Open Innovation: Promises and Pitfalls
A comprehensive look at open innovation’s benefits and how it can go awry, including the necessity of internal skills and the false economy of cutting R&D costs
Dr. Henry Chesbrough
Tags: innovation • open innovation • R&D • organization • collaboration
Not long ago, innovation was a largely internal affair. The journey from the laboratory to the marketplace took place largely within the four walls of the firm. Think of Bell Labs, IBM Research, or Xerox PARC. Each of them created important technological breakthroughs. And each breakthrough was commercialized through the company’s own businesses.
In recent years, though, this “do it all yourself” approach is increasingly hard to sustain. It costs a lot of money to support each of the many processes needed to achieve success in the market. It takes a long time to complete the journey, at a time when the world is changing more and more rapidly. And it places all the risk squarely on your own shoulders.
This unpromising combination of cost, time, and risk has caused many organizations to rethink their approach to innovation. There is an alternative approach that offers a better combination of lower internal cost, faster time to market, and shared risk. It is an approach known as Open Innovation.
Open Innovation is based on the fundamental idea that useful knowledge is now widespread throughout society. No one organization has a monopoly on great ideas, and every organization, no matter how effective internally, needs to engage deeply and extensively with external knowledge networks and communities. An organization that practices open innovation will utilize external ideas and technologies as a common practice in their own business (outside-in open innovation) and will allow unused internal ideas and technologies to go to the outside for others to use in their respective businesses (inside-out open innovation).
What evidence is there that open innovation actually works? Many individual companies such as Procter & Gamble have proudly proclaimed their success with their version of open innovation called Connect and Develop.[i]
Another consumer products firm, General Mills, analyzed sixty new product introductions in a twelve-month period. They found that those including a substantial contribution from open innovation outsold the ones that did not by more than 100%.[ii]
In the industrial sector, a recent study of 489 projects inside a large European manufacturer found that projects involving significant open innovation collaboration achieved a better financial return for the company than projects that did not.[iii]
However, open innovation can go awry as well. In particular, during the financial crisis of 2008-2009, a number of companies seem to have used the rhetoric of open innovation to make big cuts in internal R&D spending. And when the markets recovered from the significant crisis, many of these same companies had damaged their own ability to innovate and to recover their market position from before the crisis. If and when another market downturn arrives, it will be necessary to apply open innovation properly if organizations are to maintain their innovative capacity.
Defining open innovation
Let’s start by defining Open Innovation. The open innovation paradigm is best understood as the antithesis of the traditional vertical integration model, where internal innovation activities lead to internally-developed products and services that are then distributed by the firm through its own business model. Put into a single sentence, open innovation is a distributed innovation process based on purposively managed knowledge flows across organizational boundaries, using pecuniary and non-pecuniary mechanisms in line with the organization’s business model.[iv]
That is an admittedly academic definition. But it basically means that innovation is generated by accessing, harnessing, and absorbing flows of knowledge across the boundary of the firm, either flowing in or going out.
Outside-in and inside-out open innovation
There are two important kinds of open innovation: Outside-In open innovation and Inside-Out open innovation. The Outside-In part of open innovation involves opening up a company’s own innovation processes to many kinds of external knowledge inputs and contributions. It is this aspect of open innovation that has received the greatest attention, both in academic research and in industry practice. A lot has been written about technology scouting, about crowdsourcing, about open source technology, and about licensing in or acquiring technology.
Many scholars and industry practitioners think that is all that open innovation is about. But that’s wrong. There is a second branch of those knowledge flows that is also a critical part of the concept. Inside-Out open innovation requires organizations to allow unused and under-utilized knowledge to go outside the organization for others to use in their businesses and business models. This process could result in licensing out a technology, or spinning off a new venture, or contributing a project to an open commons, or forming a new joint venture. In contrast to the Outside-In branch of open innovation, this portion of the model is less well understood, both in academic research and also in industry practice.
