plan your technology strategy under the assumption that it will be rapidly diffused and imitated.
In a world of powerful forces that rapidly disseminates useful knowledge, the mind-set toward IP changes greatly. One implication of Open Innovation is that companies must increase the “metabolic rate” at which they access, digest, and utilize knowledge. Companies cannot treat their knowledge as static; they must treat it as fundamentally dynamic. A company cannot inventory technology advances on the shelf, for the day when they may prove valuable. Open Innovation companies use licensing extensively to create and extend markets for their technology. Andthe faster the technology gets out of the lab, the sooner the researchers will learn new ways to apply, leverage, and integrate that technology into new offerings.
But doesn’t this run the risk of cannibalizing your own business? This fear is based on a false premise: If you don’t make your products obsolete, no one else will either. While this premise may be true on occasion, it will more often be false in a world of widely distributed knowledge and competence. Competitors often find ways of inventing around a firm’s IP, which allows them to enter the market very quickly, even when the firm seeks to exclude rivals from using its ideas.
The costs for moving too late are much greater than they are for moving too soon. If you err on the side of premature cannibalization, you lose some potential profit you might have been able to eke out otherwise. If you err on the side of delay, the costs are deeper and longer lasting. You lose market share among your customers and must now confront stronger competitors, who now receive additional resources from your former customers.
There is also a subtle, internal cost. Think of your researchers who worked hard to bring the technology through many difficult hurdles and got it ready to go to market. They then watch as someone on the business side squanders their efforts by holding it off the market so that current sales and margins will be maximized. How motivated will these researchers befor the next big push? Will they be willing to provide the ammunition for recapturing the terrain lost to companies that didn’t delay the deployment of their new technology? If you were one of these researchers, wouldn’t you be tempted to move to a company that would make active use of your ideas as soon as you had them available? Most researchers are thrilled to see their ideas in action and to learn from the use that others make of them.
Internal Competition: Increasing the Metabolism of Knowledge
As described in chapter 2, there was a mismatch between the incentives of a laboratory, operating as a cost center, and the incentives of a development group, operating as a profit center. Open Innovation companies try to overcome this mismatch by providing additional channels to market for the technology and enabling business units to source knowledge from places beyond the internal laboratory.
Subjecting the internal path to market (i.e., the business unit expecting to receive the technology) to some competition from other paths to market is an excellent way to increase one’s metabolism of new knowledge. Just because your research team comes up with a better mousetrap does not mean that your sales team is the best way to sell that mousetrap. Your sales team may be distracted by selling earlier successful innovations you have made, while some other organization may be hungry to exploit your discovery in some new and interesting way.
Most companies refuse to countenance licensing to an outside company or refuse to take equity in a new start-up to pursue the technology, because of the risk of internal competition that would result. Open Innovation companies think that a little competition may not be a bad thing. They also know that their internal marketing and sales group may pay more attention and move faster toward adopting a new technology if an external group starts having success with the technology.14
Setting and Advancing the Architecture with Internal R&D
The Open Innovation paradigm is not simply an approach that relies on external technologies for innovation. There remains a critical role for internal R&D in this approach: the definition of an architecture to organize the many parts of a new system. An architecture, a hierarchy of connections between disparate functions within a system, joins the technologies into a useful system. In any early stage of a technology’s evolution, there are many possible ways that the different component technologies might relate with one another. The greater the number of components, the greater the number of possible interconnections between them.
Utilizing internal R&D allows the firm to create a new architecture when the many possible connections within a system are not known. Early in the life of a promising new technology, its characteristics and capabilities may be only poorly understood. The complexities of the new approach create many ambiguities about how best to incorporate it into systems. At this stage, it is difficult to specify interconnections between the new technology and the larger system.15There are many possible ways to partition the system to reduce its overall complexity, and there may be no obvious best way to proceed.
Complete reliance on external technologies to determine these interconnections in such uncertain, complex circumstances is doomed to failure, since the companies making these technologies will all differ on the best way to utilize their technology. In fact, each component maker will want its technology to serve as the critical technology in the system, to enable its maker to obtain more profits and more control over the system. They may even hold up the development of the overall system, to ensure their control over a key part of the system. Moving the resolution of this interconnection problem within the firm allows the firm to bypass the possible holdup tactics by outside companies who perceive that they have obtained control over a key part of the system, due to how the relationships among its parts are defined.
In order to coordinate the complexities and resolve the ambiguities, firms must develop deep expertise in many areas—systems-level expertise—to understand how a technology really works. In so doing, they assess what aspects of the new technology have what consequences for the larger system. The activities in one functional area influence the work of another functional area, so that there is intensive information exchange both within a function and between functions. As these influences become clearer over time, companies are able to partition tasks to resolve the earlier ambiguity they faced.
The resulting interdependencies between the parts of the system are shown in figure 3-2. In this figure, components A, B, and C constitute the system, and they all interrelate. Changing one component requires changes in all the other parts of the system, because the relationships between the parts are not clearly understood.
Developing this understanding of the relationships between the parts of a system and the system as a whole is a critical role for a company’s innovation system. Technically, researchers need to experiment with many varying parameters of the technology to map out how changes in one part of the system affect the response of other parts of the system. In figure 3-2, if someone changes component A in the highly simplified system shown, components B and C must also change. In real systems of thousands of constituent parts, the possible interactions between the components in the system could number in the millions. Mapping out the interactions and then creating architectures to bind these interactions, without having to worry about which parts are advantaged in the struggle for profits and control, are best done through an internal R&D process.
