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  • 1. Innovation SPOTLIGHT ON INNOVATION How Open Innovation Can Help You Cope in Lean Times These strategic moves can reduce HISTORY SHOWS THAT the companies that continue to invest in their innovative capabilities during tough economic the costs of R&D today without times are those that fare best when growth returns. That’s sacrificing tomorrow’s growth. how the U.S. chemicals industry overtook Britain’s after World War I, how Sears surpassed Montgomery Ward as the leading | by Henry W. Chesbrough and U.S. retailer after World War II, and how Japanese semiconduc- tor makers outpaced U.S. companies after the downturn of the Andrew R. Garman early 1980s. In a challenging business climate, focus is crucial. But com- panies face a real dilemma: how to maintain that focus and manage costs tightly while keeping growth options alive for Peter Crowther the future. Deferring or canceling less promising initiatives that might have been pursued in good times allows a busi- ness to survive and eventually thrive again. Many companies give attention and resources only to the projects that are most 68 Harvard Business Review | December 2009 | hbr.org
  • 2. Innovation SPOTLIGHT ON INNOVATION How Open Innovation Can Help You Cope in Lean Times likely to generate near-term profits, and they end that put their own money into launching spin-off up deciding quickly which initiatives fit best with companies (see the sidebar “Inside-Out Venture the company’s core business. It’s a smart short-term Capital” on page 74). These spin-offs – including strategy. Azure Solutions, Vidus, and Psytechnics – produce The downside of rigorous prioritization, however, telecommunications technologies and services that is that it halts many potentially promising projects are key components of larger offerings from BT to at an early point in their development and leaves its customers. And BT can market these offerings them stranded inside the company. Over time, so without shouldering the long-term burden of fund- hbr.org many projects get abandoned that the company’s ing, developing, and upgrading them. According This article was ability to grow beyond its core business is threat- to the firm’s chief science officer, Mike Carr, “BT originally published ened. If focus is maintained for too long or with too needed to focus on being a top provider of network at HBR.org and has been updated for much rigidity, it can become the enemy of growth. services, not on building hardware and software print presentation. When the market recovers, the company lacks a products. The partnership approach gives us suf- foundation from which to rebound. ficient funds to develop technology right through Open innovation can play an important part the marketing process.” in the solution. By breaking down traditional cor- In becoming a customer for its previously inter- porate boundaries, open innovation allows intel- nal projects and spinning off nonstrategic initiatives lectual property, ideas, and people to flow freely to other firms, BT exemplifies two of the five inside- both into and out of an organization. To date, much out open-innovation moves that we have identified more attention has been paid to the inbound flow, (see the exhibit “Move Innovation from the Inside which we call outside-in open innovation – outsiders’ Out”). All five allow a company to focus on its core contributions that enable an enterprise to create operations today while preserving growth options offerings whose scale belies its internal capabilities for tomorrow. Let’s examine these moves. (see “A Better Way to Innovate,” HBR July 2003). However, in lean economic times, it is the often Move 1: Become a Customer or overlooked “inside-out” aspect of open innovation Supplier of Your Former Internal Projects that can best serve a company. Inside-out open inno- In hard times, companies must make the tough vation refers to processes whereby a business places choice either to continue or to stop funding prom- some of its assets or projects outside its own walls. ising projects. Seldom considered is a third choice That not only saves much of the that offers greater flexibility: Pursue a project as time and money being invested a customer or supplier instead of developing and in those projects, but also can bringing it to market on your own. The simple idea IDEA nurture new supplier and part- is that by taking a smaller role in the project, you re- IN BRIEF ner relationships, promote inno- duce your costs and your risks. If the project is suc- » During tough economic times, vative ecosystems, and generate cessfully developed by another firm, you still par- placing certain assets and projects high-margin licensing income ticipate in that success, albeit in a more limited way. outside your company’s walls can (see the exhibit “The Inside-Out For example, Eli Lilly began a project called Bounty actually preserve opportunities for Process”). Chem to improve its sourcing of external ideas for future growth while you take the Consider BT (formerly British developing new drugs. The company quickly real- time to shore up the fortress. Telecom), long the leading phone ized that the project would be more effective if it » Some inside-out strategies company in Britain. During the