Open Innovation for Small and Medium-Sized Enterprises
Phyllis Speser, JD, PhD, RTTP, and Adriano La Vopa
This book is about how small and midsized companies can make money by leveraging the intellectual assets and intellectual property (IP) of others. In today’s global competition, using external sources and resources for innovation makes sound business sense, no matter what size the company. Up until now, however, most practical guides to open innovation have focused on what large companies should do. While there is a lot of overlap, small and midsized companies face different challenges and opportunities in developing, commercializing, and selling innovations—and thus how they practice open innovation should be correspondingly different.
In this book, we illustrate how open innovation can be effectively and profitably used by small and medium enterprises (SMEs). It is primarily written for managers, entrepreneurs, owners, and investors seeing to increase profitability associated with new product development. It will also be helpful for students and other people interested in a practical look at this aspect of the global “innovation economy.”
We believe this book is particularly timely. There is a glut of good technology on the global market today—a condition that most observers agree will last another decade or two. It is a great time to be a “buyer” (which includes licensee) of IP and technology because it is a buyer’s market. What we show you is how to think about open innovation and where, and how, it makes money in ways that increase your net profit on the income statement and company value on the balance sheet. Please let us know how well we have done that by e-mailing us at [email protected], [email protected].
What Is Open Innovation?
Since its birth back in 2003, open innovation has been a hot topic of discussion. By googling these two simple words, one can easily retrieve more than 86 million of results in half a second, which demonstrates the “buzziness” of the paradigm.
Open innovation has become a kind of umbrella that embraces lots of different practices and methods. Despite the diversity, one key concept runs throughout: Open innovation means opening up the boundaries of an organization and collaborating with others on the outside to share ideas and knowledge and to acquire IP rights in technologies and know-how in order to bring new products to market more profitably.
In the rest of this introduction, we provide a conceptual framework for thinking about open innovation at SMEs. The context for this framework is how companies manage their idea flow, now that external sources are as important as internal ones for bringing new process and product technologies to market.
A useful construct for discussing idea flow is the innovation funnel.The innovation funnel is basically a set of steps to be followed to bring an idea to launch. By launch we mean developing and making available a new service, product, production method, or other useful things.
The management of the funnel is subject to various theories for optimizing it. Some of these theories even have given rise to software implementations that can be used to manage the flow of innovations from idea to something accessible by others. Figure 1.1 is a visual depiction of the innovation funnel. Included are what are commonly seen as major steps and control points (e.g., gates, or milestones in the lingo of project managers). Control points ensure one step only ends after certain deliverables are provided. The deliverables open the gate for the next step to begin. Of course, the approach in the picture is not intended to be the only possible implementation of an innovation funnel. Funnels need to be customized according to each SME’s needs and processes. To use an old adage, “One size does not fit all.”
Figure 1.1 The innovation funnel
The use of the term open innovation was developed as a counter-concept to closed innovation (Figure 1.2) by Henry Chesbrough of Harvard University. Chesbrough coined the term open innovation in the book of the same name, although he was building on a body of literature that went back to the 1960s. He contrasted open innovation with closed innovation, which was a common business practice in the economic boom years after World War II (WWII) and up to the Vietnam War. The rebuilding of global economies after WWII provided a rising tide in which many boats floated. In closed innovation, the lessons of secrecy for successful military weapons development were reflected in the paradigm for corporate research and development (R&D) and new product development.
Innovation is closed when the organization does everything within its own walls without disclosing anything outside except after the IP is protected and secured. Confidentiality and noncompete agreements and a culture of secrecy existed in which R&D and new product development was controlled and occurred within the “walls” of companies. In this paradigm, the key to success was to hire the best brains possible under labor contracts that specified full control over labor conditions and stated that the output of their invention and innovation belonged to the employer.
Figure 1.2 Closed innovation model
This way of doing business is associated with the syndrome of “not invented here” (NIH). In one of the first analysis of this syndrome, by Kats and Allen back in 1982, the authors made it clear that such behavior inhibits innovating effectively. At the very beginning of their paper, the NIH syndrome is described as “the tendency of a project group of stable composition to believe it possesses the monopoly of knowledge of its field, which leads it to reject new ideas from outsiders to the likely detriment of its performance.” This definition is important because it summarizes the mindset that the R&D groups of most corporate, government, and nonprofit institutes used to have in the past. Even today, especially where the culture of innovation is not particularly ingrained, this syndrome can be a cause of poor growth by a company. Following common practice, we will call the mindset of NIH the “silo mindset” (Figure 1.3). Silos create walls within the same organization and between it and others, which prevent sharing ideas, knowledge, technology, and know-how.
