Haas School of Business

Leading Through Innovation

Henry Chesbrough on

Prof. Chesbrough: Look Outside your Firm's Walls to Innovate

Paul Horn, then the head of research for IBM, had a staff of 3,000 and a budget of tens of millions of dollars–but he also faced a complex dilemma. His research activities were geared to support a company that manufactured computer products such as servers, mainframes, and software. But most of IBM's revenues were coming from services, not products.

"I can't sustain a significant research activity at IBM if our research is not relevant to more than half of the company's revenues going forward," he told Henry Chesbrough, PhD 97, in 2004.

For Chesbrough, an adjunct professor at the Haas School, the conversation was a classic "ah-ha" moment. With the economies of Europe and North America shifting to services as manufacturing moves to lower-cost parts of the world, how can companies find new paths to competitive advantage as their old strategies are overtaken by the forces of commoditization? The answer to that question is the core of Chesbrough's latest book, Open Services Innovation: Rethinking Your Business to Grow and Compete in a New Era, which hit store shelves in January.

"Innovation in services," he writes, "is the escape route from the commodity trap and a solution for growth. As they innovate into the future, companies must think beyond their products and move outside their own four walls to innovate."

The injunction to move outside the walls should be familiar to readers of Chesbrough's earlier work in which he coined the term "open innovation," a business strategy which asserts that "a company should make greater use of external ideas in its business and allow its own ideas to go out to others to use in their businesses."

Since the publication of his first book, Open Innovation: the New Imperative for Creating and Profiting from Technology, in 2003, the principles Chesbrough presented have been widely accepted and taught at business schools and management training centers around the world. Open innovation has become so much of a mantra that Chesbrough says he has to warn students that "just
because something is innovative or a best practice, that doesn't mean it's an example of open innovation."

The Razr and Mr. Jobs

Open Services Innovation examines the strategies of companies like Apple, LEGO, and FedEx that successfully embraced the shift to services and open innovation, and companies like Motorola and Nokia that haven't.

While it may seem surprising to view Apple as an innovator in services, it is precisely that insight into the company's success that advances the argument Chesbrough made in his earlier work. Apple gave consumers a popular product when it launched the iPod in late 2001, and tellingly, it was developed with the aid of a number of outside companies, including PortalPlayer, a semiconductor design shop, and Pixo, a software developer. But the little MP3 player became a smash hit that transformed the music industry when Apple married it to the iTunes service 18 months later.

Indeed, iTunes itself is more than a service; it's a platform upon which subsequent hit products, including the iPhone and the iPad, build. "Services innovation can help companies erect service platforms, which attract customers and often a variety of other contributors, partners, resellers, and commentators as well," writes Chesbrough.

Apple's success can be better understood by contrasting its approach to that of Motorola–and the rise and fall of its one-time star, the Razr cellphone. When it was introduced in late 2004, it was the coolest, slimmest cellphone on the market, and it sold more than 50 million units. But three years later, Motorola's follow-up products, including new models of the Razr, flopped as other manufacturers learned to how to make slim, elegantly designed handsets.

Why did this happen? "Motorola's real failure was in its product-focused conception of innovation. Motorola thought about innovation in terms of coming up with another breakthrough product. What it didn't think hard enough about was its customers' experience with its products and what additional services it could wrap around its devices to deliver a superior customer experience," says Chesbrough.

By contrast, the iPhone is more than an elegant device. It's a platform that has attracted third-party developers and service providers to give users a great experience, he says. More than 100,000 applications, most not written by Apple, run on the iPhone and more than 3 billion apps have been downloaded by customers around the world.

While successful technology companies in Silicon Valley seem to carry some of the traits of open innovation in their DNA, it would be a mistake to think that the same principles don't apply in other sectors of the economy–including the service sector. But there are, of course, differences.

