The Ups and Downs of Open Innovation

Stephen DeAngelis

July 6, 2010

Although most companies would like to innovate internally so that they control the entire process as well as the fruits of their labor, only stubbornly blind organizations believe that their ideas are always better than those developed elsewhere. Most business leaders are aware that good ideas are found everywhere and they are increasingly receptive to the concept of actively looking outside of their organizations for them. This process has been variously referred to as open innovation or outsourced innovation. I have written a number of posts on different methods organizations have used to solicit ideas from outside of their organizations. One method is offering prizes to individuals or groups [see for example. Another approach is matching organizations looking for solutions with innovators who might have answers. Still another approach is to advertise your challenge and see who responds. All of these approaches beg the question: “When should open approaches to innovation be used and when should they be avoided?” A group of professors offer their opinions on that subject [“Outsourcing Innovation,” by Michael A. Stanko, Jonathan D. Bohlmann, and Roger J. Calantone, Wall Street Journal, 30 November 2009]. Dr. Stanko is an assistant professor of marketing at North Carolina State University’s Jenkins Graduate School of Management. Dr. Bohlmann is an associate professor of marketing at the Jenkins Graduate School. Dr. Calantone is Eli Broad chaired university professor and chair of the marketing department at Michigan State University’s Eli Broad Graduate School of Management. They rhetorically ask: “When should companies try to come up with new ideas themselves—and when should they give the job to outside experts?” They continue:

“It’s a question many companies are facing these days. As budgets tighten, businesses are outsourcing research and development and the creation of new products as a way to slash costs, speed development time and tap into top talent outside the company. But it can be tough to strike the right balance between internal and external efforts at innovation. How much outsourcing is too much, or too little? What amount produces the best results? To find an answer, we studied the sourcing habits and innovative performance of 359 companies based in the U.S. and reviewed existing research on outsourced innovation.”

They judged successful innovation “by the number of patents” companies produced and “how many subsequent patents built upon them.” They found that companies “used outsourcing in four circumstances” and “when firms strayed from this basic approach, their results suffered.” They explain:

“The four situations that call for outsourcing:

1. When companies would need to add lots of new knowledge to innovate, such as figuring out how to work with an unfamiliar chemical compound to make a different line of pharmaceuticals.

2. In the early stages of a project, when there are lots of technical hurdles to be overcome and the outcome is far from certain.

3. When intellectual property isn’t well protected in the industry. In these cases, since new ideas spread quickly from company to company, it may not be possible to differentiate products with innovations. So, businesses turn to outsourcing to limit spending.

4. When companies have had lots of experience with outsourcing. Let’s say all the factors above are equal—it’s basically a toss-up between working on a project in-house and outsourcing it. In these cases, companies with a long track record of contracting tend to hand off the job to outsiders—three times as often, in fact, as businesses with average levels of experience in the practice. The costs and benefits of outsourcing are more certain for experienced firms, and they can better manage the situation to produce effective results.”

It strikes me that that the latter situation is a bit of a Catch 22. If firms that have experience with outsourcing produce better results when outsourcing is used, then gaining that experience seems to be important. Yet the good professors seem to be saying that you if don’t have that experience don’t try and get it because your “results will suffer.” I suspect this is a situation where there is no gain if there is no pain. They conclude:

“So, how does outsourcing innovation affect performance? Let’s look at some common measures of performance.

COST: Conventional wisdom says that outsourcing innovation is a cost saver. But it isn’t that simple. Our own research shows balanced outsourcing may raise costs slightly, but also may create more ‘bang for the buck’ from innovation spending, making outsourcing a relatively wise allocation of resources. But beware: Our study also shows that proportionately too much outsourcing will result in dramatically higher total costs compared with too much internal product development. This is likely due to several factors, such as an inability to control spending to vendors, expenses associated with modifying existing contracts, added costs from coordinating internal and external efforts, or simply an attempt to grow quickly through outsourced development of new products, regardless of cost.

LEVEL OF INNOVATION: Businesses that followed the guidelines presented above saw big dividends here. They developed more patents, and their patents were more influential—that is, they were cited more often in ensuing patents. On the other hand, businesses that outsourced too much or too little—by just 1%—saw an 11% decrease in the expected number and influence of their patents. Even small changes made a big difference. Another drawback that researchers have found to outsourcing product development: Companies that outsource can end up with generic products. Why? For one thing, their contractors sometimes were dealing with multiple clients that had similar needs.

TIME TO MARKET: One common problem researchers have identified was turning to outsourcing too late in the development of a product, which raised a lot of thorny problems. For instance, contractors had to learn a lot more about the work that had already been done in-house. Conversely, outsourcing can help companies keep their options open and reduce time to market. Consider car makers, which face lots of uncertainty about which alternative fuel technology to pursue. By outsourcing, they can look into a number of technologies—well beyond what they might be able to do internally—and get to market quickly once a decision is made.”

Another analyst who has looked at the ups and downs of outsourcing innovation is Stefan Lindegaard, a Copenhagen-based speaker, network facilitator, and adviser on open innovation and intrapreneurship [“The Side Effects of Open Innovation,” Bloomberg BusinessWeek, 7 June 2010]. He writes:

“Open [innovation] is a new paradigm shift that has been steadily gaining attention from executives in the past few years. Successfully adopted by companies such as Procter & Gamble, General Mills, and Intuit, open innovation is about bridging internal and external resources and executing on the innovation opportunities that arise from this combination. Open innovation will not only lead to new ways of making innovation happen; there will also be side effects. As an open innovation advocate, I think most of these effects will be positive. But it’s also reasonable to expect that some will be mixed or perhaps even negative. Here, then, is a handy checklist of some of the possible ramifications from adopting and executing open innovation.”