When the individual has the NIH syndrome, he or she is not prone to learn and share. There is a high possibility that useful knowledge that both that person and others discover will be frozen. Indeed, with the silo mindset, sharing is not considered an option. The potential range of realizations and applications for an idea is limited by what is known inside the walls of the lab where the inventor is employed and by the knowledge of the few people to whom it has been disclosed. While an NIH mindset may have made sense in the age before telephones and the Internet, when knowledge was often de facto localized and territorial, it was doomed to short-circuit company success with the emergence of Internet- and cellular-based instant and ubiquitous electronic communications. Easy access to both real-time and asynchronous communication meant the ways professionals, researchers, engineers, managers, sales staff, service staff, customers, and vendors connected began evolving rapidly.
Figure 1.3 Closed silo mindset
Diverse factors have contributed to the crumbling of the “closed innovation.” The Internet with its social networking, easier global travel, and the loss of lifelong job security at a time of increased geographic mobility are a few examples. But such factors were secondary to the impact of closed walls and the silo mindset on younger employees and the students who were tomorrow’s employees. Unable to express their full potentials within 1950s-style organizations, the creative power, innovative brains, and venturesome spirits of the baby boomers and Generation Xers bumped up against “bureaucracy.” Enough smart people quit their jobs or school and started their own business based on the ideas, knowledge, and gumption that a new start-up culture had emerged whose heroes were people like Bill Gates (Microsoft), Herbert Boyer (Genetech), and Mark Zuckerberg (Facebook). They became wealthy and leaders in their markets through innovation. This dispersion of creativity and knowledge into start-ups created the humus out of which the open innovation paradigm grew. The rise of high-tech start-ups presented established big companies broader opportunities to source and benefit from outside innovation. Unlike most university technology, the technology from start-ups was more mature and thus had shorter lead times to market. The more technology there was to license—especially technology mature enough to be ready for market—the more it made business sense to acquire and use it. This wealth of outside technology encouraged companies to reinvent their business models for R&D and product development by opening their doors to external collaborations and intellectual asset and IP acquisitions. Outside ideas, knowledge, technologies, know-how, innovative people, and access to risk capital became tools for successful product innovation and the growth it can bring.
The open innovation paradigm was a consequence of such transformations. In roughly 25 years, the paradigm of R&D and product development has changed from closed to open innovation (Figure 1.4). The management of the innovation funnel has changed forever.
The open innovation paradigm, like closed innovation, is associated with a mindset, this time, “proudly found elsewhere” (PFE). PFE was presented in an article from two Proctor & Gamble (P&G) employees in 2006. Their new innovation model involved “educating” their internal R&D departments in how to find innovations elsewhere and being proud of doing so. One sentence of their article summed up the business case for open innovation: “For every P&G researcher there were 200 scientists or engineers elsewhere in the world who were just as good—a total of perhaps 1.5 million people whose talents we could potentially use.” It is clear that this approach meant a radical change in the way their company innovated and the mindset of employees involved in R&D and new product development (Figure 1.5).
Figure 1.4 Open innovation
Figure 1.5 Open mindset. When the mindset is open, there is an opportunity for exchanging more knowledge
The open approach, and the open innovation in general, created a different way of exploiting the immense resources outside the company. Open innovators are merchants of intellectual assets and IP. Their mindset endorses exporting and importing those resources via inside-out and the outside-in knowledge sharing and transactions (also shown in Figure 1.4). Large companies were among the first adopters, as in the past century, the Internet infrastructure and methods for finding and acquiring external intellectual assets and property were immature. Only larger firms could afford corporate technology scouts to walk the exhibit halls and meeting rooms of professional and trade association meetings.
Of course, the inside-out practice is not new to most of the universities, research hospitals, and research institutions. Indeed, it has been quite common for larger organizations to use licensing, sale, or donation of patents they never have used or were no longer using and which were no longer relevant to the organization’s plans for the future. This practice was used not only by corporations but also became well established at universities, government labs, and other research organizations. Whenever one hears about technology transfer, technology brokerage, licensing, IP trading, or any other similar term, it is likely that the seller (or donor) is addressing the inside-out practice. However, as explained in Chesbrough’s book, open innovation goes beyond practices focused on surplus intellectual assets or IP. Open innovation is focused on the bottom line. In open innovation, inside-out transfers go beyond surplus to potentially include any sharing, selling, licensing, or loaning of inside knowledge, know-how, and technologies. Any innovation is a candidate for being combined with expertise and risk capital to create new opportunities for bigger profits.
