Essay Question: Why should a company consider working towards an “Open Innovation” business model? Critically discuss.

Open Innovation (Click hyperlink for pdf format)

Why should a company consider working towards an “Open Innovation” business model? Critically discuss.

1. Introduction

Open Innovation (OI) is a term coined by Henry Chesbrough in his 2003 book and the concept has since been universally adopted as a model of innovation management and product development. In just nine years, Open Innovation was cited more than 5,100 times (Google Scholar, Oct 2012).

The traditional closed innovation model, which has brought Xerox Corporation much success from the 1950s to 1970s, was questioned on its viability at the turn of the 21st century. Despite Xerox being able to employ many of the world’s best researchers and the successful establishment of the Palo Alto Research Center (PARC), Xerox failed to understand and examine the resources they had as researchers left Xerox to form start-up firms funded by venture capitalists which includes Microsoft and Apple to commercialise technologies developed by PARC to achieve success outside Xerox.

According to Henry Chesbrough (2003), Open Innovation is a paradigm that assumes that firms can and should expose themselves to external concepts as well as leveraging internal resources to advance their technology in order to facilitate value creation and enhancement. Contrary to the principles of Closed Innovation, Open Innovation acknowledged the limitations of a firm to attract and retain all the best people to work for them, and hence the necessity to engage and network with external technology bases in order to maintain sustainability and competitive advantage. This is increasingly evident in the 21st century in business trends such as outsourcing, networking, and collaborations. The Internet has also altered and eased how businesses are conducted and information communicated internationally. Globalisation has also allowed firms to explore more opportunities such as cross-licensing, strategic alliances and partnership initiatives to incorporate external ideas, products and processes to their existing business models and core competencies.

Open Innovation also assumes that “internal ideas can be taken to market through external channels to generate additional values” (Chesbrough, 2006). Innovation is the fundamental issue in economic prosperity (Porter, 1980), and with the support of World Trade Organisation’s efforts to protect intellectual property by enforcing patents, copyrights legislations (Hill at el, 2012), companies are encouraged to adopt Open Innovation by sharing of ideas, products and processes to the business market in exchange for license fees or cross-licensing agreements between non competitors. For instance, Qualcomm generates majority of its revenues from technology licensing and CDMA licensing (refer to table 1).

2. The Open Innovation Model

Closed Innovation Model

Open Innovation Model

The Closed Innovation System illustrates a wide range of R&D projects that a company may engaged in, and after several testing and evaluations, the company may decide to pursue only a handful of products or services. The “one way in, one way out” model as described by Chesbrough, depicts rigidity.

Comparatively, the “holes” in the funnel-like Open Innovation System illustrates flexibility; porous boundaries where ideas can be externally derived in the beginning and in the later stages of research and development, which is an evident absence in a closed innovation model. External technology bases may refer to long-term strategies such as merger & acquisitions (M&A), collaborations with universities and research centres, strategic alliances, outsourcing contracts to short-term practices such as minority holdings in other companies and technology transfer programs. The “spin-out” refers to potential projects that a company may have decided not to produce or enter and through licensing out to generate additional value.

The aim of this essay is to discuss why firms should adopt an Open Innovation concept over the traditional Closed Innovation system in today’s context.

3. Considerations to work towards an “Open Innovation” system

Relevant model

The closed innovation concept can be closely related to traditional economies theories; firms are assumed to have perfect information, and are able to optimise performance. Through the works of Cyert and Simon (1983), Nelson and Winter (1982) and from the aforementioned example, we are able to conclude that it is often not the case; even the biggest corporations make mistakes. Behavioural theories, which describes firms having bounded rationality and limited ability; evolutionary theory that formulated the Variation, Selection, Retention (VSR) processes between firms, resemble the Open Innovation model and portray a more appropriate competitive market in today’s context.

Sustainability and Adaptability

The seminal work of Joseph Schumpeter laid the foundation of innovation and technical change. Based on the Schumpeterian approach, innovation is the force that sustains economic growth. The term ‘creative destruction’, describes companies that once dominated markets are replaced by newer technologies. Examples would be the Xerox’s copiers, Atari’s video game consoles and in more recent cases, Nokia’s falling market shares and Eastman Kodak’s struggle against digital technology which led to its eventual bankruptcy protection filed in January 2012.

It is imperative that firms should continuously adapt to its environment at a time of rapid technological changes. Having an ecological model means that the organisation which adapts most successfully to its environment will survive (McDonald, 1996). Without adapting and cumulating new technological strengths to the firm’s existing skill sets, a firm is less likely to be competitive (Coombs, 1996). Firms have come to the acceptance of the difficulties creating and exploiting technological capabilities on their own (Howells et al, 2003), and opportunities may rise from across sectors. The increasing multi-disciplinary researches and studies such as mechatronics, nanotechnology and fiber-optics communications led to the new discoveries on products and processes. Additionally, the trend of overlapping product markets such as telecommunications, personal computers and television which involves multiple technologies complicates the market orientation and organisation learning process as highlighted by Cravens (1998). Because of the higher amount of resources and time required to develop a technology for products and processes, it will prove to be a challenge for inward-thinking firms to be on par or even surpass open innovation oriented companies.

