Business Model Innovation By H Chesbrough

Business Model Innovation: The Next Frontier in Innovation Presentation on the Occasion of the Launch of “Open Business Models” Firenze, Italia Henry Chesbrough Haas School of Business UC Berkeley © 2008 Henry Chesbrough 1

Great Successes from the Closed Innovation Model • The Venetian Glass Industry • The Roman Catholic Church • The Chemicals Industry – Germany and later US • Edison, GE, and the rise of electrification • Vannevar Bush – Science: The Endless Frontier • Chandler: Internal R&D key to the rise of the modern US corporation in 20th century © 2008 Henry Chesbrough 3

Hidden Assumptions in the Internally- Focused Innovation System If I discover it, I will find a market for it. If I discover it first, I will own it. The important technologies I will need can be anticipated in advance. “Misfits” are regrettable, but are a cost of doing business. The best people in this field work for us. © 2008 Henry Chesbrough 4

The Open Innovation Paradigm Other Firm’s Licensing Market Technology Spin-offs New Internal Market Technology Base Current External Market Technology Base Technology Insourcing © 2008 Henry Chesbrough R D 5

Closed innovation Open Other firm´s market Licence, spin Our new out, divest market Internal technology base Internal/external Our current venture handling market External technology insourcing External technology base Stolen with pride from Prof Henry Chesbrough UC Berkeley, Open Innovation: Renewing Growth from Industrial R&D, 10th Annual Innovation Convergence, Minneapolis Sept 27, 2004 6 C 2002 Henry Chesbrough EIRMA SIG III, 2005-10-20

The Logic of “Open Innovation” • Good ideas are widely distributed today. No one has a monopoly on useful knowledge anymore. • Financial managers must play poker, as well as chess, to capture the value in false negatives. • We must manage IP in order to manage research: – need to access external IP to fuel our business model – need to profit from our own IP in others’ business model • Not all of the smart people in the world work for us. © 2008 Henry Chesbrough 7

What is Innovation? Before After • Invention • Commercialization • Product • Business, including process and biz model • Technology-driven • Business/value-driven • Internally generated • Internal Integration of • Engineering’s job int. and ext. stuff • Everyone’s job © 2008 Henry Chesbrough 9

Ryan Air • Ryan Air is a regional low-fare airline operating in the United Kingdom and northern Europe. • Only flies into regional airports, no landing fees. • Guarantees airport certain # passengers in their terminal • Airport pays Ryan Air to operate out of its airport • Airport provides Ryan Air a percentage of the revenues from shops, restaurants, car hire and hotels at airport. © 2008 Henry Chesbrough 14

IBM: Its Closed Value Chain All IBM – pre 1993 Solutions Value-Added Activities Applications Productivity SW Operating Systems Computers Chips, devices Atoms Materials Value Chain © 2008 Henry Chesbrough 16

IBM’s Open Business Model Integration Other Integrators Solutions Value-Added Activities Applications Applications Productivity SW Productivity SW Operating Systems Operating Systems Computers Computers Chips, devices Chips, devices Atoms Materials Materials IBM Chain OEM Market © 2008 Henry Chesbrough 17

IBM’s Open Source Business Model • Spends about $100M each year on Linux – 50% for general improvement – 50% for specific improvements for IBM gear • Others spend another $800M a year • IBM creates value through Linux – Also donates development tools, patents • IBM captures value through value-added services and software “up the stack” © 2008 Henry Chesbrough 18

The Business Model • Identifies a market segment • Articulates the value of the proposed offering • Focuses on the key attributes of the offering • Defines the value chain to deliver that offering • Creates a way for getting paid • Establishes the value network needed to sustain the model © 2007 Henry Chesbrough 19

Business Model Maturity Stages 6 stages 1. Undifferentiated business model 2. Differentiated business model 3. Segmented business model 4. Externally aware business model 5. Integrated business model 6. Platform leadership business model © 2007 Henry Chesbrough 20

Stage 3 - Segmented • Can serve multiple segments • More profit, more volume (low cost) • More sustainable • Still too internally focused • Example: many industrial firms; Xerox © 2007 Henry Chesbrough 23

