Innovation Networks: Looking for Ideas Outside the Company
Published: November 14, 2007 in Knowledge@Wharton


http://knowledge.wharton.upenn.edu/

This posting is a bit longer than usual but it touches on the critical issues of forming and managing Open Innovation networks.

According to Larry Huston, managing partner of consulting firm 4INNO, future competitive advantage will depend on "innovation networks" -- individuals and organizations outside a company that can help it solve problems and find new ideas for creating growth. Now the interview......

Knowledge@Wharton: I understand that you have been doing some work on innovation networks and arguing that these will be a major disruptive change, affecting all companies in the future. Could you explain that a little bit?

Huston: First of all, let's define what innovation networks are. Innovation networks are people, institutions and companies that are outside the firm -- they can also be inside the firm, but for purposes here they're outside the firm. They are intellectual assets that companies can link up with to solve problems and find ideas, while beginning to think about those assets as an extended part of their organization -- and therefore quickly create top-line growth and bring new things to the marketplace.

From a competitive-advantage standpoint, yes, I think it's going to be a really big deal. I don't believe we're at a tipping point yet, but I think, in the future, the companies that identify those assets outside and begin to build relationships with them have a real shot at building a competitive advantage and preferential relationships.

Knowledge@Wharton: Could you give an example of a company that has built an innovation network and is using it to its advantage?

Huston: I think there are a number of them. Procter & Gamble spent a lot of time defining the assets outside that could help it in its various science areas and business areas and set about developing, in different regions of the world, assets, hubs where we could link into those. [It also] developed a proprietary network of individuals who could contact others in different parts of the world….


Knowledge@Wharton: It sounds like there would be concerns about intellectual property when it comes to building these kinds of networks. Is that the case?

Huston: Yes. There are concerns and I think they're well-founded, in fact. There are good ways to handle them. One of the major concerns is, if we go out and share what we're looking for on the outside, it's going to tip our hand to our competition. So one way to handle that might be to not clearly state what the problem is that you're trying to solve.

You don't talk about the end-product application, but you talk about the science problem you're trying to solve, and you don't even put your company name on it in some cases. You may do this anonymously, so that people are reading about a physics problem or a baking problem and they have no idea what company it might be coming from, or anything.

In some cases, however, you might want to deliberately put your name on it, because people want to associate themselves with perhaps a big company that can scale their idea. If you're not concerned about the competition seeing that, you may deliberately want to put your name on it. My experience has been [that] when you put your name on it, you get about twice the response rate.

The other issue is in sharing intellectual property like this outside, particularly in regions of the world like China, where there aren't as many intellectual property protections as there are, say, in the U.S. or Western Europe. You do need to be careful in terms of what you share, so you need to have good practices, good review points, good vetting by your business, by your purchasing people, by your legal counsel; but with the proper precautions there's not really a problem. It's just taking what you normally do and scaling it up big, utilizing the Internet and the ability to globally distribute e-mails and things like that.

Knowledge@Wharton: In offering the examples of companies that do this, you referred to Procter & Gamble, Boeing and Microsoft. Does that imply that this is only something for big companies, or can smaller companies also build their own innovation networks?

Huston: No, I think small companies can build them. In fact, a lot of these practices are based upon the kinds of things that little companies do, who don't have a lot of resources. They're always looking at what problems they have; they can't build a given technology capacity, or they can't go and hire a group of people, and so they're searching the patent literature, the technical literature, they're on the Internet, trying to find people who have the ideas and [then] go knock on their door.

So it's certainly something that small companies can do, and with the development of the infrastructure outside of companies -- things like InnoCentive, NineSigma, Alibaba in China, the innovation relay center system in Europe -- there's a whole infrastructure of companies, some of them government-sponsored, to help you get in touch with companies out there at fairly low costs. So it's certainly something that small companies can do.

Knowledge@Wharton: I guess it's pretty clear what the incentives might be for the company who's building a network like this, but what are the incentives on the side of the people who participate in the network or the other companies?

Huston: Thirty-five percent of the patents in the world are now going to small companies. When most companies built their R&D and innovation capacity, it wasn't long ago that a very small proportion of the patents were going to these small entrepreneurs, these small companies. The world has changed. In fact, many of the most innovative people out there are in small companies. They were leaders. They were technologists in big companies. They didn't like the environment in big companies and so they went and became a small company.