In a recent issue of the MIT Sloan Management Review, Chesbrough warns that open innovation is far from a one-size-fits-all solution: "It's important to realize that open innovation works somewhat differently in services businesses, in part because the role of the customer is different in such businesses. Services are intangible by nature, so that customers often cannot specify exactly what they want. It is often much harder to measure the services that are delivered. And different customers might experience the same service differently," he wrote.

Let the Outside in

Openness, obviously enough, is part of the open innovation model. But what does that actually mean? According to Chesbrough, there are at least two types. There's "outside in," where a company makes greater use of external ideas and technologies in its own business. "Openness in this context means overcoming the 'not invented here' syndrome, where the company monopolizes the source of its innovations, and instead welcomes new external contributions.

"The other kind of openness is 'inside out,' in which a company allows some of its own ideas, technologies, or processes to be used by otherbusinesses," he writes. "Openness here means overcoming the 'not sold here' syndrome, in which the company monopolizes the use of its innovations, prohibiting use outside of its own business."

Perhaps the most striking example of "outside in" innovation is LEGO, the maker of a familiar line of snap-together toys. In 1998 the Danish company introduced LEGO Mindstorm, in which motors were included with the plastic parts so consumers could build moving structures. Not long after, Chesbrough recounts, someone hacked into the software that came with the motors, allowing the LEGOs to do things the company hadn't thought of.

Not surprisingly, LEGO wasn't happy about that and considered it an illegal intrusion. However, LEGO later had second thoughts and opened the software so that anyone could modify it. The hacks opened up whole new areas of use. For example, a middle school curriculum was developed to teach children robotics using LEGOs. Other innovations followed and LEGO has gained adult buyers who probably wouldn't have been interested in the product if the company had kept the gates closed.

Amazon, the giant online retailer, exemplifies the "inside out" approach to open innovation. Given its success, it could have stuck to the old "closed innovation" paradigm and continued to hold its expertise closely and perform all work by itself. But it didn't. Instead, Amazon opened its powerful website to other merchants, allowing them to list their own merchandise, says Chesbrough. As a result,
Amazon achieved powerful economies of scale as other merchants swelled the company's offerings and even paid Amazon to host their websites.

Open Innovation at Haas

Students, particularly undergraduates, don't often have the chance to tell leaders of major businesses how they should run their businesses. But on a wet morning near the end of the fall quarter, two dozen undergraduates had that chance. In fact, their grades depended on it.

The students had just completed Open Innovation and Business Models, a course taught by Solomon Darwin, associate director of the Open Innovation Program at Haas, who also has taught classes on open innovation to executives from China, Switzerland, and the United Kingdom during the past year. The challenge for these undergrads, as described in the course listing, was daunting: "Come up with innovative solutions for a publicly traded company that either suffers from a lack of innovation or whose business model is showing signs of breaking down or simply not working and falling apart."

The companies they were assigned to study–Best Buy, Shell, Dole, Nike, and UnitedHealth Group–are all very large and quite complex, with business opportunities across the globe.

Each group began its presentation with an overview of its company's financial position, followed by a "SWOT" analysis–a snapshot of its strengths, weaknesses, opportunities, and threats. The heart of each presentation was a plan to restructure or rethink a significant line of business.

For UnitedHealth, the team proposed an innovative program to engage diabetic and pre-diabetic patients in their own care. What made the plan an example of open innovation? UnitedHealth would partner with Nike, using that company's running shoe that monitors calories burned, heart rate, and other metrics, and with Dole, encouraging patients to use its line of sugarless food products.

The team assigned to Shell envisioned the multinational oil company capitalizing on the emerging market for electric cars by building a network of charging stations. Shell, said senior Tim Chen, BS 11, would create an ecosystem including manufacturers of solar panels, whose products would generate electricity on the roofs of the charging stations; battery makers; and companies
that would help create standards for charging. "We're looking at groups of companies coming together to solve big problems. You might think of it as crowdsourcing," he said.

Or as Chesbrough puts it at the conclusion of his book: "By embracing the Open Services Innovation approach, you can get the best external ideas joined to your best internal ideas and take those combinations to new markets."

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