sourced ideas for lots of other companies, too. So involve opening up projects to 1990s, the company transformed Lilly helped launch what became InnoCentive and investment and development by itself into a global telecommu- was its first customer. Lilly paid only for the services existing outside firms; others call nications services firm. After the it actually used; the costs and risks of the InnoCen- for spinning off projects as sepa- rate ventures that still allow you telecom bubble burst in 2000, BT tive project were shared by multiple customers and to retain some equity. needed to marshal its resources outside investors. and refocus. One critical step An interesting variation on Move 1 makes sense » The inherent cultural, political, was to create a process for plac- in situations where three conditions are met: A and organizational challenges ing its homegrown technologies company has identified a new market or appli- of inside-out open innovation can be met by approaching it holisti- and intellectual property in ex- cation for a product; the cost of engineering a cally and placing it under the ternal hands. Since 2003, BT has solution or building a channel to market is high; leadership of senior executives formed strategic partnerships and the solution doesn’t fit with the firm’s core in strategic roles. with venture capital investors strengths. For example, Element Six, a subsidiary 70 Harvard Business Review | December 2009 | hbr.org
  • 3. of De Beers, is the world’s leading The Inside-Out Process supplier of diamond supermateri- WHEN YOU PLACE some of your internal projects outside als for industrial applications. The the company’s walls, you can reduce R&D costs without company discovered that an appro- relinquishing related growth opportunities. Each project will priately engineered diamond wafer take a unique path to its most strategically sensible destina- could be used to create the anode tion. Your job is to chart the course. in a small electrolytic device that generates ozone in water at a low RESEARCH DEVELOPMENT cost. (Ozone can be used to help kill waterborne pathogens.) Ele- Existing Outside Firms Some projects you ought to ment Six has a strong core compe- open up to investment and tence in manufacturing diamond development by existing wafers but not in engineering and outside firms (orange dots). distributing electrolytic devices. In 2009, Element Six created a new Your Company company, Electrolytic Ozone, to de- Some projects should sign, manufacture, and market the be kept in-house (gray dots). devices. The spin-off company will ultimately become a significant purchaser of the parent’s diamond wafer product, with the majority of Spin-Off Ventures Others can be spun off as the capital and resources coming separate ventures that allow from third parties. you to retain some equity Internal Projects (green dots). Move 2: Let Others Develop Some projects migrate during development. Your Nonstrategic Initiatives A tough economic period calls for focus and crisp execution and, thus, is an opportune time to eliminate distractions. scarce funds to support “freed” projects is reduced Simply killing projects that haven’t yet proven or eliminated. However, when a project succeeds, their potential – or that lie outside the core – is an management may need to be reminded that the easy way to refocus, but ending too many of them spin-off kept options alive and that owning part of diminishes the company’s long-term growth pros- something is better than owning all of nothing. pects. A better strategy is to spin off some of those Spin-offs, of course, face demanding survival projects to outside investors, perhaps keeping a challenges. They have to find outside sources of piece of the action for yourself. If the spin-off fails, capital, recruit talented leaders and staff, and ulti- you save the additional time and money you would mately attract customers. These are difficult tests have spent on the project. If it fares well, you have that many projects will not pass. However, those several attractive options: maintaining or increas- that do will develop with others’ time and money, ing your equity position, acquiring the spin-off, or not yours. Consider Lucent’s experience with an selling your position to other investors. internal project that eventually became Lucent One obvious caveat is that spinning off projects Digital Video. Initially, management viewed the means sharing the upside value with third parties. technology as being ahead of its time and, there- In a downturn, that makes sense: The outflow of fore, too small to be of strategic interest. So the A company may abandon so many projects that its ability to grow beyond its core business is threatened. hbr.org | December 2009 | Harvard Business Review 71