And so they're out there, and they're doing highly innovative work, but what they lack is market access, scale....

That's the kind of thing a Microsoft or a Procter & Gamble or Eli Lily or companies like that can do. It's because they have scale, and the small company has the agility and the entrepreneurship to think, "I've got to do this well. I've got to do it at low cost." And, you know, they have some advantages that big companies don't have.

So what you do is marry the scale advantages of the big company and sort of the hungry attitude and agility of a small entrepreneur, and that's what you get. You get this capability, and it can be done in that way.

Knowledge@Wharton: I think you've made a very persuasive case about why companies might want to build innovation networks and participate in them. What may not be very clear, though, is how they go about it. Any thoughts on how a company could do this?

Huston: Well, yeah. One is get very clear on what your strategic intent is. Are you doing it to solve a specific problem? I might be a car company and I'm looking for a new battery technology. Well, am I trying to solve a battery technology problem? Or, am I like a Procter & Gamble, which fundamentally has said, "The invent-it-yourself innovation model is broken, it's not sustainable. Therefore, I've got to build a totally new capability. I've got to redefine my organization as my ten thousand people in addition to the two million people that are outside, and redefine myself as two million, ten thousand people."

So, the very first step is to get very clear about why you're doing it, and what your strategic intent is. And then begin to really design the network around the strategic intent. Do you need just incremental problem solving? Do I need to build idea nets? Do I need to build solution nets? Do I need cost innovation networks? Am I looking for disruptive innovation? Do I need to reach from one domain into another domain of knowledge outside of my industry where I might find more disruptive innovation?

So, getting very clear on that, designing around that, and then really creating an architecture of participation. How can you involve the outside world? I've seen some very interesting things. For example, Toyota at Nagoya -- they have supplier days. They have a briefing center, and anyone can theoretically knock on the door and come in and pitch an idea for Toyota.

GE will hold events in China, say, in their appliance industry, and they'll invite hundreds of suppliers in and say, "Here are our top problems. Can you solve them?"
So, how do you create this architecture of participation, where the outside world also can come in, and you can tap them? So there's a variety of different things that you need to consider in terms of the design.

Knowledge@Wharton: Once you've got this architecture worked out, how does one sort of get the ball rolling? What are things to keep in mind? How do you get a conversation started?

Huston: Well the number-one thing is, again, you have to really understand how you are going to use the networks and what you are trying to do. So typically, the best way that networks work is to create a brief, or a problem description that you're trying to solve. It might be that you're trying to make a diaper that's flushable in the toilet [for example].

From a problem like that, you begin to break it up into its components. It might be something that has to hold liquid, yet dissolve in liquid. It's a very difficult problem to solve.

You begin to develop what I call a "solutions playbook" for a problem area. And from that solutions playbook, you have a number of problem descriptions. Those get written up in a precise way in a two- or three-page brief process. Then, based upon the brief, you develop a taxonomy of science terms. And so in your brief, there may be 30 or 40 different science terms that you want to express in three or four hundred ways, because different industries would express it in a different way.

And then what you want to do is find people in the world utilizing search engines or the Yellow Pages, and begin to distribute out to these people your brief, so that you can make a connection and they can get back to you. That's a transaction-based network. And so there's a transaction. I want something. I send it out. I get something back. That's one way to go.

The other way to go with networks is to think about a relationship based model -- [that is,] to identify small, medium, large companies that have strategic technologies where I would develop relationships -- top-to-top relationships between my firm and those firms. We basically co-invent, or collaborate together to create the inventions.

The reality is, you can't support a lot of those because those are time intensive. It takes a couple of years to get them off and going. They need to understand you. You need to build trust in them back and forth.

So what you're really doing is, you're building a portfolio of relationships with the outside world. Some of them will be transactions where you just send things out and look for things to come back. Others will be a portfolio of relationships that you very carefully have thought about and you leverage your networks in that way.

So, it's this combination of thinking, and this is a foreign concept because people think about their products that they want to take to market, what their portfolio is, but they never think about the portfolio of relationships that it's going to take and the demands of those relationships on the organization. So you have to begin to think about, in this network global economy and networks that we're talking about, the underlying capability and portfolio of relationships that you want to build in order to build disruption and top line growth in the business.

