Open Innovation – The Missing Link in Many Innovation Strategies

In his speech and interaction with Kaihan Krippendorff, Zach Ferres talks about how Covid has impacted the way we think about innovation and highlighted the importance of collaboration in the innovation journey. “It is the long history of humankind (and animal kind, too) that those who learned to collaborate and improvise most effectively have prevailed”. – Charles Darwin Initially, we used to think the world revolved around entrepreneurs and the garage is the place where all these great innovation concepts get started, but we started to realise that more and more of the ideas that we are starting are coming from small and medium businesses (SMB) and their venture large enterprises. There has been a rising trend of openness in the last few years for the open innovation concept, and we are now seeing it start to become more and more successful. Henry W. Chesbrough is one of the founding fathers of this concept of open innovation. He came up with an interesting model in 2003 that was adapted a little bit in 2009. Chesbrough’s theory is that open innovation initiatives enable programs that consider both internal and external ideas as well as both internal and external paths to market for innovation concepts. It’s all relevant now more than in the modern era. An early illustration of open innovation is the development of graphical user interphase. It started out of a non-profit research center in the 1960s, the project called NLS came out of the Augmentation Research Center at SRI International, California. The work that was done in the project went to Xerox PARC in the early 1970s, and in 1973, Xerox PARC developed the Alto personal computer, the first personal computer that had a graphical user interface and it used the bitmap screen. Fast forward to 1978, Steve Jobs and Jef Raskin began the development of the Apple Lisa desktop computer, which was the start of the adoption curve for the graphical user interface. Released in January of 1983, Lisa became one of the first personal computers to have a graphical user interface. Apple Lisa was one of the desktop computers whose design was greatly influenced by the Alto. In this way, a technology that developed in a non-profit research centre found its way into a large organization, Xerox of the 1970s, and found its way eventually getting into the hands of startup entrepreneurs Steve Jobs and Jef Raskins, who commercialised this and drove the beginning of the adoption curve for the graphical user interface. There has been a rising trend of openness in the last few years for the open innovation concept, and we are now seeing it start to become more and more successful. Why open innovation and why now? An analysis done by Kaihan Krippendorff on the “30 most transformative innovations in the last 30 years” shows that a vast majority of innovation concepts came out of enterprises and a very small percentage came out of entrepreneurs. A lot of these innovation concepts were conceived in an enterprise and then went on to be developed in either universities, start-ups, or in some cases a competitive organization that went and commercialized these things. Further analysis shows that for 27% of the innovation concepts, the idea source was the same as commercialization source, something that can be considered a more cut and dried example of closed innovation where an idea came out of the organization and it became commercialized within the organization. For open innovation on the other hand, where the idea source and the commercialization source are two different organizations (73%), you find the vast majority of them are the most incredible inventions in the last 30 years, such as MRI, the internet, email, LCDs and flash memory. These are examples of the concepts that came out of open innovation initiatives. Looking at the 2006 data of the R&D 100 awards, one can see that close to 70 out of the 100 winners were concepts that involved heavy inter-organizational collaborations. So, we are starting to see this collaborative trend emerge between organizations, non-profits, start-ups, and even venture capitalists. Innovation is happening faster than ever before because of things like instant and immediate global connectivity, reduction in the cost of developing innovation projects and initiative, and the standardisation of frameworks, platforms, programs, and methodologies. It’s really difficult to keep up with the pace of innovation. There have been enough examples in the recent past itself as global collaboration is happening to solve some of the problems created by the virus. We’re also seeing different types of innovation. About 20-40 years ago, innovation was a lot about science, it was about the actual physical product or the thing, but now we have all of these different dimensions that you can innovate on. It is not just about the product itself, but you can find interesting ways to twist the business model around and get more creative. You can create innovation concepts without adapting the product itself, so you can change the way the product is brought to the market, change the experience, customer engagement, etc. There are a lot of different ways now that you can innovate that didn’t exist or were not popular 20-30 years ago. Another important component is organizations today have untapped unique resources like access to channels, access to existing clients, capital, intellectual property, and research ideas, which can be leveraged to increase the probability of success for innovation initiatives at any stage both inside and outside of the organization. Coplex model Here at Coplex, we have developed a model similar to the open innovation model, the Modern Open Innovation Funnel comprising three stages, to look at the inflow and outflow of innovation units from the idea stage to commercialization stage and its growth stage. As we go through this journey, there are both opportunities for concepts or innovation units to come in from the outside and innovation units from within the organization to