  • 4. Innovation SPOTLIGHT ON INNOVATION How Open Innovation Can Help You Cope in Lean Times company spun it off as a separate venture. Once up One recent example comes from CH2M Hill, a and running, the venture demonstrated that China $6 billion environmental services company. With and other key markets in the developing world had partner ADA Technologies, it codeveloped valuable a pressing need for technology that would help patents describing an inexpensive and effective way them accommodate future digital traffic. Moreover, to control mercury emissions from coal-fired power many of those markets were buying Lucent equip- plants. Neither partner is a product company, so ment alongside the venture company’s digital video they both contributed IP to a new product-based encoders. As a result, Lucent eventually decided to start-up funded by outside investors. This mercury- reacquire the company. control technology will be jointly marketed by The odyssey of Lucent Digital Video illustrates CH2M and the start-up, thereby complementing how you can get an unexpected dividend from this CH2M’s utility-service offerings to its customers kind of spin-off. Having off-loaded the burdens of (and using the principle of Move 1). funding and managing the project, Lucent was able Royal Philips Electronics, of the Netherlands, to profit from the market’s “second opinion,” which has done something similar. A global leader in con- revealed the project’s true strategic value. If Lucent sumer electronics, Philips has sought to restructure had kept the project inside, it probably wouldn’t in response to intense, low-cost competition from have identified the opportunity so quickly. Asian manufacturers. It has spun off its semicon- ductor business and now focuses on the health care Move 3: Make Your IP Work Harder and wellness markets. This strategic shift stranded for You and Others many internal ideas and IP assets originally de- Many companies own lots of intellectual property veloped for the legacy electronics business, and (IP) that delivers no direct financial benefit be- the company is using them to make several open- cause it sits on the shelf. A valuable inside-out open- innovation moves. It’s capitalizing on the more than innovation move is to put that IP to work in other 60,000 patents in its portfolio to earn hundreds of companies. millions of euros annually from licensing (Move 3). Move 1: Become a customer Move 2: Let others Move or supplier of your former internal projects develop your nonstrategic initiatives Innovation from the IF your business is pursuing an important capability that it can neither afford to de- IF your business is refocusing on its core activities and you’ve identified adjacent, Inside Out velop itself nor acquire on the open market, and others in or beyond your industry also complementary initiatives that drain too much attention, time, and capital but that covet the capability… might attract outside interest and FIVE OPEN-INNOVATION MOVES investment… provide a framework for getting the greatest value from your research THEN join with those others to fund, THEN spin them out to investors who can initiatives – now and in the future. develop, and launch it as an independent take over the development burden. Others business, and become its first customer. will fund the progress, and you can keep some equity in case they make it big. You can even reacquire the best ventures. EXAMPLE Eli Lilly turned an internal proj- EXAMPLE Lucent Digitial Video was built ect whose goal was to create a superior upon technology that Lucent initially judged process for sourcing ideas and expertise to be nonstrategic. Putting it up for adop- for new-drug development into an inde- tion helped Lucent focus on its core. Once pendent venture that eventually became investors proved there was a strong global InnoCentive. market for digital video encoders, Lucent brought the technology back inside. 72 Harvard Business Review | December 2009 | hbr.org
  • 5. hbr.org It has also embraced incubation, launching more coveries and growth options. Assets kept on the shelf The online exhibit than 20 new ventures. Some of these – including create no new value, and their value-generating “The Birth of a Company Liquavista, Silicon Hive, and priv-ID – are potential potential diminishes over time, as competing ap- from the Inside Out” future suppliers (Move 1) and have attracted exter- proaches emerge and as the people who developed illustrates how BT used relationships within its nal investment (Move 2). According to Ronald Wolf, the IP leave for new jobs or retirement. However, business ecosystem a senior business development manager at Philips companies should be aware that stranded technol- to spawn a firm called Texert. View it at Corporate Technologies, “The goal [of incubation] ogy, once liberated, may turn into competition. A texert.hbr.org. is to transform new ideas that otherwise would project that could become a substitute for one of have been left unused into successful businesses for the company’s current offerings might better be Philips. This allows us to extract more value from left on the shelf. Bear in mind, though, that inter- our R&D efforts.” nal managers sometimes overstate competitive Developing this internal capability, though threats and underestimate the complementarities time-consuming, can generate significant income and learning that liberating a project might yield. that – apart from legal costs – flows directly to the You should manage these stranded assets at the bottom line. At scale, this flow can be substantial, corporate rather than the business-unit level, so though it varies by industry. IBM often reports li- that concerns about minor competitive risks don’t censing income of $1 billion or more and spends thwart additional growth