Knowledge@Wharton: When you source innovation from within an organization, the sort of chain of command is relatively clear. When you do it in a network, I can imagine that all kinds of governance issues might come up. How should a company tackle those? What issues come up?

Huston: Well, you're right. It's, number one, trust based. You give me something, I give you something back. You can't order people what to do, right? And in the end, your reputation is important.

You want to become the preferred partner to the outside world because, look, if I'm Procter & Gamble, for example, and I turn off a certain group of innovators, the next competitor can pick up those relationships. So, in the end we're in competition for building these relationships as time goes on. But I think the important aspect of this is, really think through the customer-supplier relationship and how do you become the preferred customer of the external worlds.

Innovators, they want information. They want transparency. They want quick speed and "get back to me quickly." They want a fair deal. And frankly, the word-of-mouth and advocacy networks are very rapid. OK? Because these people all move in the same circles. They all talk amongst each other as we do. So, you have to really think through what is your innovation brand? What do you stand for in terms of branding yourself in this global competition for talent?

Knowledge@Wharton: We've talked quite a bit about the value of participating in the networks. What are some of the risks or the disadvantages?

Huston: Well, there are a couple of them. Again, if you're not smart, you give away things from an intellectual property standpoint. You have to be very smart about deal making because very often, it's like the slot machine; the dollar wheels are spinning immediately. So, most scientists are not very good in terms of talking money and they give away way too much information. They're not exactly the people that you want negotiating your next car or your next house price; we'll say it that way. Now some are, of course. So I think you have to be very careful about having the wrong skilled people getting involved in deal discussions. I mean, that's an issue. The IP certainly is an issue.

The other one is that if you're not smart, the world is so big and you can throw requests out there and you'll just be inundated with responses. So you have to be very careful to match your absorptive capacity with the outside world. The ideal network is if you have three problems, three outside people right? This is because you want to contact somebody, do a deal and get it into the market. The fact that we have to build networks with many people is because we can't easily get to people. As a result, you tend to throw your briefs out and talk to a lot of people. But, you know things come home to roost at some point and everybody is knocking on your door and you're inundated. So, designing the network to match your absorptive capacity is a key issue.

Productive Friction: How Difficult Business Partnerships Can Accelerate Innovation
The “hassle factor” of transacting with other companies isn’t always something to be eliminated.
by John Hagel III and John Seely Brown

This is a very interesting discussion on the importance of strategic alliances in building the Capability Platform I showed in the last posting – the base of capabilities needed to get from where you are to where you want to be. I suggest ordering the article: HBR (February 2005, Reprint: R0502D).




Companies are becoming more dependent on business partners, but coordinating with outsiders takes its toll. Negotiating terms, monitoring performance, and, if needs are not being met, switching from one partner to another require time and money. Such transaction costs, Ronald Coase explained in his 1937 essay “The Nature of the Firm,” drove many organizations to bring their activities in-house.

But what if Coase placed too much emphasis on these costs? What if friction between companies can be productive? Indeed, as John Hagel and John Seely Brown point out, interactions between organizations can yield benefits beyond the goods or services contracted for. Companies get better at what they do—and improve faster than their competitors—by working with outsiders whose specialized capabilities complement their own. Different enterprises bring different perspectives and competencies. When these enterprises tackle a problem together, they dramatically increase the chances for innovative solutions.

Of course, misunderstandings often arise when people with different backgrounds and skill sets try to collaborate. Opposing sides may focus on the distance that separates them rather than the common challenges they face.

How can companies harness friction so that it builds capabilities? Start by articulating performance goals that everyone buys into. Then make sure people are using tangible prototypes to wrangle over. Finally, assemble teams with committed people who bring different perspectives to the table.

As individual problems are being addressed, take care that the underpinnings of shared meaning and trust are also being woven between the companies. Neither can be dictated—but they can be cultivated. Without them, the performance fabric quickly unravels, and business partnerships disintegrate into rivalrous competition.