flow out of the organization into other entities and other partnerships. Examples of inflow at the idea stage would be university tech transfer (in-licensing), innovation networking and peer groups, and even crowdsourcing. Examples of outflow would be out-licensing, community incubator partnerships, or even partnering with a different organization that might be better suited to commercialize. Similarly, there is both inflow and outflow at the commercialization stage as well as the growth stage. So pretty much along the entire innovation spectrum, we see opportunities for open innovation via inflow of ideas, commercialization opportunities in later-stage businesses as well as an outflow in each of the different stages that could go and drop these innovation units outside of the organization to grow faster. Innovation is happening faster than ever before because of things like instant and immediate global connectivity, reduction in the cost of developing innovation projects and initiative, and the standardisation of frameworks, platforms, programs, and methodologies. Innovation portfolios The next question is how is it important in the broader context of our innovation strategy. We’re big believers in the development of innovation portfolios as a way to achieve both strategic and financial goals of innovation efforts. When we evaluate these innovation portfolios, we see a connection point into open innovation strategies. Extrapolating the three horizons model (core, adjacent and transformational), we have come to believe that open innovation does a great job when you start to get into adjacent (Horizon 2) and transformational (Horizon 3) seasons of innovation initiatives. Getting into those categories, the open innovation programmes start to become that much more effective because when you start to break out of the standard capability set and culture and structure of the organization, you get more and more aligned with open innovation to see things through to scale. On the other hand, the innovation units that are close to the core or Horizon 1 are more likely to start in-house or stay in-house. So, the further you go from Horizon 1, the more likely you will need open innovation programs as part of your strategy. While developing an innovation program, it is also crucial to consider the importance of open innovation as a link in the larger corporate innovation strategy, and ensure that there is a balance across the three horizons. So, in designing each portfolio, you should place bets in each Horizon. Open innovation can then become a tool to help you get more bets in Horizon 2 and Horizon 3 and also get better outcomes for those bets. Conclusion In recent times, the importance of collaboration has been highlighted further by the scientific community and triggered by COVID-19. A recent New York Times article says, “While political leaders have locked their borders, scientists have been shattering theirs, creating a global collaboration unlike any in history. Never before, researchers say, have so many experts in so many countries focused simultaneously on a single topic and with such urgency. Nearly all other research has ground to a halt.” “Normal imperatives like academic credit have been set aside. Online repositories make studies available months ahead of journals. Researchers have identified and shared hundreds of viral genome sequences. More than 200 clinical trials have been launched, bringing together hospitals and laboratories around the globe.” Hence, as we move through this COVID era and come out at the other end, I believe it is going to impact the way we think about innovation and the importance of collaboration in the innovation journey. Kaihan Krippendorff in Conversation with Zach Ferres and Rita McGrath Kaihan Krippendorff: How do you choose other organizations that will fit well into this open innovation model? Zach Ferres: I think it depends on the program. Each of the things that I mentioned in both the inflow and the outflow bullets are essentially separate types of programs or initiatives. Based on which of the initiatives you feel are the right one for your organization, you can then identify the right strategic partners to help with some of these things. Depending on which initiative you are looking for, different partners make the right fit along the way. Krippendorff: As you see opportunities to partner with other organizations that are historically competitors, what are the phases or critical success factors to begin the conversations and ultimately agree to share IP? Ferres: It depends on which innovation program you are running. Recently, two of the big automakers -one of them was Honda- partnered on something, and are doing more work on the Autonomous Vehicle (AV) segment. The AV space is the one to watch closely because all the big automakers are partnering with other big automakers on these autonomous vehicle initiatives, whether it be through corporate venture capital investments or some kind of joint venture. Corporate venture capital is one of the interesting trends to watch in the next decade. We are seeing a lot more inter-organizational competitive cooperation because of corporate venture capital now. Structurally, there are some interesting ways to do it. A lot of the work we do at Coplex is, we embrace the idea of the spin-out company. If you are building this innovation portfolio and you build a portfolio outside of the organization, it gives you opportunities to adjust the cap table of the business to reflect the structure of the partnership. Thus, it gives you a way to partner with a competitor on bringing something to market. You could use this spin-out separate entity, corporate venture capital-like structure to divvy up the cap table and find ways for both to participate outside, without having to divulge your entire innovation IP portfolio. Krippendorff: You help people come up with ideas to commercialise that aren’t a part of their core, that isn’t the business that they are in, so when you are sitting with a client or you are working in a company and