Stage 4 – Externally Aware • Now harnesses external sources of technology to complement internal • More “at bats” with same dollars • Share risks as well as rewards • Broader market now available to serve • Example: SAP R/3; Big Pharma © 2007 Henry Chesbrough 24

Stage 5 - Integrated • External sources routinely utilized to fuel your business model • Unused internal ideas allowed to flow outside to others’ business models • Company becomes a systems integrator of internal and external technologies • Examples: Millennium, other biotechs; Nike; Procter & Gamble © 2007 Henry Chesbrough 25

Stage 6 - Platform • Ultimate stage, an ideal • Company now benefits from investment of others in the platform. Company can induce investment. – Suppliers, customers, third parties • Ecosystem created – Company must balance value creation with value capture – Cannot become predatory, destroys ecosystem • Examples: iPod; .NET, WebSphere, Dell, WalMart © 2007 Henry Chesbrough 26

Who Owns Business Model Innovation? Marketing? Research and Development? Operations? Business CEO/COO Unit GM ? Corporate Strategy Office? ? Business Development? Finance? | 27 |

Why Business Models are Hard to Innovate: Mapping Across Domains Business Technical Model Economic Inputs: • target market Outputs: e.g., • value prop. e.g., feasibility, • key attributes value, performance • value chain price, • how paid profit •Value network Measured in technical domain Measured in social domain © 2007 Henry Chesbrough 28

3Com • Metcalfe left PARC in Jan. 1979 • Did consulting work until Feb. of 1981 – DEC, GE, Exxon • Brokered alliance between Xerox, DEC, and Intel for IEEE 802 (aka Ethernet) • Initial plan: sell to Unix workstations, via direct sales force © 2007 Henry Chesbrough 30

Then…. • As part of consulting, created directory of LAN dealers and VARs across US – first of its kind – sold many hundreds of copies at $125 each – did this for 5 years • IBM PC took the world by storm • 3Com formed, Krause joined from HP – VCs financed: • New plan: add-on boards for IBM PCs, sold through IBM retailers and VARs © 2007 Henry Chesbrough 31

Adobe • Warnock and Geschke at PARC – creating fonts for Star Workstation – wanted to make into a standard – Xerox said no: “how can we make money if we give it away?” • They leave, and form Adobe • Initial plan: turnkey publishing system, complete with own hardware, software, and fonts © 2007 Henry Chesbrough 32

“We were originally going to supply a turnkey systems solution including hardware, printers, software, etc. “Steve Jobs and Gordon Bell were key ingredients in getting things going… Gordon said, “don’t do the whole system” Steve said, “just sell us the software”. That’s how the business plan formed. It wasn’t there in the beginning.” - Charles Geschke Today, Adobe’s market value exceeds that of Xerox © 2007 Henry Chesbrough 33

Different Financial Processes Chess: Type I errors Poker: Type II errors • Plan several moves • Pay to play ahead • Pay for new • No new information information needed • You know what • You discover what you’ve got, what you’ve got, what opponent has other players have • NPV • Options © 2007 Henry Chesbrough 34

Xerox: Great at Chess, Lousy at Poker 40000 Xerox 3Com 35000 Adobe Doc Sci Documentum FileNet 30000 Komag Objectshare SynOptics SDLI US Dollars (millions) 25000 VLSI Sum (10) 20000 15000 10000 5000 0 78 80 82 84 86 88 90 92 94 96 98 00 19 19 19 19 19 19 19 19 19 19 19 20 © 2007 Henry Chesbrough 35 Year

The Economic Pressures on Innovation in the Market Product Life Shorter Revenue Market Own Revenues Own Market Revenue 0 Internal. Internal Development. Development Costs Costs Costs Rising costs of innovation Closed Closed Model Model After Before © 2007 Henry Chesbrough 37

The New Business Model of Open Innovation Revenues New Mkts New Spin-off Revenue Licensing Own Own Market Market Revenue Revenue Internal. Internal and Development. Cost External Dev. Costs Costs Cost and Time savings from leveraging External development Closed Open Innovation Model Business Model © 2008 Henry Chesbrough 38

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Business Model Innovation By H Chesbrough

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