FIGURE 3-2
* * *
An Interdependent Architecture
The use of architectures to reduce interdependencies and limit complexity is only one element of the value added by internal R&D.Companies’ architectures also have powerful implications for how the value chain and surrounding ecosystem will be structured. A valuable architecture not only reduces and resolves technical interdependencies, but also creates opportunities for others to contribute their expertise to the system being built. A good architecture does this even as it reserves opportunities for the firm to carve out a piece of the chain for itself to profit from the research that led to the creation of the new technology. Even very good technologies will flounder if they do not connect effectively to outside complementary technologies, while seemingly inferior ones may overtake them if they are better connected. The need for effective connections requires firms to collaborate with others in their ecosystem, as well as to compete with them.16
Over time, as the technology matures, interdependencies become clearer and more manageable. Companies can specify what they want, they can verify what they get, and they can add or drop vendors to reward or punish compliance. Intermediate markets can now emerge at the interfaces in the architecture, and specialist firms can enter to serveone layer within the architecture. The earlier vertical character of technological competition in the immature phase of the technology, in which internal R&D was critical to sort out the complexities, gives way to a more horizontal phase of technological competition, in which external technologies compete within the partitions of an established architecture.17
FIGURE 3-3
* * *
A Modular Architecture
Figure 3-3 shows the system with the component interdependencies now well understood. In this system, components A, B, or C could change without causing any change in the other components. Firms can now compete to produce the best component A, without having to worry about the potential impact of their better product on other parts of the system. This modular mode enables companies to assemble systems more easily, since they can “plug and play” components whose interface characteristics are now well understood. In a well-established architecture, hundreds and even thousands of firms can innovate better component technologies without worrying about the possible impact of their improvements on other parts of the system.
Open Innovation firms must be adept enough to shift their approach when this transition to a modular architecture arises. Deeply vertical integration, which was vital to sorting out the intricacies of the immature technology in the earlier phase, now becomes a millstone around a company’s neck. Companies must open themselves horizontally by participating in the intermediate markets within the architecture. This may involve externally buying some parts that save money, reduce development time, or provide desired features to the system. It may involve offering components externally to companies that compete at the systems level.
Crafting an Architecture for the Business
Crafting connections between technologies inside a system is necessary to manage the tremendous complexity of modern-day products and services. As challenging as that is, it is only a portion of the task of the innovating firm. It is at least as important to identify how the firm is going to create and capture value from its innovation activities. In chapter 4, we will explore the business model as a construct that creates an architecture for the business through a blend of internal and external activities. As we will see, the activities of external firms can help create significant value for a firm and its customers, while the firm’s own activities are central to retaining a portion of that value for itself.
4
* * *
The Business Model
Connecting Internal and External Innovation
Not everything we start ends up fitting with our businesses later on. Many of the ideas we work on here involve a paradigm shift in order to deliver value. So sometimes we must work particularly hard to find the “architecture of the revenues” . . .Here at Xerox, there has been a growing appreciation for the struggle to create a value proposition for our research output,and for the fact that this struggle is as valuable as inventing the technology itself.
—John Seely Brown
IN CHAPTER 3, I argued that Open Innovation companies needed to combine internal research with external ideas and then needed to deploy those ideas both within their own business and also through other companies’ businesses. The key for these firms is to figure out what necessary missing pieces should be internally supplied and how to integrate both internal and external pieces together into systems and architectures.
The business model is a useful framework to link these technical decisions to economic outcomes. Although the term business model is usually applied in the context of entrepreneurial firms, it also has value in understanding how companies of all sizes can convert technological potential into economic value. Firms can create and capture value from their new technology in three basic ways: through incorporating the technology in their current businesses, through licensing the technology to other firms, or through launching new ventures that exploit the technology in new business arenas.
One critical aspect of this process is that technology by itself has no single objective value. The economic value of a technology remains latent until it is commercialized in some way, and the same technology commercialized in two different ways will yield different returns. In some instances, an innovation can successfully employ a business model already familiar to the firm. Other times, another company will have a business model that can make use of the technology via licensing, and“hires” the technology that it will in turn commercialize.
In still other cases, though, a possible new technology may have no obvious business model. Here, technology managers must expand their perspectives to find an appropriate business model or “the architecture of the revenue,” to capture value from that technology. If the managers fail to do so, these technologies will yield less value to the firm than they might have yielded otherwise. If others outside the firm uncover a better business model, they may realize more value than would the firm that originally discovered the technology. Put differently, a mediocre technology pursued within a great business model may be more valuable that a great technology in a mediocre business model.
The term business model is often used, but not often clearly defined. My colleague Richard Rosenbloom and I have developed a specific and useful working definition.1
The functions of a business model are as follows:
To articulate the value proposition, that is, the value created for users by the offering based on the technology
.To identify a market segment, that is, the users to whom the technology is useful and the purpose for which it will be used
To define the structure of the firm’s value chain, which is required to create and distribute the offering, and to determine the complementary assets needed to support the firm’s position in this chain
To specify the revenue generation mechanism(s) for the firm, and estimate the cost structure and target margins of producing the offering, given the value proposition and value chain structure chosen
To describe the position of the firm within the value network linking suppliers and customers, including identification of potential complementary firms and competitors