Like Professors Stanko, Bohlmann, and Calantone, Lindegaard advocates a balanced approach to innovation when using internal and external sources. He provides his personal checklist for when open innovation should be used:

• Open innovation is about managing change. While some executives are open to change, most seem to prefer to keep things just as they are. A risk of disturbing the status quo is inherent in the open innovation process—and should be recast as opportunity. The winners will be the companies and executives that are best at handling this.

• As a company matures, executives often end up focusing more on internal needs than on those of the market. Before long, that focus can turn a corporation into its own worst enemy. Innovating with partners can remind corporate leaders to keep their eye on funneling resources toward serving real commercial needs. This mindset can be helpful way beyond the innovation process.

• Beyond the benefit of ensuring that companies remain focused on the marketplace, working with external partners means executives become familiar with other ways of getting things done. Open innovation also allows corporate leaders to evaluate their practices in light of other real-world examples. Then they can gauge whether (and how) to adjust their processes or perhaps even develop entirely new ways of doing things.

• Increased focus on customers can be harnessed through open innovation and can lead to better relationships with them. Sure, there are dangers in listening too closely to existing consumers, who might just ask for an improvement to an existing product or service rather than imagining a new way of doing something. But closer ties to brand evangelists can change the role of sales and marketing units. Those groups need to be involved with innovation initiatives, too, so this is a healthy side effect.

• When corporate executives accept that experimentation and a fair amount of failure are an important part of innovation, they will begin to understand that it delivers best when different business functions—and external partners—come together. Then they can develop products, services, solutions, and processes that meet the needs of users and customers. Tools and solutions such as LinkedIn, Twitter, blogs, and other social media tools can be useful here.

• The increased number of stakeholders afforded through open innovation provides new ways for people to be creative. It also, of course, increases the level of complexity in place throughout an organization. Figuring out a way to relinquish top-down control while maintaining efficiency within an organization is a key challenge for those looking to embrace open innovation.

• As open innovation becomes more prevalent, the functional, divisional, or matrix organizational structures we know today will change. Perhaps they might even break down altogether. What will replace them is unclear, but new systems will be a clear side effect of these types of initiatives.

• New relationships built with the multiple stakeholders of the open innovation process are complex. Executives need to be sure to develop an overarching strategy that can be clearly articulated to all employees and participants. Everyone needs to understand what is expected from them, or frustration will bubble up. Prolonged periods of frustration can hamper organizational effectiveness and even result in the flight of smart and creative people.”

Lindegaard concludes that “the key to managing open innovation initiatives successfully is to be flexible enough to deal with issues as they arise.” For me, that means being open to possibilities. When an executive closes his or her mind to new ideas, they are wasting resources and threatening the future of their organization. According to another article, it’s easier for executives to become enemies of innovation than one might think [“Innovation’s Accidental Enemies,” by Roger L. Martin and Jennifer Riel, Bloomberg BusinessWeek, 14 January 2010]. Martin and Riel provide a perfect example of an executive that opened the door to innovation and then slammed it closed.

“Once upon a time there was a very big bank. Its CEO wanted to better serve its best customers and hired some consultants to tell him what to do. At the time, the very big bank served its high-net-worth customers at stately private banking offices in downtown branches. The consultants discovered that many of these wealthy customers—lawyers, executives, and partners in big professional services firms—were unattractive customers. They chose plain-vanilla services and were both demanding and price-sensitive. But the consultants found another high-net-worth segment that was underserved: entrepreneurs and partners from smaller firms. These folks had diverse needs, such as mortgages for their homes and investment properties, and investor agreements for multipartner ventures. But they didn’t want to bounce from one banking specialist to another to get a deal done, or drive to a fancy branch filled with high-backed chairs and wood-paneled walls, paid for with their fees. Instead, they wanted integrated, personalized service in their neighborhoods, with no divide between their commercial and personal banking services. At the final meeting, the consultants presented a strategy built around this new segment. As they wrapped up, the CEO asked: ‘Have any other big banks done this?’ The lead consultant answered brightly, ‘No, you’d be the first,’ certain that this would seal the deal. Not even close. The CEO killed the idea on the spot. And the very big bank’s rivals lived happily ever after.”

Every commentator on innovation that I know reiterates the fact that innovation and risk are inseparable companions. Repeated failures invariably accompany any innovative process. Martin and Riel write, “Innovation is killed with the two deadliest words in business: Prove it.” They conclude:

“So when a CEO, like our banker friend, demands evidence that an idea will succeed, he is driving innovation away. Does that mean we are doomed to live in world devoid of proof—that innovation must be consigned to a realm of cross-our-fingers hopefulness? No, it’s not so bleak. Instead, when facing an anomalous situation, we can turn to a third form of logic: abductive logic, the logic of what could be. To use abduction, we need to creatively assemble the disparate experiences and bits of data that seem relevant in order to make an inference—a logical leap—to the best possible conclusion. … Asking what could be true—and jumping into the unknown—is critical to innovation. Nurturing the ideas that result, rather than killing them, can be the tricky part. But once a company clears this hurdle, it can leverage its efforts to produce the proof that leaders depend on to make commitments—and turn the future into fact.”

Open innovation reduces the unknown a little bit by involving individuals that are more experienced in areas that might be unfamiliar to a company. The unknown, however, will never be eliminated completely and results can never be guaranteed when one starts down the path to innovation. The future, however, depends on individuals and companies being willing to traverse that foggy path to a brighter day.