you have an idea, how do you help them think about whether this is part of the core or not? Ferres: There are different interpretations of the three horizons framework and the one we use classifies core as one where you are serving the same market and the same customers with existing products and assets. You start moving into adjacencies when you either move into a new market or if you have a substantially different product or a service offering. As soon as you do one of those two things, you move into adjacencies, and if you are doing both of those, you are moving into Horizon 3. That’s how we simplify the model. You can argue on whether it is really a new product or is it just an expansion of the existing. You have to gut-check that a little bit but it is pretty clear. When we are working with organizations, one of the big challenges we hear is organizations looking for business units to commercialise their concepts, but none of the business units would ever pick it up. It is because they don’t have the capabilities; it’s either the channel or market or customers they are unfamiliar with, or they don’t have the capabilities to build or deliver the product or the service. The third reason is that it requires collaborating with other business units and the mechanisms to do that are lacking. So, usually, when you start peeling back the layers, it is easy to see what things are core and what things are moving into the adjacencies. Krippendorff: What is the best way to introduce this concept of open innovation to your organization and how to start? Ferres: Every corporate innovation discussion should start with this idea of portfolio strategy. We come from the venture capital world into the corporate innovation world, so everything we do is about portfolio design and developing a thesis around corporate innovation. If you are starting or restarting your innovation programs, the first place to start is around how the portfolio looks like and what are the goals and the objectives that the organization has for this portfolio. I disagree with the idea of innovation accounting being the only way to measure innovation. You can and should connect your innovation strategy to measurable financial objectives, but when in venture capital, you work at things like Total Value to Paid In (TVPI) over five years and unrealised gains in the portfolio, which are things we need to apply to the development of our portfolios. Krippendorff: I’d like to invite Rita McGrath. Rita, would you like to add anything to the ongoing conversation? Rita McGrath: Sure. The first thing I think we misunderstand is how important ecosystem ripeness is for innovation. To take a historical example, in 1964, AT&T debuted this thing called the picturephone at Walt Disney parks. They introduced it to the market in 1970 in Pittsburgh. It was the first commercial outing, and the idea was to be able to have a phone in which you would see people’s faces. There was this sense that this was the need, but the ecosystem surrounding the initial phone, that is, the bandwidth was nowhere near what it is today. The pictures in the cell were small and very grainy, and not very attractive. The sound quality wasn’t so great either, and it was really expensive, so nobody took them up on it. Fast forward to today, here we are living our lives on the modern-day equivalent of the AT&T picturephone. One of the reasons that they were not successful was not that the people didn’t want it but that the ecosystems needed to create a truly satisfying phone experience just weren’t in place yet. One of the things I am studying now is how to tell when an ecosystem is right because the same idea all of a sudden works after 5-10 years. The poster child for this would be General Magic. In the early ‘80s, they invented everything that is in a smartphone today but the ecosystem wasn’t ready. There were no apps, no network, no bandwidth, nobody to connect to. It’s an interesting complementary question to this idea of co-opetition and figuring out what your innovation ecosystem needs to be. Krippendorff: Zach, when you decide which clients to work with, do you think, within your ecosystem, whether you should not only launch the idea but also launch the innovations that create the ecosystem around the idea? Ferres: When we are designing these business models, there are a lot of questions we have to ask on the business model side to see if the stakeholders necessary to make the business work are there and ready. Before we go and start commercialising things, we always do some customer development. We go out and try to assess if the market is ready for this business model that we define or not. Sometimes, we take these little innovation units and go out and do customer development before we commit a bunch of resources towards building them, to make sure that we can at least get some validation around our assumption and readiness that can help us gauge the market timing, and see whether or not the channels are ready, whether or not the customers are ready, whether or not the value proposition is sticking at this point in time. These are things you can test before you go and put a lot of resources and time behind the innovation unit. So, I’ll say we test our way around it but we haven’t done a truly extensive analysis of these ideas around the ecosystem. Krippendorff: You use that to test the ripeness of the idea but you maybe aren’t yet shaping the ecosystem itself? Ferres: Right. And if you would have taken the picturephone in the early ‘80s and done customer development, my guess is you would have pretty quickly realised all the reasons why it wouldn’t work and why it wouldn’t have gotten adopted. You would have been able to suss out the market readiness factors with some customer development work. Krippendorff: Have you seen in overweight and large corporations in healthcare and education sectors doing outside-in innovation or you still see more inside-out innovation? McGrath: Healthcare is more traditional inside-out and that is an ecosystem issue. There have to be these following