Raising Costs and Complementary Technologies

One of the main reasons for the adoption of open innovation is the rising costs of R&D. Worldwide R&D costs have increased exponentially over the years (OECD STATS 2012, UNESCO 2008,  Factiva STATS 2012), signifying that costs of technology development would only get bigger.

Source: Global Factiva 2012

The example of rising costs was illustrated in Chesbrough’s article in 2007 whereby building a semiconductor fabrication facility or “fab” in 2006 was estimated to cost more than $3 billion and a new fab would have cost about 1% of that in less than 30 years ago. In June 2012, Taiwan Semiconductor Manufacturing Company (TSMC) announced a fab project, which is estimated to cost around $US8-10 billion. The effect of rising costs has accelerated firms’ efforts to collaborate to reduce uncertainty and risk.

The number of strategic alliances has grown dramatically since 1980s and one would attribute it to technological exchange, which looks into sharing of innovation costs. Griliches (1998) illustrated the photographic equipment industry and the scientific instruments industry, which “may not buy much from each other, but may be, in a sense, working on similar things and hence benefiting much from each other’s research” as an example of cost sharing. The development in Information and Communication Technology (ICT) has also converged and unified communication technologies and thus reduced the roles of R&D systems in firms as knowledge producers while expanding that of scouting and integrating knowledge that resides outside the firm (Dodsgon et al, 2006). As such, firms with complementary technologies are incentivized to establish strategic partnerships to enhance their innovation performances, as well as sharing costs and risk. One example is the partnership between Cisco Systems and Fujitsu.

 

How Cisco Systems Benefitted from Open Innovation

The alliance of Cisco Systems and Fujitsu since late 2004 has allowed both firms to synergise their R&D initiatives and gain a competitive advantage by providing superior customer services. Prior to the collaboration, Fujitsu’s competitive advantage was in telecommunications products but lacked a strong presence in routers whereas Cisco was mainly strong in routers only. Because of the interrelationship and its overlapping technologies that are involved in both products, Cisco and Fujitsu are able to share experimental facilities and research costs while reducing new product discovery times relevant to a wider range of sectors. Besides, the combination of the two companies’ products enabled customers to have lengthwise communication solutions, which boosts sales because of the convenience for customers during the purchasing process thus gaining a competitive advantage for both firms. Similarly, Cisco also has several strategic partners such as IBM, Intel, and Microsoft. The reduction of costs, uncertainty and gaining competitive advantage are the successful results of collaboration between two companies driven by corresponding technologies.

Open Innovation has been the approach of Cisco since the early years of its establishment. Back then, Cisco was able to compete against Lucent Technologies despite having little or no basic research on their own as it was able to leverage on venture capitalists, partnerships and acquisitions. These strategies, which were still fairly unfamiliar in the 1980s, have enabled Cisco to attain access to patented technologies as well as speed up the development of new products. Today, Cisco is ranked as one of the Top 100 largest corporations by Fortune 500. Indisputably, Cisco, being a networking technology based firm, has welcomed the concept of Open Innovation. An interview with Lew Tucker, the Vice President and CTO of Cloud Computing was conducted in July 2012 (Cisco’s Technology News Site) concluded Cisco’s philosophy and culture; “Open source is increasingly a part of Cisco’s future. We able to take advantage of the developments of others in the industry.”

Shorter Life Cycles and Market Uncertainty

The concept of Product Life Cycle (PLC) is a universal model that is commonly used in marketing management but has its limitations in the discussion of innovation strategies (Grantham, 1997). Nevertheless, the different stages in a PLC have valuable implications for strategic product management: products decline over time.

Research In Motion Limited (RIM), which develops the Blackberry product line was ranked the fastest growing company in 2009 by Fortune. However in a short span of 2 years,  RIM was ranked top in terms of falling shares in 2011. RIM’s initial disinclination to change its QWERTY keyboard input layout was rapidly losing market shares at the time where consumers are more appealed to fully touch-screen smartphones, which is still a dominant feature in most of the handsets today. On the other hand, firms such as HTC & Samsung have became dominant players in the mobile market despite being late entrants and without an independent Operating System like RIM and Apple. Approaching an open innovation concept and being members of the Open Handset Alliance (OHA) consortium, HTC and Samsung are able to focus and expedite on hardware technologies and development to make better performing microchips and design without neglecting software as most of their mobile phones are dependent on Android, an OS developed by Google Inc. In addition, both companies enjoyed cost-savings and quicker product introductions from the partnership, such as incorporating applications like Google Maps and Google Play into the mobile phones; developments that would have cost a substantial amount of research and investment if they were to be produced internally by HTC or Samsung. The dynamics of markets today have pushed firms to continuously explore new knowledge and innovation opportunities to keep up with the volatile market trends.