How open innovation works
My 2003 book Open Innovation[v] is credited by Wikipedia[vi] and other observers for being the first sustained analysis of this new approach to innovation. That book was based on close observation of a small number of companies’ innovation practices. It found a number of cases where what these companies were doing was contrary to the prevailing wisdom about innovation at that time. The prevailing wisdom of the time derived from the work of Michael Porter and Alfred Chandler, two very influential Harvard Business School professors.
Porter’s work argued that firms would innovate more effectively by creating or increasing entry barriers, to keep other firms out of the industry.[vii] Chandler argued that managing R&D was done best by managing internal R&D to create economies of scale and scope. In both professors’ views, the real action was inside the firm, and the outside world was not fundamentally a part of the innovation process.[viii]
In my 2003 book, I showed that this conception was no longer a valid description of the innovation activities of many leading industrial companies. In order to understand what these companies were doing, we needed to move past Porter and Chandler, to a new approach. It is helpful to visualize this transformation via “before” and “after” diagrams of an innovation process (see Figures 1 and 2 below).
Figure One: The Closed Model of Innovation
Figure One shows a representation of the innovation process under the previous Closed model of innovation. Here, research projects are launched from the science and technology base of the firm. They progress through the process, and some of the projects are stopped, while others are selected for further work. A subset of these are chosen to go through to the market. This process is termed a “closed” process because projects can only enter in one way, at the beginning, and can only exit in one way, by going into the market.
AT&T’s Bell Laboratories stands as an exemplar of this model, with many notable research achievements, but a notoriously inwardly-focused culture. Other celebrated 20th-century examples of this model included IBM’s TJ Watson Research Center, Xerox PARC, GE’s Schenectady laboratories, Merck, and Microsoft Research. (It is worth noting that each of these storied institutions has greatly altered its innovation model since my book appeared, and they no longer restrict themselves to a closed innovation model.) In other countries such as Japan, however, the Closed model remains quite popular among many leading companies to this day.
Figure Two shows a representation of the Open Innovation model. The initial focus remains inside the firm, examining its R&D activities. There is still an innovation “funnel”, conducting projects from an initial ideation stage through to the market. However, there are important differences.
Figure Two: Open Innovation
In the Open Innovation model, projects can be launched from either internal or external technology sources, and new technology can enter into the process at various stages, the Outside-In portion of the model. In addition, projects can go to market outside the initial business model of the firm, such as through out-licensing or a spin-off venture company, in addition to going to market through the company’s own marketing and sales channels. This is the Inside-Out part of the model.
I labeled this model “open” because there are many ways for ideas to flow into the process, and many ways for it to flow out into the market. IBM, Intel, Philips, Unilever, and Procter & Gamble all provided early illustrations of some of these aspects of this open innovation model.
As the discussion above shows, the business model plays a critical role in the innovation process. As I reflected further upon this point, I realized that making business models more adaptive might allow companies to obtain more value from innovation, from technology projects that did not fit the organization’s then-current business model.
P&G is an example of such a company. It is best known for its embrace of Outside-In open innovation via its Connect and Develop initiative. But P&G also opens up its business model to license out many of its technologies for others to use. This isn’t as weird as it might seem, because P&G is strategic about how, when, and on what terms it licenses those technologies. As Jeff Weedman of P&G put it to me:
The original view [of competitive advantage] was: I have got it, and you don’t. Then there is the view, that I have got it, you have got it, but I have it cheaper. Then there is I have got it, you have got it, but I got it first. Then there is I have got it, you have got it from me, so I make money when I sell it, and I make money when you sell it.[ix]
Today, business model innovation is becoming a growing area of interest for many authors.[x] However, most organizations treat R&D activities quite separately from the design and improvement of business models. This approach has held back progress in this area.
