Opportunities & Pitfalls of

Open Innovation

10/09/2010
Executive Summary

The introduction of open innovation has immensely changed the rules of the game in regards to idea
and innovation creation. Open innovation was not established to do away with internal R&D in
organizations but to build a bridge in which internal and external R&D could complement each
other effectively through the use of collaborative partner management.

Open innovation creates a wealth of opportunities for organizations such as, creating flexibility in a
company’s R&D process which would enable it to adapt to frequently changing market demand,
initiating an increase in a company’s revenue through a reduction in R&D costs and fees from
licensing patented technology, duration reduction in a new product development life cycle through
collaborative efforts, reduction of risk by distributing cost of project execution across collaborating
partners and also participatory marketing to get customers involved in the product development
process.

Although there are a lot of beneficial aspects of open innovation, it still possesses a number of
pitfalls which companies must consider before deciding to implement an open innovation strategy.
The identified open innovation pitfalls which have the potential to be counter- productive in an
organisation included, ineffective implementation of open Innovation which could lead to a company
wasting a large amount of human and financial resources without any viable returns, neglect of
internal technology development due to over dependence on externally developed technology,
potential to tarnish a company’s brand image in the event of a partnership with an inefficient
company and finally intellectual Property and confidentiality issues which can lead to technology
being imitated by a competitor.

For open innovation to succeed in an organization, the management need to create platforms which
would encourage interactivity with external sources. Online environments such as social networking
websites and blogs should be used to extract innovative ideas from the general public. The closed
innovation approach should be ditched for a business strategy which promotes information sharing
and proactive collaboration with external parties.

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Introduction

The emergence of the World Wide Web has substantially removed the geographical and physical
barriers which used to prevent companies from using knowledge from different parts of the globe to
improve their innovation capabilities. In the past, many major companies used the closed
innovation strategy which entailed creating and utilising innovations that were solely generated
from their internal departments. The introduction of open innovation has immensely changed the
rules of the game in regards to idea and innovation creation. The term “Open Innovation” was
originally coined and brought to the lime light by a Haas Business School professor, Henry
Chesbrough. In the 2003 edition of the book “Open Innovation: The New Imperative for Creating and
Profiting from Technology” Chesbrough defines open innovation as follows.

“Open Innovation is a paradigm that assumes that firms can and should use external ideas as well
as internal ideas and internal and external paths to market, as the firms look to advance their
technology. Open Innovation combines internal and external ideas into architectures and systems
whose requirements are defined by a business model” [1]

Based on my analysis of open innovation, I would define it as the approach companies undertake to
improve their innovation capabilities by utilising knowledge and ideas derived from external sources
in order to improve revenue and profits streams.

Open innovation was not established to do away with internal R&D in organisations but to rather
build a bridge in which internal and external R&D could complement each other effectively through
the use of collaborative partner management. Innovation intermediaries such as Nine Sigma have
been creating distributed markets for innovative ideas; they help connect organisations with
potential external solution providers through their established networks. [2]

Companies are able to acquire innovative ideas and solutions from a number of sources such as
customers, start-up businesses, Universities, Individual inventors etc. The main idea behind open
innovation is not just for idea creation, but it also encompasses the development of a robust and
flexible business model which would ensure that the investment in collaborative innovation
development yields the most return. [1]

For open innovation to survive and be sustainable in an organisation, management would have to
implement an effective business model in order to form effective and compatible partnerships with
external parties. Partnerships usually involve upstream and downstream partners. Upstream
partners comprise of Universities, Start-up businesses and individual inventors while downstream
partners are groups of customers. The use of customer insight in the new product development
process would yield products that resonate with the target market. [3]

The main body of this essay would analyse the opportunities and pitfalls that may arise when the
open innovation approach is executed by an organisation and what ways organisations can prevent
the risks associated with collaborative innovation activities.

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Opportunities of Open Innovation

Flexible R&D Process

Open innovation enables companies to adapt quickly to ever changing market trends . [4] Companies
can produce products and services that are more likely to meet their customers’ requirements and
demands by engaging in customer centricity; this is a form of open innovation whereby customers
are involved in the R&D process for new products. Customer centricity in action is best described in
the case of Best Buy, a leading US electronics retailer. The management of Best Buy decided to
improve their business sustainability by moving away from a centralised, corporate focused business
model to a segmented, customer centred strategy. Best Buy created channels for directly interacting
with customers to determine what their exact needs were and to extract ideas on how Best Buy’s
services could be improved. The information gathered from executing a customer centricity strategy
enabled Best Buy to restructure its operational processes to meet the demands of its customers.
This change ensured Best Buy’s survival during the 2008 recession while its main competitor Circuit
City went bankrupted [5] [6].

