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Open innovation - realizing the potential

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open innovationDespite all the hype about open innovation, the reality is that few have institutionalized open innovation practices in ways that have enabled substantial growth or industry leadership.

The ability to move into and out of different industries by capitalizing on ideas and concepts from inside and outside the organization – open innovation – has tremendous value, but without the appropriate mindset and the operational structure in place, the promise of open innovation cannot be realized.

There is a key first step for corporate leaders – to deliver on the promise of open innovation, start by making the change from a competition-focused, market-share mindset to a competence-based one.

Open Innovation

Seven years ago, open innovation was a bold and radical notion, challenging established innovation mindsets in R&D labs and boardrooms around the world. As companies sought competitive advantage via innovation, Professor Henry Chesbrough urged top leaders to recognize and act on his radical concept of opening up the corporation to the outside world.

A few leading corporations like IBM, Apple, Procter & Gamble (P&G) and several pharmaceutical companies were already experimenting with variations on Chesbrough's ideas, wrapping process and discipline around the theory developed by the University of California's innovation guru. Indeed, one could argue that the notion gave focus to a massive cultural transformation of "openness" that was as much about changing mindsets about customer value as it was about shifts in the product development and commercialization processes.

Why no institutionalized open innovation?

We believe that there are four common chronic conditions that explain the gap that exists between the promise and reality of open innovation in most organizations:

  1. An unwillingness to change comfortable habits and practices, especially when it comes to sharing ideas and intellectual property with anyone outside the organization.
  2. A managerial mindset that thinks of competition primarily in terms of a battle for market share in a zero-sum game – rather than a battle for new markets using competence-based advantage to produce customer value.
  3. Organizational and incentive structures that promote and reward the exclusive use of internal resources for high-value added activities.
  4. A mindset that views open innovation only as a new product development and commercialization process – rather than an integral part of ongoing strategy.

As a result, open innovation is unlikely to achieve its potential in most companies. So, the first step in delivering on the promise of open innovation is for leaders to start making the change from a market-share mindset to a competence-based mindset. This leads to an organizational environment in which open innovation can become a key enabler for organizational growth and competitive advantage.

IBM learns to compete based on new competencies

IBM was a textbook example of how to compete within an industry. Its economies of scale, depth of expertise, and organizational command made it impossible to attack head-on. Yet, by 1993, this giant was failing to keep-up with new rivals in the computer industry.

Had IBM continued to pursue an industry-focused mindset, it would never have become the company that we see today. IBM's changes can be traced back to a mindset shift – from one that was industry-focused to one that was benefit-driven and competence-focused. While the old IBM failed to see the changes that the PC brought to the industry, the new IBM would not fail to capitalize on the new opportunities created by those changes. IBM changed its mindset from competing solely on market share to competing for competence-based leadership – choosing, for instance, which parts of IBM's vertically integrated value chain were worth keeping and which were not. This mindset change led to a cascade of managerial decisions that required rethinking everything from organizational structure to marketing actions.

Starting with a new foundation for a more open culture early on, IBM went on to create a much more open business model, flexible enough to continuously drive organic growth. The lesson here though is that it was the combination of cultural expectations, managerial mindset, and competence-based focus that led to IBM's success in becoming open.

IBM's story is vital to understanding the risks one takes when focusing too heavily on a market-share mindset. But, it's also a case study in how an organization can grow through open innovation. When the two ideas are brought together, the case illuminates why organizations should focus on competence-based strategy before looking to open innovation as the engine for growth.

Know who you are (and who you are not)

Organizations that excel at open innovation have a deeply shared view about "who they are." They have spent time and effort defining themselves not in terms of the products or services they offer or the markets they serve, but in terms of what they are uniquely good at that can make a difference in the world – their core competences.

They ask questions related to two fundamental aspects of the opportunity and the business:

  • How far removed is the opportunity from the core competencies that define our organization?
  • If far enough removed, is there a reason to believe that the opportunity will enhance the space we've chosen to compete in?

By answering these questions, these companies begin to compete outside of their traditional boundaries.

"Done right, open innovation can bring tremendous value to you, your customers, and your shareholders."

P&G learns how to be open

P&G are arguably the world's most notable open-innovation company. P&G knows something about who it is and who it isn't. It believes that it is a master of brand management and marketing, which recently has translated into powerful brand extensions in markets it dominates. Its transformation of the dental-care market provides a great example. Crest, its flagship dental product, generates brand loyalty for P&G every time a customer chooses the product over the many others available. Now, if Crest can solidify a strong relationship with customers in regards to oral hygiene, then it can potentially attract loyal customers for an entire oral-hygiene solution. To deliver an entire oral-hygiene solution might add significant costs without adding significant value. Therefore, P&G looks at open innovation as a means to solving a very specific problem: the need to source products and technologies in a way that leverages and strengthens its brand.