The big shift in corporate paradigms, which led to open innovation, occurred when larger companies began embracing outside-in. Bill Joy, cofounder of Sun Microsystems, used to say: “No matter who you are, most of the smartest people work for someone else.” This illuminating sentence summarizes the essence of the outside-in approach. It is an approach now commonplace for multinational corporations and for agile SMEs. It means an organization is sourcing its “missing knowledge” from the outside world, looking into different domains and arenas for intellectual assets available for sharing and IP to buy. It can be passive or proactive, as when an entity goes live with broadcast challenges either on its own website and through its network or via open innovation intermediaries. Open innovation need not be restricted to companies either. For example, the Harvard Medical School launched a challenge for gathering new ideas on Type 1 diabetes research. This challenge resulted in 190 submissions from different members of Harvard’s community, and 12 of them were selected as pioneering ideas to be developed in proper research projects. It is interesting to note that some of the winners were not experts. Some of the winners were still undergraduate students or patients. It is important to note that, because in open innovation the sourced idea is more important than the source itself. P&G Connect + Develop portal is an example related to for-profits. Through this portal, P&G calls for inventors, other companies, and individuals to submit their innovative proposals to them. Those ideas are assessed and evaluated by their internal employees, and if a match is found, the submitter is encouraged to work with P&G to further develop the idea to bring it to life.
A unique type of outside-in open innovation is crowdsourcing. This term applies to any practice that sources ideas, knowledge, or technology from a defined crowd of people (e.g., experts, companies, individuals, users’ communities, etc.), which can include the public in general. In Figure 1.6 are some examples of crowdsourcing platforms and providers, divided into domains of offered services: marketplaces, platforms, media and content, ventures, and product markets.
Being open to innovation means, then, being willing to allow new sources of knowledge, information, and resources cross the walls of the organization, whether it is out in or in out. It means collaborating with the external world and using what is outside of the organization in order to attain greater SME short-, mid-, and (or) long-term profitability. Open innovation practices create a higher number of opportunities, avoid “reinventing the wheel,” and leverage the achievements and failures of others. The scholarly literature is full of dissertations and case studies (Apple, Intel, Hewlett Packard, Xerox, P&G, Philips, etc.). In this book, we mine that literature and our experiences as practitioners of open innovation to provide some practical and essential methods, as well as clear guidelines on how to use open innovation in SMEs.
When Does It Make Sense to Practice Open Innovation?
For SMEs, it makes no sense to get involved in open innovation unless you are going to make more money doing it than you would not doing it. Whether the product you hope to sell is a knickknack or something that will feed the hungry, clothe the naked, house the homeless, heal the sick, bring energy to cities and clean water to the deserts, and do all that at the same time, companies still have to make money or they will go out of business. Open innovation works when it gets you novelties more cheaply than other alternatives or gets you new products or services, where IP protection enables charging monopoly prices. In short, it gets you increased net revenues. As David Speser, cofounder of Foresight Science & Technology, says, “Without sales, companies die.”
Figure 1.6 Crowdsourcing landscape
Net Revenues − Cost of Goods Sold = Gross Profit
Revenues need to be considered in light of expenses. The next item in determining if practicing open innovation makes sense is the cost of goods sold. Costs in open innovation include expenses for finding ideas and technologies, doing due diligence on them, using or acquiring them, and productizing them (or incorporating it in another product or adapting it to use when making, selling, or supporting products). If IP is involved, it also involves layers and filing fees for obtaining and maintaining those rights, monitoring for infringement, and enforcing those rights against infringers. The best-case open innovation scenario is you “buy” ideas or technologies that allow you to get a product or service that
- • Is in high demand;
- • Is IP protected; and
- • Can be competitively priced and still make you a good profit.
When you own IP, it means that a group of intellectual assets is protected. Protected means you have a legal monopoly to exploit your product for the life of the patent, copyright, or mask. The know-how you develop can be protected through trade secrets, enhancing your ability to execute better and thus discourage infringement by copying or stealing. Good trade and service marks can provide additional protection if customers associate your mark with that type of goods.
On top of all this is the fact that your company, in the best-case scenario, gets to market ahead of your competitors. We call that having the first mover advantage. First mover advantage gives you a de facto monopoly on top of any IP-driven monopoly—at least until the competition responds.
Costs of Goods Sold (TIME 2) < Costs of Goods Sold (TIME 1)
It also means you have learning curve advantages. As you are already making, selling, and supporting the product, your company is figuring out the “tricks of the trade” ahead of others. The company is also able to respond to the market by improving the product and adding on tag-alongs like service and training contracts, warrantees, and consumables used with the product.
SMEs practicing open innovation often can drive down costs further by accessing government or foundation money. Around the world, local, regional, national, and multinational governments and nongovernmental organizations (NGOs) have money available to help acquire, further develop, and commercialize technology as part of economic development or human health and welfare initiatives. Winning government contracts and grants drives down the costs of goods sold as they subsidize those expenses. Where internal development of a technology is an option, conducting cooperative research and development with a government lab, university, nonprofit institute, or other company is another way to reduce costs.