A Spanish telecoms company called Telefonica enables customers to communicate with researchers
during the development stage of a product. This interaction between researchers and customers
resulted in Telefonica producing products customers found engaging. Social networking platforms
such as Facebook and Twitter can also be used as mediums for companies to interact with its
customers during the product development process. [7]

Shorter Production Life Cycle

Open Innovation reduces the production life cycle time, hence decreases the cost of product
development. Apple’s IPOD case serves as a perfect example, the IPOD music player was first
conceptualised by computer engineer Tony Faddell; upon gaining backing from Apple to develop his
idea, he completed a product solution within 8 weeks. Apple eventually collaborated with a number
of companies to produce the IPOD with Portal Player being apple’s main partner. Portal Player was
responsible for developing the platform and the reference design of the MP3 player. Portal Player
had already completed 80% of the reference design before Apple decided to use their technology
and this immensely reduced the product development period ultimately saving Apple money. The
IPOD was finally completed in 8months which was extremely fast for an innovative product of such
magnitude. [4][8][9]

This case shows that a well implemented open innovation strategy can significantly reduce the time
spent developing and releasing a product to the market which can serve as a competitive advantage
for any company.

Minimization of Risks

Collaborative product development can minimize the risk of a project in an organisation because the
cost of the R&D process can be distributed amongst partners in the project. A company involved in a
collaborative project could contribute expert human resources alone if the other partners involved
in the project deem the experience and knowledge possessed by its staff as highly valuable. In the

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event of the project failing, the company could move the human resources to other projects without
making substantial losses. [3]

Increase in Revenue

The increase in idea and knowledge creation derived from initiating an open innovation strategy can
result in an increase in revenue for a company. Innovative products that resonate effectively with
customer demands would result in an increase in sales which would be financially beneficial to a
company. In 2000, Proctor & Gamble implemented an open innovation model called “Connect and
Develop” to develop new innovative products. Since launching its open innovation model, 50 % of its
innovations have been developed in collaboration with external sources. P&G’s annual revenue in
2008 was $83.5 billion compared to $43 billion in 2003. This growth in revenue was realised even
though its R&D percentage on revenue fell from 4.8% to 3.4%. [10]

British Telecom has been applying open innovation processes to its organizational operations and as
a result of this approach BT generated £500 million in revenue between 2002 and 2006 from
innovative new products and services acquired from external partners. [11]

These results show that effective implementation of an Open Innovation strategy can not only
increases revenue streams but it can also consequentially reduce the cost of R&D through spreading
the cost with external partners. A survey conducted by Accenture determined that 63% of
communications industry executives accepted that open innovation was a cost effective alternative
to the traditional way of developing new products [7]; which confirms the cost saving benefits that
open innovation brings when implemented in an organisation.

Open innovation creates an opportunity for companies to generate substantial revenue from
licensing their patented technology. In the technology industry, licensing is a form of technology
transfer, whereby the holder of the IP rights for a particular technology gets to charge a fee for
usage of their technology without relinquishing ownership. The IP holder can sell licenses to
different companies to generate multiple streams of income. According to an analysis carried out by
Napa Consulting, 75% - 95% of patented technologies are stored away and squandered by
organisations. [12]

Companies that create patented technologies can generate substantial profits by making the
technology available to external companies through licensing contracts. For example, the company
with the largest patent portfolio, IBM [13], has been intensively engaged in technology licensing.
Through its licensing initiatives, IBM made 10 billion dollars from 1993 to 2003 [14].

Qualcomm, a company which produces computer chip sets is almost totally reliant on revenue
generated from licensing its technology; it made 10.4 billion dollars in revenue in 2009, much of it
realised from licensing and royalty fees [15]..

These results serve to show the enormous benefits licensing technology can have on a company’s
bottom line.

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Identify New Opportunities & Solutions

Open Innovation enables companies to identify new opportunities and ideas that may have not been
included in an original project being implemented. The use of a global network of solution providers
can yield ideas and solutions to current and future problems which could be of financial benefit to a
company. An example in regards to this opportunity would be the case of Nami Research
Engineering firm in the United States. The firm had been using Nine Sigma to connect with
companies that were seeking solutions to various problems. Hamilton Beach home appliances
company had previously rejected all the proposed solutions submitted by Nami Research but later
on requested they find a solution for reducing noise emitted from their blender appliances. Nami
consequently developed a prototype of a blender incorporating noise reduction technology. This
case demonstrates how open innovation enables companies to offer and identify new solutions for
far reaching challenges. [10]

Accessing New Markets

Companies can use the open innovation approach to access new markets by spinning out
independent ventures. Spinning- out entails a parent company launching products and services into
a market through a new separate business enterprise. This new venture can have strategic and
commercial importance to the parent company because it can be used as a medium for tapping into
a new lucrative market which can be a source of substantial revenue. The risk involved in
establishing the new venture can be reduced by the parent company co-investing with external
partners, with the equity split accordingly. For example, BT and its external partner New Venture
Partners, have jointly spun-out a number of successful companies such as, Azure Solutions which
was the world’s largest revenue assurance company, it successfully merged with Subex telecoms
software company in 2006 and was renamed Subex Asure Systems Ltd [11] [16].