So what answers would P&G get if it asked the two key open innovation test questions?

Is the opportunity far removed from our core competency? Yes, as described above, the technology and science required to develop these products don't require the same set of skills, processes, technologies, values and assets required to build and maintain a brand focused on oral hygiene.

Does the opportunity enhance the space we've chosen to compete in? Yes, by considering the opportunity space as "oral hygiene" instead of "toothpaste" Crest has opened the door to bringing to the marketplace any product that improves oral health.

Apple's use of open innovation to serve many markets

Of all the turnarounds in the past decade, Apple is arguably the most successful. The company came from the brink of irrelevance to become the largest technology company in just over a decade. Apple diversified outside of the computer niche it lived in for two decades into many new markets, where it competes successfully.

The historical challenge to Apple was that this approach dictated that many aspects of its computers be controlled – including design, operating systems, manufacturing and software. Limited to the PC industry, these controls pushed Apple into niche markets – such as for educators, designers, graphic artists. However, when Apple made the decision to use its competency to solve problems in other industries, like music, it discovered that it could indeed solve – or at least simplify – those problems and create new growth in these industries.

What Apple learned to benefit from in music – either accidentally or on purpose – is the same lesson it applied openly in software. The question Apple asked was, "why limit software development to only large development companies that charge significantly for their development?" The capital requirements of software development these days are minimal, and the demand for variety is huge. Therefore, Apple let anyone create and market (using the technological constraints that make them "Apple-like") mobile applications in exchange for a small share of the revenue generated by these apps. In doing so, Apple is offering an incentive for developers to create, within an open environment, applications that compliment the value that they bring. At the same time, they are extracting their own value out of the relationship.

Apple uses a form of open innovation to exploit its customers' desire for variety in content, which can be delivered by its competency set. It achieves dramatic growth by connecting its competency to content that is created both within and outside its organization.

Taking the next steps

Chesbrough's original concept of open innovation provides a means for developing a strategic advantage. The ability to move into and out of different industries by capitalizing on ideas and concepts from inside and outside the organization has tremendous value. It also provides established companies with a way to keep up with new entrants as industries mutate and evolve. However, without the appropriate mindset and, ultimately, operational structure in place, the promise of open innovation cannot be realized. The three companies discussed – IBM, P&G, and Apple – and many others like them that have begun moving into open innovation, have found that, in order to be successful, they need to change organizationally before they can fully embrace open innovation. Their culture, leadership, incentives, skills, operational process, and a whole host of internal systems have historically been optimized for maintaining a closed system. Knowing who they are and what they are good at, they are then able to begin restructuring their organizations to take advantage of the benefits that open innovation offers.

Q. How do you identify productive avenues for open innovation in your organization?
A. By following these steps:

  1. Define your company's core competences – the one, two, or three bundles of skills, processes, technologies, assets, and values that explain your success and deliver value to customers.
  2. Define new areas of growth where you can leverage your core competences.
  3. Each area of growth you define might require a business model that needs not only your core competence, but also some additional ones. Define competence gaps for each area of growth.
  4. Look for potential partners who can fill these gaps so that you don't have to change your core competences.
  5. Change your internal processes and culture to allow these outside partners to begin playing a vital role in filling the gaps and completing the business model required for success in your new growth area.

Instituting a process that provides comfort as you move into open innovation is not something that happens overnight. It’s an iterative process that takes time and experimentation to get right. Additionally, it's a company-specific process – because each company is different in terms of who it is, what it delivers, and how it has historically structured itself to get to where it is today.

Which brings us to a final word of caution – this is not a copycat process. Each company has a specific set of competencies that allows it to compete in different and unique ways. Those who just go about copying, because something was successful, will find themselves asking, "Why doesn't this work for me?" If you're doing that, then you're not focused on what it is you can offer the market. Done right, open innovation can bring tremendous value to you, your customers, and your shareholders. Ask the right questions, establish the right internal structure, and plan appropriately, and you'll find yourself well on your way to success.

January 2011
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This is a shortened version of "Delivering on the promise of open innovation", which originally appeared in Strategy & Leadership, Volume 38, Number 6, 2010.

The authors are Jorge Rufat-Latre, Amy Muller and Dave Jones.