The good news is that some pioneering thinkers in the entrepreneurship area have created a set of processes that have the capability to explore new business models with potentially valuable internal R&D projects. This is the Lean Startup movement, initiated by Eric Ries, advanced by Steve Blank, and from a design perspective, illustrated by the Business Model Canvas by Alex Osterwalder. Because of their collective work, we know now a great deal more about how to design and test potential new business models.
Open innovation: shifting into services.
Another recent development in open innovation is the consideration of how innovation occurs in services. Most of the top forty economies in the Organization for Economic Co-operation and Development (OECD) have half or more of their GDP from services; and many individual companies are witnessing a shift to services as well. Xerox now gets more than twenty-five percent of its revenues from services. IBM is another classic case, along with GE and Honeywell. And in Silicon Valley these days, there is a whole cottage industry of XaaS, or Everything as a Service.
In some cases what’s really happening is the business model is shifting, which can turn a product business into more of a service business. For example, a GE aircraft engine can be sold for tens of millions of dollars to an airframe manufacturer.
That same engine can also be leased on a so-called “Power by the Hour” program to that airframe manufacturer. In the first case it is a product transaction. In the second case it becomes a service. And in the second case a hidden benefit for GE is all the aftermarket sales and service, spare parts, and so on, that accrue during the thirty-year operating life of the engine. With a Power by the Hour offering, all that work – and revenue – comes back to GE.
More generally for services, innovation must negotiate a tension between standardization and customization. Standardization allows activities to be repeated many times with great efficiency, spreading the fixed costs of those activities over many transactions or customers. Customization allows each customer to get what they want, for high individual satisfaction. The problem is that standardization denies customers much of what they want, while customization complicates the efficiencies available from standardization.
The resolution to this dichotomy is to construct service platforms. These platforms invite others to build on top of your own offering (the platform), so that there are economies from standardization in the platform, along with customization via the participation of many others adding to the platform. Recall that a fundamental premise of open innovation is “not all the smart people work for you”.
If that’s the case, there’s actually more value, not in coming up with yet another building block of technology, but rather in coming up with the architecture that connects these things together in useful ways that solve real problems before other people do. So that system architecture – that system integration skill to combine pieces together in useful ways – becomes even more valuable in a world where there are so many potential building blocks that can be brought together for the purpose.
Platform leadership to me is the business model side of systems integration.[xi] To get others to join your platform, you need to construct a business model that can inspire and motivate customers and developers and others to join the platform. You design your model in ways that they can make money and they can create business models that work for them, even while your business model works for you. Done well, their activities increase the value of your business to you, so their money makes your business more valuable.[xii]
What are open innovation’s problems? When might it go awry?
So far, you might think that Open Innovation sounds wonderful, maybe even too good to be true. And if it is so great, why doesn’t everyone do it? Two large-sample surveys, done in 2013 and 2015, reveal that in large companies, nearly 80% of companies are practicing at least some elements of Open Innovation.[xiii] But those same surveys showed that companies are not satisfied with their measures for managing open innovation.
It is high time to consider some of the problems involved with practicing open innovation. Academics are still publishing open innovation success cases for the most part, or performing large scale statistical analyses that show an innovation benefit to open innovation.[xiv] Some academics have done excellent work on crowdsourcing, to explore how best to construct a request for submissions, and whether or not to have submitting respondents collaborate or compete for the rewards.[xv] With a few notable exceptions,[xvi] however, academics have ignored the very real problems of open innovation failures.
Meanwhile, inside companies one finds many who celebrate their successes with open innovation in a very one-sided way. The barriers they faced, the projects that failed, “the ones that got away,” are all swept under the rug. Many consulting firms now offer open innovation services for interested clients. They too are quick to trumpet positive results, while discretely burying anything that didn’t work as expected.
This behavior shouldn’t surprise us, as these consultants do not want to embarrass their clients (and in the process, perhaps themselves). But we miss the chance to learn from negative experiences with open innovation, causing us to overlook its risks, its problems, and its true character.