opportunities. roughly $6 billion annually on R&D. John Tao, for- Move 3 also has a potential “blowback” bonus: merly of Air Products and now VP of open innova- The external success of previously unused technol- tion at Weyerhauser, estimates that once a chemi- ogy can prompt managers to reconsider their as- cal company (or a company in a related industry) sessment of its prospects. For example, Air Products establishes a licensing process, 15% or more of R&D developed an industrial burner, based on large-scale is a reasonable target for licensing income. vortex technology (LSV), which decomposes the Putting unused IP assets to work also generates by-products of a chemical process. Although LSV new business possibilities in the form of further dis- was pioneered for internal use, the company’s plant Move 3: Make your Move 4: Grow your Move 5: Create open IP work harder for you ecosystem, even when you domains to reduce costs and others are not growing and expand participation IF a lot of your company’s intellectual IF your company is an active innovator, IF your internal ideas are likely to attract property sits on a shelf and generates no continually engaging with its customers, interest from valuable outside communi- direct financial benefit and you understand collaborators, industry experts, trade ties, potentially creating breakthrough ad- that its value, to you and to others, will dis- associations, and others to identify future vances or even changing the game within sipate unless it is continually developed… opportunities… your industry… THEN let outside partners benefit from THEN build on your ecosystem of potential THEN consider establishing open domains what you’ve created, continue its develop- innovation partners. Be like Major League that either exchange information and ideas ment, and pay you licensing fees. Many Baseball general managers, who always or provide shared facilities and services. businesses recover 10% to 20% of their know which team will be interested in annual R&D spending in this way. which player at what price. EXAMPLE Faced with intense competi- EXAMPLE Unilever has an incubation pro- EXAMPLE Philips turned its R&D facility tion in the semiconductor business, Royal cess that develops ideas either for internal in the Netherlands into an open campus, Philips Electronics shifted its strategic placement in suitable business units or home to more than 7,000 researchers from focus, stranding a wide range of innova- for potential spin-off as turnkey ventures. a dozen other companies. Once a cost tion initiatives. It has developed a thriving One spin-off, a purveyor of personalized center and now a profit center, the campus licensing business around its more than wellness counseling called MiLife, delivers expands the company’s ecosystem and 60,000 patents and has spun out nearly added value as a platform for advertising encourages knowledge sharing among the two dozen new ventures. Unilever products. tenants. hbr.org | December 2009 | Harvard Business Review 73
  • 6. Innovation SPOTLIGHT ON INNOVATION How Open Innovation Can Help You Cope in Lean Times managers chose not to invest the money to retro- Unilever, the global consumer products and fit it in their plants. So Air Products licensed the health care company, has developed a series of eco- technology to another company, which managed system-related innovation processes. It frequently to sell it successfully to customers who then used it uses incubators to nurture promising projects that to advantage. Air Products’ plant managers are now have commercial potential but aren’t ready for one adopting LSV technology. of its businesses. The offspring of its incubators can The LSV example raises the further point that be- either be adopted by a Unilever business that sees fore a company adopts inside-out moves, business- a good fit or seek outside funding for further com- unit managers enjoy an exclusive right to either use mercialization. That choice benefits R&D staffers, or reject the fruits of internal R&D – and suffer no who see more paths for their work to get to market ill effects from that decision. Once the moves have and have an impact on the world. Plus, the company been implemented, however, business units that adds a new, friendly partner to its ecosystem. don’t use internal technology may lose it to an out- One recent Unilever incubation project that mi- side party. If it later succeeds, managers will face the grated outside the company was MiLife, a business uncomfortable task of explaining why they rejected that delivers personalized wellness and weight-loss it. Ironically, therefore, inside-out moves can prompt coaching to consumers via wearable devices that are more-thoughtful evaluation – and may even catalyze linked to the internet. The capital for this spin-off greater use – of internally developed technology. came from New Venture Partners and from Uni- lever’s own venture capital fund, Unilever Ventures. Move 4: Grow Your Ecosystem, John Coombs, the managing director of Unilever Even When You Are Not Growing Ventures, says, “Once the basic model is proven, Ecosystems offer a variety of partners, allies, re- future market collaborations between MiLife and searchers, and other resources to innovative com- core Unilever brands are expected.” panies. And