It is also worth mentioning the concept of Technology Life Cycle (TLC), which may relate more closely to the study of innovation management. As pointed out by Burgelman & et al (2004); Wheelwrigh & Clark (1992), firms invest in exploration to generate disruptive innovations that will sustain their competitiveness. The initial technology S-Curve (e.g floppy diskettes), follows a PLC-like pattern of  introduction- growth-maturation cycle and over time is replaced (abruptly) by a new breakthrough in technology, depicted by another S-Curve (e.g flash drives, subsequently computer networks such as cloud computing). The TLC of a particular product or process hence contains a series of S-curves introduced at different stages. To gain a sustainable competitive advantage, firms are pressured to raise innovation (Arrow 1962; Aghion et al. 2002) for profitability and survivability.

Disruptive Innovations

 

 

 

Breakthrough technologies such as cloud computing, MRI scan and 3D printers generally involve a network of unified infrastructures and services to develop. The sophisticated technology gives the firm a cutting edge over its competitors as competitors require time and resources to understand and apply the technology. Hence there is a strong call for companies to adopt open innovation through learning and developing so as to not lose out, and to create the ‘next S-curve’ to generate a competitive advantage.

Furthermore, it is increasingly harder for companies to foresee the market environment today;  as Prahalad and Hamel (1990) pointed out, ‘looks are deceiving’. A company which may seem to be involved in unrelated businesses could be a competitor one day. For instance, Canon’s initial knowledge in optics and imagining to produce cameras have allowed its core competencies to enter into seemingly diverse markets such as selling business machines and image scanners. Apple’s decision to enter the music players and mobile phones industry is another example. Because of the unpredictability of today’s markets, companies have stepped up efforts to strive for lower costs by outsourcing while simultaneously exploring the extension of its core competencies through business contracts, licensing deals, alliances and acquisitions etc through open innovation.

Branding

Partnerships have allowed co-brandings companies to overcome the Not Invented Here (NIH) syndrome as well. For instance, Japan as one of the countries with the highest uncertainty avoidance index (Hofstede, 2001), would be more inclined to trust Fujitsu, a like-minded Japanese firm for its good connections and reliability. Cisco was able to leverage on these non-tangibles assets provided by their alliance to strengthen their market presence in Japan and increases customer base and trust to enhance their profitability and brand.

Opportunism

Due to constraint of resources, firms sometimes have to forgo core competencies which they mistakenly thought as mere “cost centers” (Prahalad & Hamel, 1990). It was in 1979 when Apple’s investment in Xerox (venture capital) allowed them a ‘sneak peek’ at what the latter was then developing which subsequently played a critical role in influencing how Apple’s computers were modelled; such as its interface and the usage of a mouse. On Xerox’s technologies, Steve Jobs was quoted, “It was so obvious once you saw it”, and they (Xerox) literally did not know what to do with these technologies (Chesbrough, 2010). Apple’s achievement is largely attributed to identifying opportunities and strategic partnerships to leverage on the strengths of other firms to complement and add values to their own products.

Companies define opportunities differently. Companies like Motorola and GE chose to stop the production of televisions in the 1970s because the market was viewed as declining and not profitable, whereas firms such as LG & Samsung have continuously gain market dominance through new and improved technologies (LCD, SmartTVs, 3D). These technologies, as explained earlier, are usually developed through collective effort of different companies. The adoption of RFID, a technology that dates back to as far as World War II, has moved from anonymity into more common applications such as in service industries (Moon & Ngai 2008). The benefits include facilitating inventory management to save costs and sell products at a lower price and enhancing customers experience by monitoring their buying behaviours.

By strategically learning, exploring and converting a technology developed elsewhere such as RFID and WIMP, firms like Wal-mart, Tesco and Apple created a distinctive business model which is inspired by Open Innovation.

Conclusion

With the considerations brought up, it is apparent that firms should adopt an Open Innovation model. It would be a big challenge for a firm to compete against companies with extensive networks and strategic alliances should they adopt an inward mindset. Even the biggest corporations today are dependent on other companies’ skills and knowledge. Coupled with the effect of globalisation and the Internet, firms are facing even more uncertainty. Therefore, many have raised their efforts in hopes of outpacing the ever increasing competition.