To summarize the message: To achieve productive friction, the authors recommend the following things when collaborating on innovation, which they call the 4P's: performance requirements, people, prototypes and pattern recognition:

• Build a shared sense of what must be achieved (a. create a basis of shared meaning and trust, b. use forward looking incentives, c. avoid overemphasizing near-term cash rewards, d. define the concept 'trust' narrowly, e. trust-but-verify)
• Parties must have relevant specializations and diverse perspectives,
• Use a prototype (boundary object) to enable participants to see beyond the boundaries of their specialization,
• Capture and disseminate the learning, leveraging various ICT systems.

ORGANIC GROWTH EXECUTIVE EDUCATION PROGRAMS AT THE KELLOGG SCHOOL
Warning – This is an advertisement

Hello everyone. I want to share with our community insight on two Kellogg School executive education programs focusing on growth that incorporate much of what we discuss in our blog. The classes -- Driving Top Line Growth (DTLOG) and Implementing Organic Growth Strategies (IOGS). --are designed to integrate the total challenge of driving top line driven earnings growth. They are designed to be independent, standalone classes as well as offering the complete story when taken in any sequence. The Kellogg School offers special incentives for taking the courses within one calendar year and/or if company teams attend (which we highly recommend)

The market validated Market Driven Growth (MDG) process is the design skeleton for the classes:

DTLOG centers on the Leadership Framing and Business Builder components as well as Leadership Resourcing at a business level. IOGS starts with Leadership Resourcing at a project level and focuses on the Concept Validation and Execution process components.


The underpinning of both classes is the focus on market tested tools and methodologies that can be deployed immediately on returning to your jobs. To facilitate the learning as well as allowing you to achieve real time business results, both classes allocate time to work on what we call the Growth Initiative Journal. You will apply the concepts presented to your real business challenges. We leverage the incredible intellectual capital of the best Kellogg School faculty with the experience of business people (outside speakers and me).

The current course is entitled Driving Organic Top Line Growth which many of you have taken.

http://www.kellogg.northwestern.edu/execed/programs/LEAD17/index.htm

The “center of gravity” of the course is innovating across the entire business design:

The course material includes:

CUSTOMER SEGMENTATION AND VALUE PROPOSITION -- Professor Mohan Sawhney offers deep insights into the underpinning of this model.

MAKING BUSINESS DECISIONS - Professor Vicki Medvec discusses the basic issues of making critical business decisions that underpins all this work while highlighting the dangerous traps to avoid.


We also discuss in great detail the challenges that medium to large companies face in developing these concepts and implementing them at a strategic level using a series of highly interactive cases and supporting lectures:

RESOURCING CRITICAL BUSINESSES TO WIN
Portfolio processes are an essential part of the growth effort – you must free the resources needed to drive the critical growth businesses while still meeting your short term commitments. We deploy an exciting case on the challenge of deploying resources across the major businesses of a corporation using tools developed to accomplish this goal in real business situations.

DEPLOYING A NEW BUSINESS DESIGN
We discuss the use of the Innovation Radar to think though all the issues required to implement a new business system at a strategic level. The case is based on a real business challenge of bringing a disruptive offering to a market with well entrenched players.

MANAGING GROWTH INITIATIVES IN A LARGE COMPANY
We use the case of IBM who faced this challenge and developed an incredibly successful organizational system. The case is rich in the most fundamental issues of managing new businesses. In this context, Professor Wolcott discusses the different corporate models of accomplishing sustained growth engines based on his extensive research and I discuss the critical challenge of managing businesses in highly uncertain business environments—Managing Business Risk.


The new class is entitled Implementing Organic Growth Strategies.
http://execed.kellogg.northwestern.edu/programs/LEAD20/index.htm

The “center of gravity” for the course is developing the “Staircase to Growth”

We cover all the issues that should be considered in taking your business from where it is to where you want it to go – the new business design ( we will dedicate a session on ensuring you have the Business Design fully developed)

The content covers:

RESOURCING THE PROJECTS TO WIN – an interactive case study on a powerful set of portfolio tools and approaches at the project level – what projects do we stop to afford the budgetary head room required to resource critical growth projects while meeting short term numbers?

BUILDING THE STAIRCASE—a combination of lecture and a case study that bring the Discovery Driven Planning (DDP) process to life. DDP is a market tested tool that successfully enables businesses to execute the riskiest part of the Staircase: how do you begin to scale while there is still substantial uncertainty?