firms with active R&D programs con- SAP, a long-established company renowned for tinually generate technology options that may its deep internal integration of enterprise software, eventually prove valuable. However, options that has also evolved substantial external ecosystems don’t align closely with a company’s core businesses around its technologies. It created EcoHub, a mar- can be hard to preserve in tough times. Luckily, some ketplace for ecosystem solutions that are certified might prosper outside the company but within its and supported by SAP and its partners. Both the ecosystem. company and the partners benefit from having an Inside-Out Venture Capital THE PROCESS of win- technologies and tech- it served as an internal Ventures, of San Francisco nowing internal IP and nologists and nurturing venture capital fund to spin (staffed by former execu- innovation initiatives can them in pursuit of the right out Bell Labs, NVP became tives of Intel’s corporate be a new source of deals markets. Moreover, ven- independent in 2001. Since venture capital group); for venture capital firms. ture capitalists must learn then, it has worked closely Pequot Ventures (now First- As companies focus dur- to make this shift in a true with Lucent, BT, Philips, Mark Capital), based in New ing a downturn, they may partnership with the parent Intel, IBM, Unilever, Telstra, York; and Burrill & Com- choose to jettison market- corporation. and other firms to create pany, also of San Francisco, ready technologies that A small but grow- independent companies. which has a fund for life require additional funding ing number of venture Corporate venture capital sciences companies. Such and entrepreneurial ex- capitalists have seized this funds are also supporting firms can be valuable allies pertise. From the venture opportunity to focus on some of these spin-offs, for businesses that wish capitalist’s perspective, the such inside-out ventures. such as those of Intel, Uni- to refocus their internal requirements shift from New Venture Partners, in lever, and Siemens. activities and put capital traditional, entrepreneur- New Jersey, is one of the Other venture capitalists and expertise into projects led selection of invest- pioneers. Formerly a busi- that have worked on inside- that might otherwise wither ments to finding attractive ness unit of Lucent, where out deals include Blueprint on the vine. 74 Harvard Business Review | December 2009 | hbr.org
  • 7. open forum that accelerates the discovery of new capabilities and elicits insights about marketplace needs. A related creation is the SAP Developers Network, an online community where any SAP de- The People Side of veloper or power user can ask fellow members for support with an SAP software problem. The per- Inside-Out Moves son with the problem awards points to the person COMPANIES SHOULD RECOGNIZE the hu- who solves it, and SAP posts at regular intervals the man costs of moving ideas and projects out the names of the 200 contributors who have earned the door – good people are often let go along with the most points. Developers often include their point assets they’ve created. There can be considerable totals on their résumés as proof to prospective em- long-term value in keeping many of your depart- ployers of their facility with SAP software. At very ing employees either provisionally connected little cost to SAP, this network provides both solu- to the company or active within the surrounding tions to its customers and business opportunities to ecosystem. its ecosystem partners. Spinning off a venture, rather than laying off By engaging with your ecosystem during a down- employees outright, is a good way to avoid the high turn, you become a preferred partner for innova- emotional and economic costs of severance while tive opportunities that emerge from the many par- boosting morale for remaining and departing work- ties surrounding your business and its value chain. ers alike. In BT’s spin-off of Azure Solutions, the When growth returns to the market, companies that company’s human resources team worked hard to have pursued only cost cutting may find themselves ensure that several hundred employees would retain at the back of the line. the same compensation they’d had at BT and would have an opportunity to take stock options in the new Move 5: Create Open Domains to Reduce venture; it also addressed trade unions’ concerns Costs and Expand Participation through negotiation. In effect, employees could Bringing internal ideas and projects out into an make their future career with the new organization. open domain has the practical benefit of shifting In 2001, Cisco weathered a serious downturn after costs outside as well. More important, open do- the telecommunications market collapsed. But it mains stimulate participation in those projects by a found creative ways to handle involuntary separa- much wider community and, potentially, accelerate tions. For example, it offered many employees 30% progress that advances the overall market. of their salary, with benefits, for six to 12 months. Merck successfully executed this move with its Some accepted this program in order to take jobs Merck Gene Index project. Given the rapid progress with nonprofit and social ventures where, in several in sequencing of