However this is not to say that such a model is perfect. Adopting a more complex model has its apparent challenges, such as integration of business processes, gaining trust and differentiating core competencies and ‘cost centres’. But that would require another discussion altogether. Firms today must initiate to engage external technology bases to survive, which is a fundamental `necessity. They have to realise their own abilities (and limitations) as well as core competencies to keep up with the market. There is no good reason for firms to limit to one instead of being ‘to all’, especially in the context of innovation. “The world is our lab”, rather than the other way round, is a much more practical approach today.

Words:   2,774     (excluding appendix and references)

370        (references)

(Table 1)

                                           

 

 

Factiva

Top of Form

QUALCOMM, Inc.

Statement Type: Business Segment Breakdown

Period End Date

30-Sep-2011

30-Sep-2010

30-Sep-2009

30-Sep-2008

30-Sep-2007

Annual Business Segment Breakdown: (USD, In millions)

CDMA Technologies
External Revenue

8,859.00

6,695.00

6,135.00

6,717.00

5,275.00

Total Revenue

8,859.00

6,695.00

6,135.00

6,717.00

5,275.00

Operating Income

2,056.00

1,693.00

1,441.00

1,833.00

1,547.00

Total Assets

1,569.00

1,085.00

892.00

1,425.00

921.00

Technology Licensing
External Revenue

5,422.00

3,659.00

3,605.00

3,622.00

2,772.00

Total Revenue

5,422.00

3,659.00

3,605.00

3,622.00

2,772.00

Operating Income

4,753.00

3,020.00

3,068.00

3,142.00

2,340.00

Total Assets

36.00

28.00

89.00

2,668.00

29.00

Wireless & Internet
External Revenue

656.00

628.00

641.00

785.00

828.00

Reconciling items
External Revenue

20.00

9.00

29.00

12.00

1.00

Source: FactSet Research Systems Inc.

Bottom of Form

http://global.factiva.com.libproxy.sim.edu.sg/ar/default.aspx

Bibliography

Chesbrough, H W 2003, Open Innovation: The New Imperative for Creating and Profiting            from Technology, Harvard Business School Press, Boston, Massachusetts.

Chesbrough, H 2007, ‘Why companies should have open business models’, Sloan   Management Review, Winter 2007 Vol. 48 (2), pp 22-28.

Coombs, R 1996, ‘Core Competencies and the Strategic Management of R&D’, R&D        Management, 26, 4.

Cravens, D W 1998, ‘Examining the impact of market-based strategy paradigms on           marketing strategy’, Journal of strategic Marketing, 6, pp197-208.

Cyert, R M, Simon, H A (1983), ‘The Behavioural Approach: With Emphasis on    Economies’, Behavioral Science, Vol.28, pp95-108.

Ferrary, M 2011, ‘Specialized organisations and ambidextrous clusters in the open innovation paradigm’, European Management Journal, 29, pp181-192.

Grantham, L M 1997,’The validity of the product life cycle in the high-tech industry’,

Marketing Intelligence & Planning, Vol. 15 (1), pp 4 – 10

Griliches Z 1998, Handbook of the economies of innovation and technological change,       Blackwell, Oxford UK & Cambridge USA

Hill, C W L, Wee, C H & Udayasankar, Krishna 2012, International Business: An Asian    Perspective, Mc-Graw-Hill/Irwin, New York

Howells, J, James, A, Malik, K 2003, ‘The sourcing of technological knowledge:    distributed innovation processes and dynamic change’, R&D Management, 33,           pp395-409.

Huizingh, E K R E 2010, ‘Open Innovation: State of the art and future perspectives’,         Technovation, 31, pp2-9.

McDonald, M 1996, ‘Strategic Marketing Planning: Theory, Practice and Research            Agendas’, Journal of Marketing Management, 12, pp 5-27.

Miozzo, M, Walsh, V 2006, International Competitiveness and Technological Change,      Oxford University Press, Chapter 9: Networks and Alliances.

Moon, K L, Ngai E W T 2008, The adoption of RFID in fashion retailing: a business value-          added framework, Industrial Management & Data Systems, 108:5.

Petroni, G, Venturini, K, Verbano, C 2012, ‘Open Innovation and new issues in R&D       organisation and personnel management’, The International Journal of Human   Resource Management, 23:1, pp147-173.

Trott, P, Hartmann, D, ‘Why ‘Open Innovation’ is old wine in new bottles’, International   Journal of Innovation Management, Vol. 13, No.4 (Dec 2009), pp 715-736.

Websites

FACTIVA GLOBAL STATS (2012), viewed October 7 2012,  https://global-factiva-com

Geert Hofstede (2001), viewed October 7 2012, http://geert            hofstede.com/research.html

OCED (2012), viewed October 5 2012,         http://stats.oecd.org/Index.aspx?DataSetCode=GERD_FUNDS#

S Curve diagram, vied October 10 2012, http://www.digitaltonto.com/2012/facebook-pinterest-and-the-singularity/

UNESCO (2008), viewed October 5 2012,  http://www.unesco.org/new/en/

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