In order to move beyond simply celebrating open innovation’s successes, we can start by considering some underlying conditions that must be satisfied. At its root, Open Innovation is about generating, disseminating and absorbing inflows and outflows of knowledge. It isn’t enough to simply discover or locate useful knowledge. That knowledge has to be disseminated to the right people and the right places in the organization. And other people in the organization need to learn it, understand it, and potentially modify or extend it, in order to put it to work inside the organization.
The best way to move knowledge from one person to another, even in this hyper-connected, always-on world, is to put people in close proximity (while not endangering their health because of a pandemic, of course), so that they interact enough to really share and transfer that knowledge. So one critical requirement for effective open innovation is a high level of education and skill in the workforce, combined with a reasonably high level of labor mobility from one organization to other organizations, to diffuse that knowledge broadly throughout society.
Here is one place where we can see why using the rhetoric of open innovation to savage one’s internal innovation capabilities can be so harmful. If you eliminate many of the people who use and transmit this useful knowledge throughout the organization, you effectively reduce the ability of the remaining staff to absorb and apply this knowledge.
In fact, It’s a good idea to rotate people between innovation groups and business units, in order to transfer a promising innovation project into a business unit, make the necessary modifications and adjustments to incorporate it into a business unit, and take it to market. And to take advantage of the Inside-Out branch of open innovation, one or more people often need to move with the project, for some extended period of time, to effectively transplant the project outside the originating firm.
Another requirement for dissemination and absorption of new knowledge is the presence of internal R&D. Some consider open innovation to be a rationale for outsourcing R&D. But this misunderstands the nature of innovation. To transfer knowledge effectively in a way companies can really make use of it, you need a certain amount of creative abrasion and a certain amount of dwell time for people who are working to apply that knowledge together.[xvii]
Open Innovation works best when you have people collaborating side by side, interacting with people who are sharing knowledge from one organization to another. [xviii]These aren’t people from Purchasing, but instead are very talented people from your own organization. A related requirement is people who operate in a boundary-spanning role to connect knowledge from different sources and find ways to mash them together. Such people are sometimes termed “T-shaped managers”.[xix] This is part of the absorption process.
A well-known phenomenon in R&D that can impair Open Innovation’s effectiveness is the “Not Invented Here” (NIH) syndrome. Organizations with strong technical histories often feature R&D personnel who are convinced that if they didn’t invent it themselves, it must not be important or must not be very good. This hubris arises typically in organizations with a solid history of good technical results, and non-technical people are not able to evaluate the capability of internal R&D very effectively on their own. Open innovation depends on internal R&D staff at many critical stages of the innovation process, and so an organization with a strong NIH culture might find many ways to subvert the open innovation process.
One recent paper documented the impact of NIH upon open innovation quite clearly. Hila Lifshitz Assaf did her doctoral studies at Harvard Business School under the direction of Karim Lakhani. She studied the adoption of open innovation practices at NASA, and focused particularly upon the use of crowdsourcing to generate new ideas for NASA. One successful idea allowed NASA to significantly improve its ability to predict solar flares.
But Lifshitz Assaf’s (2017) work went beyond this successful idea. She looked at the impact that the idea had inside the engineering organization at the Johnson Space Control Center at NASA. Internal engineers were troubled by the result obtained from outside. Their sense of identity, and their understanding of their role in the organization, seemed threatened by the open innovation outcome. I suspect that many R&D intensive organizations have responded similarly to the practice of open innovation in their own company.
There are more subtle problems that arise with Open Innovation as well. If one succeeds in fielding a successful call for solutions to a crowd or innovation community, one will likely attract a lot of submissions. It takes time to review all of these submissions, and the level of quality of most of them is often rather poor. Perhaps worse, if a great many more ideas enter into a company’s innovation process, and the company has not invested in greater downstream capacity to process these ideas, the wealth of new ideas can create bottlenecks that slow down the overall innovation process – instead of stimulating far more innovation.