BUILDING THE CAPABILITY PLATFORM – Professor Edward Zajac will discuss forming and managing strategic alliances fill your capability gaps.

SECURING THE MARKET POSITION – Professor Thomas Conley will review how to secure the new market position via lecture and a case study deploying all forms of intellectual property. He will emphasize how to incorporate the planning early in the Staircase process.

THE ROLE OF LEADERSHIP IN INNOVATION- Professor Mohan Sawhney will lecture on this all important topic and will be supported by a case study of a company that grew via a dramatic change in their strategy.

IMPLEMENTING NETWORK-CENTRIC INNOVATION -- Professor Mohan Sawhney will discuss this all important trend that is beginning to impact all businesses.

Please visit the listed web sites for further details.

Learning from Tata's Nano
The innovations of the $2,500 car carry important lessons for Western executives
by John Hagel and John Seely Brown
http://www.businessweek.com/innovate/content/feb2008/id20080227_377233.htm

This is one of the most powerful innovations I have come across. After reading, think what this approach could accomplish from enhancing innovation; enabling mass customization; and reducing capital intensity. It just blew me away!!

Last month by Tata Motors of its newest car, the Nano, was revealing on many levels. The announcement generated extensive coverage and commentary, but just about everyone missed the Nano's real significance, which goes far beyond the car itself.

But, O.K., let's start with the car itself—particularly the price. At about $2,500 retail, the Nano is the most inexpensive car in the world. Its closest competitor, the Maruti 800, made in India by Maruti Udyog, sells for roughly twice as much. To put this in perspective, the price of the entire Nano car is roughly equivalent to the price of a DVD player option in a luxury Western car. The low price point has left other auto companies scrambling to catch up.

Thinking Outside the Patent Box

How could Tata Motors make a car so inexpensively? It started by looking at everything from scratch, applying what some analysts have described as "Gandhian engineering" principles—deep frugality with a willingness to challenge conventional wisdom. A lot of features that Western consumers take for granted—air conditioning, power brakes, radios, etc.—are missing from the entry-level model.

More fundamentally, the engineers worked to do more with less. The car is smaller in overall dimensions than the Maruti, but it offers about 20% more seating capacity as a result of design choices such as putting the wheels at the extreme edges of the car. The Nano is also much lighter than comparable models as a result of efforts to reduce the amount of steel in the car (including the use of an aluminum engine) and the use of lightweight steel where possible. The car currently meets all Indian emission, pollution, and safety standards, though it only attains a maximum speed of about 65 mph. The fuel efficiency is attractive—50 miles to the gallon.

Hearing all this, many Western executives doubt that this new car represents real innovation. Too often, when they think of innovation, they focus on product innovation using breakthrough technologies; often, specifically, on patents. Tata Motors has filed for 34 patents associated with the design of the Nano, which contrasts with the roughly 280 patents awarded to General Motors (GM) every year. Admittedly that figure tallies all of GM's research efforts, but if innovation is measured only in terms of patents, no wonder the Nano is not of much interest to Western executives. Measuring progress solely by patent creation misses a key dimension of innovation: Some of the most valuable innovations take existing, patented components and remix them in ways that more effectively serve the needs of large numbers of customers.

A Modular Design Revolution

But even this broader perspective fails to capture other significant dimensions of innovation. In fact, Tata Motors itself did not draw a lot of attention to what is perhaps the most innovative aspect of the Nano: its modular design. The Nano is constructed of components that can be built and shipped separately to be assembled in a variety of locations. In effect, the Nano is being sold in kits that are distributed, assembled, and serviced by local entrepreneurs. (what a breakthrough in thinking)

As Ratan Tata, chairman of the Tata group of companies, observed in an interview with The Times of London: "A bunch of entrepreneurs could establish an assembly operation and Tata Motors would train their people, would oversee their quality assurance and they would become satellite assembly operations for us. So we would create entrepreneurs across the country that would produce the car. We would produce the mass items and ship it to them as kits. That is my idea of dispersing wealth. The service person would be like an insurance agent who would be trained, have a cell phone and scooter and would be assigned to a set of customers."