four elements. First, there have to be a source of resources. There has to be firms, each of whom has idiosyncratic combinations of resources and capabilities touching this. There has to be some kind of connective tissue, which can be defined as whatever the governance process is for that ecosystem. Then, there has to be a regime of access and ownership. Unless you have those four things fairly well-defined and understood, your innovation ecosystem is not yet ripe. The autonomous vehicle is an example of an industry that doesn’t have all four elements. Thus, even though the technology is there, it’s all the other considerations about what makes a commercial opportunity that is creating the issue. As for the education sector, it is ahead of healthcare in terms of outside-in innovation, but it depends on where you look in education. We are seeing an awful lot of innovation in ways of delivering engaging content to people. There used to be monopolies in the space of traditional universities, and so they haven’t been incented to do a lot of innovation. We have been talking about online education for at least 20 years. Columbia had got itself into a horrible deal with a company called Fathom because online was going to be the next big thing but then the dot-com crashed. Now, everybody is experimenting with online education, and that is going to create some permanent change. Ferres: The timing is pretty incredible if you are in healthcare or education right now. We have got just over 50 equity positions in companies in our active portfolio right now, and about a third of the companies are struggling badly, about a third of them are not impacted, and then the other third are actually doing well. Most of the ones that are doing really well are either in healthcare, education, or digital media. On the outside-in, inside-out as it relates to healthcare, we are seeing lot more healthcare companies moving to corporate venture capital. We are also seeing more healthcare companies collaborate with start-ups and tech companies. There is also the increased drive to invest in these venture scale businesses outside of the organization, so I’d say I’m seeing a little bit more on the inside-out than the outside-in for healthcare. Krippendorff: How can we get our companies to embrace this mindset of open innovation? How can we get them to embrace it when they are not as big as Amazon and therefore don’t actually have the assets to build an ecosystem? Ferres: Amazon went out and single-handedly amassed JP Morgan and Berkshire Hathaway. They put together the big guns to go down this healthcare path, so not everybody can do that. The question of how to get to work on this open innovation stuff and whether it is a cultural shift is an interesting one. I would say it is. A lot of the organizations are following the default when they think about innovation as closed innovation. They don’t think they need outside involvement and instead prefer their employees for it, or hire more to build teams if required. More companies are now starting to realize that they cannot do all of it internally. We have to make the cultural shift too, but we can’t make all this work look like Amazon overnight. It’s going to take at least another decade for traditional brick and mortar Fortune 500 companies to think, act, and build like Amazon. That doesn’t mean we shouldn’t be moving in that direction; we need to start instilling some of these cultural norms now. We also need to find ways to do some open innovation in the meantime because it gets the larger, more traditional organizations one step closer to what Amazon has. So, we have work to do but embracing some of these open innovation programmes might accelerate our path to get there. McGrath: I would add that we are seeing signs, especially in healthcare, of companies that take a non-traditional view. In the case of Caterpillar, to address the mounting prescription drugs costs, they put a supply chain person on the job. He broke down every single piece of the supply chain and it was found that the cause of all the price issues and the rapid price inflation came down to how the pharmacy benefit managers, negotiated and integrated with the pharmaceutical companies. Caterpillar went so far as to create a medical unit that could test and create their formularies because the ability to sell drugs depends on which insurance company says this drug is okay, and it is then on the formulary list. If you are not on the formulary list, you are not going to get reimbursed so you are not going to sell any drugs. Caterpillar realised that this whole thing, all the way up the chain, was being gamed by the pharmacy benefit managers. They solved this issue and their rise in medical costs has been substantially less. This is innovative, but if they can do it then others can too. You need to have that doggedness to trace that whole chain all the way through, and not many companies have made this a priority. Krippendorff: Any last-minute advice or anything you want to share? McGrath: People think innovation is this dark art, but it isn’t. It is a set of practices and processes that have been honed over many years. There is a growing group of practitioners, educators that now understand this, and you can learn it. The reason most of us haven’t is that in most of our careers, we are either in a business that is slowly growing or is stable or is slowly declining, so we have never actually bumped up against innovation in our lives. We are now on the brink of these processes becoming much less mysterious and much more accessible. Ferres: We have gotten a taste of what collaboration and innovation can do, because of COVID-19. The silver lining to all this is that it is a good reminder for all of us that this decade is going to be about collaboration and about working together. As leaders go into their innovation strategy and planning discussions, they should think about how open innovation can play a role in their broader innovation plan over the next 10 years.

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