So open innovation doesn’t come for free. It requires capable, knowledgeable, experienced internal staff, and it requires new skills from that internal staff to connect, collaborate, and transfer useful knowledge across the boundaries of organizations. I recently did a search on LinkedIn, and found over 58,000 people that had “open innovation” as part of their role in their job. At that same time, I found over 6,000 open jobs that had “open innovation” as part of the job description. So this approach is clearly a growing trend.
Where is Open Innovation Going?
Open Innovation began as a series of case studies that examined collaborations between two organizations to open up the internal innovation process of the focal firm. Today, though, we see many instances in which the concept is being used to orchestrate a significant number of players across multiple roles in the innovation process. Put simply, designing and managing innovation communities is going to become increasingly important to open innovation’s future.
Many observers have noted how firms like Uber, Airbnb, and Amazon have developed quite valuable businesses by building and scaling platforms that connect customers for various goods and services with disparate suppliers of those goods and services. These are relatively pure forms of platforms, characterized by the platform owner not needing to own any of the assets being traded.
But open innovation goes well beyond these pure play examples. It is actually transforming a variety of consumer (B2C) and industrial (B2B) businesses, by extending their reach and focus to the surrounding ecosystem in which they operate. Playing close attention to one’s ecosystem can unlock new sources of growth for these firms. Ron Adner has written a wonderful book that addresses this point at length, though not in the context of open innovation.[xx]
To see concept this more clearly, take the example of General Electric and its “ecomagination” challenge back in 2010. While GE has a very large energy business of its own, with revenues of nearly $40 billion annually, the company has noticed a great deal of venture capital and startup activity in green and renewable energy technologies. Recognizing its own limits, GE sought to establish a process to tap into the potential project ideas out there that had the potential to become promising new ventures in green and/or renewable energy.
But GE did this in an open way. Instead of doing all the work itself, the company enlisted four active venture capital firms who had already had experience investing in this space. Together, the four VCs and GE pledged a total of $200 million to invest in attractive startup ventures. The ecomagination challenge was born. In July of 2010, the challenge was launched to the world, and everyone was invited to submit potential project ideas for consideration for startup investment.
In the process, more than 3,800 venture proposals were received (they were expecting perhaps 400). Twenty-three ventures have been funded, with five other projects receiving other awards, and even a People’s choice award was given as well. While the ventures are still quite young, the VCs and GE are all enthusiastic about the experience. GE’s level of enthusiasm has led the company to adapt the model to the health care space (a Healthymagination challenge was launched in 2011) and also in China (a challenge was launched there as well).
And one need not be a large company to open up to the community in one’s innovation process. A small firm in Florida, Ocean Optics, has instituted a community innovation challenge on a much smaller scale.[xxi]
Open innovation offers a great deal of opportunity, for the firms that embrace it and for the larger society that sustains it. To get the most out of open innovation, however, we will need to pay close attention to the boundary conditions that support or inhibit effective open innovation.
The innovation capabilities of organizations around the world will no longer stop at the boundaries of one’s own organization. Instead an organization’s open innovation practices will extend to suppliers, customers, partners, third parties, and the general community as a whole. And new work skills will be required, in order to get real business results out of this new innovation process.
As one R&D manager explained to me, “It used to be that the lab was our world; with open innovation, the world is now our lab.”
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About the Author
Henry Chesbrough is best known as “the father of Open Innovation.” He teaches at the Haas School of Business at the University of California-Berkeley. He is also Maire Tecnimont Professor of Open Innovation at Luiss University in Rome. He has written several books including Open Innovation (Harvard Business School Press, 2003), Open Business Models (Harvard Business School Press, 2006), Open Services Innovation (Jossey-Bass, 2011) and Open Innovation Results (Oxford, 2020). He has been recognized as one of the leading business thinkers by Thinkers50. He received an Innovation Luminary award from the European Commission in 2014. He received the Industrial Research Institute Medal of Achievement in 2017, and has two honorary doctorates.