In fact, Tata envisions going even further, providing the tools for local mechanics to assemble the car in existing auto shops or even in new garages created to cater to remote rural customers. With the exception of Manjeet Kripalani, BusinessWeek's India bureau chief, few have focused on this breakthrough element of the Nano innovation (BusinessWeek.com, 1/10/08).

This is part of a broader pattern of innovation emerging in India in a variety of markets, ranging from diesel engines and agricultural products to financial services. While most of the companies pursuing this type of innovation are Indian, the U.S. engineering firm, Cummins (CMI) demonstrates that Western companies can also harness this approach and apply it effectively. In 2000 Cummins designed innovative "gensets" (generation sets) to enter the lower end of the power generator market in India. These modular sets were explicitly designed to lower distribution costs and make it easy for distributors and customers to tailor the product for highly variable customer environments. Using this approach, Cummins captured a leading position in the Indian market and now actively exports these new products to Africa, Latin America, and the Middle East.

"Open Distribution" Innovation (I see this going far beyond the challenges discussed here of do working in emerging markets)

We have called this "open distribution" innovation because it mobilizes large numbers of third parties to reach remote rural consumers, tailor the products and services to more effectively serve their needs, and add value to the core product or service through ancillary services. Three innovations in products and processes come together to support "open distribution:"
• increased modularity (both in products and processes)
• aggressive leveraging of existing third-party, often noncommercial, institutions in rural areas to more effectively reach target customers
• creative use of information technology, carefully integrated with social institutions, to encourage use and deliver even greater value.

Modular designs combined with creative leverage of local third-party institutions help participants to get better faster. Companies such as Tata and Cummins are going far beyond "customer co-creation" in the narrow sense of soliciting isolated ideas from customers. Instead, they are building long-term personal relationships with customers, enriched by the specialized capabilities of broad networks of third parties that generate much deeper insight into customer needs and afford opportunities to tailor value.

Such innovations are quite different from those in the retail distribution systems pioneered by companies such as Dell (DELL) and the leading big-box retailers. These U.S. companies developed completely self-contained and highly standardized facilities and services for customers. But the open-architecture approach pioneered by Indian companies may offer much greater opportunity to deliver more tailored value to customers than the closed-architecture U.S. approach. The techniques initially developed to reach poor and rural customers may have even greater potential when used to reach highly demanding, affluent, urban customers in Western economies. (this is it as well!!!)

Welcoming Users Back into the Design Loop

The Tata Motors/Nano approach contrasts with the strategy of most other manufacturers. For more established automakers each new model represents an advance in tight integration, with more and more of the functionality deeply embedded in electronics that truly represent a "black box" to the customer. The days of customizing cars to personalize them and push their performance limits are rapidly receding into distant memory for the average customer. Yet, as Kathleen Franz, makes clear in her wonderful book, Tinkering: Consumers Reinvent the Early Automobile, it was the open design of early automobile models that blurred the lines between consumption and invention and led to a wave of innovations that were later embraced by the auto industry.

What are the broader lessons that Western executives should learn from this innovation story?
Emerging markets are a fertile ground for innovation. The challenge of reaching dispersed, low-income consumers in emerging markets often spurs significant innovation. Western executives should be careful about compartmentalizing the impact of these innovations on the edge of the global economy. As we suggested in Innovation Blowback, these innovations will become the basis for "attacker" strategies that can be used to challenge incumbents in more developed economies. What's initially on the edge soon comes to the core.

• Find ways to help customers and others on the edge to tinker with your products. Modular and open product designs help engage large numbers of motivated users in tailoring and pushing the performance boundaries of your products, leading to significant insight into unmet customer needs and creative approaches to addressing those needs.

• Pay attention to institutional innovation. Western executives often become too narrowly focused on product or process innovation. Far higher returns may come from investing in institutional innovation—redefining the roles and relationships that bring together independent entities to deliver more value to the market. Tata is innovating in all three dimensions simultaneously.

• Rethink distribution models. In our relentless quest for operating efficiency, we have gone for more standardization and fewer business partners in our efforts to reach customers. As customers gain more power, they will demand more tailoring and value-added service to meet their needs. Companies that innovate on this dimension are likely to be richly rewarded