the human genome, the company cases, Cisco provided coaching and mentoring, in realized that many young biotech companies might part to maintain ties with its former employees. try to patent key parts of the genome. Such pat- Workers gained a longer runway – and suffered much ents would block the ability of Merck and other less trauma – for their departure from the company. pharmaceutical companies to develop new drugs Cisco also earned considerable goodwill and en- for genetically based conditions. Notwithstanding hanced its reputation as a great place to work. When Merck’s considerable resources, however, the cas- its market came back, some of the separated workers cade of information from human genome research rejoined the company because they still felt con- dwarfed the ability of any single organization to nected to it. Cisco even managed to attract worthy patent it all. Merck’s solution was to fund a variety applicants who hadn’t participated in the program of university-based human genome research proj- but had heard about it. ects and then publish all of the findings. (Many bio- Cisco’s method is, of course, not the only way to tech firms initially rely on university research for turn unavoidable layoffs into an opportunity. Con- basic technology.) The Merck Gene Index became sider, for example, giving departing employees train- part of the public domain, where everyone can use ing grants to help them acquire new skills or improve it but no one can patent specific gene sequences and existing ones. The concept comes in many flavors, thereby block further drug development. but the basic point is to impress upon talented Philips did something similar with its High Tech people who must nonetheless depart the company Campus in Eindhoven. A decade ago, the Dutch that you are holding out opportunity for a continuing campus was a key internal R&D facility with more relationship.
  • 8. Innovation SPOTLIGHT ON INNOVATION How Open Innovation Can Help You Cope in Lean Times than 1,500 employees, and supporting the opera- so deeply that they lose some of their high perform- tion was expensive. In 2004, as part of embracing ers. A thoughtful organization will want to handle open innovation, Philips invited other companies that process with care (see the sidebar “The People and their R&D teams onto the campus, which Side of Inside-Out Moves”). went from being a cost center to a revenue center. Taken together, these are complicated activities The space is now shared by more than 7,000 peo- that should be approached holistically, under the ple from 15 companies, including ASML, Bekaert, leadership of senior executives in strategic roles. IBM, and NXP. Philips also embarked on a broad If that sounds challenging, it is. But negotiating a series of collaborations with these other compa- downturn without mortgaging your future is worth nies, sharing many ideas that had previously been the pain and effort. Darwin taught us that it’s nei- discussed only internally. The campus today is an ther the strongest nor the most intelligent species innovation hub, winning support for its activities that survive; it’s those that adapt best to changes in from the government of the Netherlands. Philips the environment. Inside-out open innovation will has done this withlittle additional spending; and enable your organization to become more agile and it collects rent from the companies that use the responsive as it copes with tough times. facilities. Henry W. Chesbrough teaches at the University Putting Inside-Out Moves into Practice of California at Berkeley’s Haas School of Business, Despite the clear advantages of inside-out open where he also runs the Center for Open Innovation. innovation, you should not underestimate the dif- He is the author of Open Business Models: How to ficulty of developing a program for doing it. There Thrive in the New Innovation Landscape (Harvard are inevitable cultural, political, and organizational Business School Press, 2006). Andrew R. Garman challenges to face. For example, internal and exter- (agarman@nvpllc.com) is a founder and manag- nal channels will compete for the fruits of R&D, ing partner of New Venture Partners in Murray Hill, and you’ll have to manage that tension. You’ll New Jersey, and a former vice president at Lucent also have to coordinate and harmonize the vari- Technologies. ous roles and interests of your company’s technical, Reprint R0912F To order, see page 131. marketing, finance, and legal functions. Intellectual property must regularly be inventoried, analyzed, and classified into assets to be either retained for further development or offered to the outside world. You’ll need to evaluate a range of financial structures in order to identify the best combi- nation of expense reduction today and upside potential tomorrow. You’ll also need to negotiate with outside parties, including investors, allies, partners, customers, and suppliers. And don’t forget about human resources challenges. Inside-out open innovation often involves letting go some of the employees who John Caldwell are working on the initia- tives you decide to spin off. Once a downturn is in full “Just let them know that it’s my way or the crumbling infrastructure.” swing, companies may cut 76 Harvard Business Review | December 2009 | hbr.org