[i] See L. Huston and N. Sakkab, “Inside Procter & Gamble’s new model for innovation: Connect and develop”, Harvard Business Review, 2006.
[ii] Personal conversation between Mike Helsel and the author, Oct. 15, 2014
[iii] Du. Leten and Vanhaverbeke, “Managing open innovation projects with science-based and market-based partners.” Management and Organisation, Amsterdam Research Institute, 2014.
[iv] See H. Chesbrough and Marcel Bogers, in Chesbrough, Vanhaverbeke and West, New Frontiers in Open Innovation, Oxford University Press, 2014, p.1.
[v] H. Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Press, 2003.
[vii] Michael Porter, Competitive Strategy, (Free Press:New York, NY), 1980; Michael Porter, Competitive Advantage, (Free Press: New York, NY), 1985
[viii] Alfred Chandler, Scale and Scope: The Dynamics of Industrial Capitalism, Harvard University Press, 1990
[ix] The quotation is from H. Chesbrough, Open Business Models, Harvard Business School Press, 2006, p. 201
[x] See Mark Johnson’s book, Seizing the White Space: Business Model Innovation for Growth and Renewal, Harvard Business Press, 2010, Alex Osterwalder’s book, Business Model Generation, Wiley, 2010, and a special issue of Long Range Planning that was dedicated entirely to academic articles on business models, volume 43, issues 2-3, 2010.
[xi] See Annabelle Gawer and Michael Cusumano’s excellent book Platform Leadership (2002), for an in-depth analysis of what it takes to build and sustain leadership within a platform. Geoffrey Parker and Marshall VanAlstyne’s Platform Revolution: How Networked Markets Are Transforming the Economyand How to Make Them Work for You (2016) updates this thinking for today’s digital era.
[xii] H. Chesbrough, Open Services Innovation: Rethinking Your Business to Grow and Compete in a New Era, (Jossey Bass, 2011).
[xiii] For details on these surveys, see Chesbrough and Brunswicker, 2013, and Brunswicker and Chesbrough, 2015. Our sample was restricted to firms with annual sales over $250 million, headquartered in either the US or Europe. So they cannot inform us about small firms’ use of open innovation, nor the use of open innovation in other parts of the world.
[xiv] See Laursen and Salter, 2006 and Du. Leten and Vanhaverbeke, 2014, for two excellent large sample analyses that show a statistically significant benefit to the use of open innovation in firms.
[xv] See K. Boudreau and K. Lakhani, “How to manage outside innovation”, Sloan Management Review, 2009 for a good discussion of the benefits of competition vs. the benefits of collaboration in innovation communities that propose solutions to problems.
[xvi] See Hila Lifshitz-Assaf’s excellent article on OI at NASA: “Dismantling knowledge boundaries at NASA: From problem solvers to solution seekers,” SSRN 2016, forthcoming, Administrative Science Quarterly.
[xvii] Ikujiro Nonaka and Hiro Takeuchi (1995) established the importance of managing knowledge by getting team members to engage with one another extensively. This was particularly needed for experiential, or tacit, knowledge.
[xviii] A nice recent analysis of the role of teams in open innovation initiatives can be found in Amy Edmondson and Jean-Francois Harvey’s 2017 book Extreme Teaming. They were even kind enough to allow me to write the Forward to their book!
[xix] Morten Hansen (1999) has done some excellent work on the importance of T-shaped managers. The base of the T refers to the person’s deep expertise in some domain of knowledge. But the cross of the T refers to the ability of that manager to engage with other experts from other domains of knowledge, and to find connections between the domains.
[xx] See Ron Adner, The Wide Lens (2012) for an insightful discussion of the role of complementers in the ecosystem in promoting a successful innovation, or inhibiting the success of an otherwise promising innovation.