Net Revenues From IP (TIME 2) − Cost of Goods Sold due to IP (TIME 2) > Net Revenues From IP − Costs of Goods Sold due to IP (TIME 1)
The icing on the cake in the best-case scenario is you license the IP rights for noncompetitive uses. You can also license it to competitors when the competitive advantage the IP formerly gave is no longer there. You might also license it to competitors if you know they are starting to work on competing technology. One increasingly used response is to make money off the competitors from royalty and fee payments to offset the reduction in revenues anticipated when they introduce their product. As revenues go down, your own costs usually do too. The result is a net profit so long as royalty and fee payments exceed IP maintenance fees and the costs of monitoring for, and preventing, infringement.
∑tNet Revenues (Product Contribution + Royalties and Fees) − ∑tCost of Goods Sold (Obtaining IP + Developing and Productizing IP + Maintaining IP + Enforcing IP) = ∑Gross Profit From IP
∑Gross Profit × Discount Factor = Discounted Gross Profit From IP
We end up here: Open innovation makes sense when it creates a gross profit that, after discounting, meets your company’s hurdle rate for investment of company money. Essentially, you only acquire a technology from outside where you can make a good profit off it.
Amortized IP (TIME 2) > Amortized IP (TIME 1)
In open innovation, there is often another plus. The value of the company, and thus its stock, goes up. As the IP is productized and contributes to sales revenues, its value on the balance sheet goes up. That bumps up intangible assets, which in turn bumps up total assets. Increases in total assets increase (without offsetting liabilities) the value of a company’s stock.
Goodwill (TIME 2) > Goodwill (TIME 1)
Goodwill is another intangible asset. Product success generates goodwill for companies. So does a reputation for great technology and innovation. In open innovation, this intangible can bump up the value of goodwill. Where goodwill comes into play, the bump will be multiplied if the product heals the sick, feeds the hungry, brings water to the desert, makes clean energy, reduces pollution, or some other thing everyone agrees is a good thing. After all, doing good things usually generates goodwill.
Price Stock + Stock Options Price (TIME 2) > Price Stock + Stock Options Price (TIME 1)
Acquiring intellectual assets and IP relevant for the business contributes to stock price in two ways. First, the cost of acquisition (which is its current market price) now increases the value of the company’s intangible assets. In the best-case scenario, the assets are up and the liabilities stable or down. The value of the stock goes up. The company can raise money by selling stock. As the price of stock goes up, less stock needs to be sold to raise the same amount of money.
In the best-case scenario, the IP will be very significant for the company. If it is, it is likely for some period there will be increased volatility in the stock price until the stock market settles on the value impact of the IP and related assets. Since volatility is an input when determining the value of a stock option and higher volatility drives up option prices, open innovation means a company can sell fewer stock options to raise the same amount of money than it would have had to sell without open innovation. If government regulations allow and it makes business sense, it can also buy back its options when volatility is lower and the price has settled.
Like any corporate practice, open innovation works when the net profits on the income statement and the value of company stock increase. This book provides SMEs with an overview on open innovation at SMEs and a set of tools to use in their innovation processes in order to increase profits and enhance the value of company stock.
The Chapters
The book has six chapters.
In Chapter 2, we focus on the use of brokers and auctions. Every SME has two choices in practicing open innovation: Do everything yourself or get help from vendors selling services that support open innovation. In this chapter, we look at some ways to address how to think about that choice and some tools to use, whichever the choice. This chapter also introduces you to the wealth of free web portals that have sprung up to help you find technologies that may be of interest.
Chapter 3 addresses technology transfer, which involves working with representatives from universities, research hospitals, government laboratories, and nonprofit research and development institutions to acquire technology. Technology transfer is now a mature field, and these kinds of public institutions have dedicated professionals to help you find and license the technology they have invented. Technology transfer works best when you have at least a rough idea of what you are looking for. As the technology invested by these institutions tends to be relatively immature, technology transfer works best for SMEs that have in-house capabilities in R&D and product development or access to these skills and capabilities.
Chapter 4 looks at crowdsolving (also called crowd sourcing), one of the newer approaches to open innovation. Crowdsolving can be an effective and cost-efficient tool for SMEs. It leverages the power of the web for finding new products or product enhancements and the technology for making and creating them. It is also a tool for selling or licensing technology.
Chapter 5 rounds out our discussion by presenting the spin-up business model. Spin-up involves in-licensing an immature technology and then out-licensing a “market-ready” technology or product. Almost every country today has subsidies available for developing technology intensive products and services. Much of this funding is only available to SMEs.
We conclude in Chapter 6 with a brief discussion on open innovation strategies for SMEs that leverage the approaches and tools in the earlier chapters to make you more money and greater profit.