Participatory Marketing

Participatory Marketing is a marketing strategy where by companies get customers directly involved
in marketing a product through means such as social media web portals and blogging sites. In an
open innovation context, Participatory marketing is utilised by companies to invite their customers
and the general public to propose new ideas for marketing campaigns and product design. Since
2000, Peugeot has been organising an automotive design competition event, whereby people across
the globe are invited to submit car design concepts based on a particular theme. Since the initial
launch of the competition, Peugeot has received over 12600 entries from thousands of designers.
The last event in 2008 attracted over 600,000 visitors to the Peugeot website. A full sized model of
the winning design concept was showcased at the Shanghai motor show [17] [18] [19].

This form of open innovation gives companies the opportunity to develop and launch innovative and
original products that their customers would relate with, it would ensure that a company’s
marketing and product development strategy constantly stays aligned with market trends and this
would reduce the risk of releasing products that do not meet customer expectations and
requirements. Open innovation of this nature would also subvert the likelihood of a company
missing out on financially beneficially market opportunities.

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Pitfalls of Open Innovation

Ineffective Implementation of Open Innovation

Open innovation not being implemented in a sustainable and long lasting way by the management
team of a company would lead to staff gradually losing interest in the process and the collaborative
system put in place would be obsolete. This kind of event could lead to a company wasting a large
amount of human and financial resources without any viable returns. The top management in a
company executing open innovation need to ensure that concrete changes are made across the
organization’s departments and culture from the very beginning. This would ensure that the entire
staff of the company would be fully behind the open innovation strategy and contribute to its
longevity and success. The use of services from innovation intermediaries like Nine Sigma and
Innocentive can be very helpful in establishing a platform that would facilitate long lasting open
innovation capabilities and processes [20].

Neglect of Internal Technology Development

Technology oriented companies that fully embrace the open innovation approach run the risk of
being overly dependent on externally developed technology and this dependence may cause a drop
in internally developed technology. The company may eventually lose competitive advantage
derived from its internal capabilities. Crucial long term R&D projects which may be of monumental
financial benefit in the future maybe dropped for collaborative projects with a short product
development life cycle. Diminished internal capabilities can affect a company’s ability to use internal
resources to effectively identify lucrative opportunities from external sources. Senior management
in companies can avoid this predicament by ensuring the innovative technology derived from
external sources compliment technology developed in-house. The use of external knowledge should
not extinguish internal R&D but should serve as a supplement which would help increase the
commercial value of a company. The amount of technology acquired from internal and external
sources should be balanced to ensure both mediums of innovation acquisition are maintained on a
sustainable scale. [4] [21].

Potential to Tarnish Brand Image

A company can risk tarnishing its brand image if it collaborates with a business that is inefficient and
poorly regarded by customers. In this event, open innovation can be counter-productive and may
lead to a loss in revenue for the collaborating company due to customer dissatisfaction and
ineffective operational processes. It is essential that companies that decide to partake in open
innovation thoroughly vet any partner they wish to collaborate with to ensure their reputation is
protected.

Intellectual Property and Confidentiality Issues

Confidentiality and IP issues can arise due to collaborative product development. The nature of the
open innovation paradigm leaves companies susceptible to having their valuable knowledge and
technology falling into the hands of their competitors. In order for companies to avoid this problem,
IP generated within a company has to be effectively managed and comprehensive directives have to

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be established during collaborative product development to guarantee that a partnership does not
jeopardise the IP ownership of the companies involved.

When Nestle engaged in open innovation, its solution to IP issues was to establish a Master Joint
Development Agreement (MJDA) with its collaborating partners at the start of the partnership. The
MJDA covered full terms of any confidential agreement drafted and a detailed description of the
project to be implemented. The MJDA mainly covered the resources, intellectual property and other
elements of the collaborative project to ensure partners worked in harmony throughout the
project’s life cycle [3].

However, for an open innovation project to be beneficial to the parties involved there must be some
form of flexibility in the way IP ownership is managed to promote a fluid flow of information
between collaborating partners.

Conclusion

For the management of an organisation to successfully execute an open innovation strategy, they
would need to create a platform which would encourage interactivity with external sources. Virtual
environments for collating and distributing innovative ideas should be open to the public in order to
initiate the flow of a large number of unique and diverse ideas [4]. Virtual environments such as the
Internet break down physical boundaries and increase the potential for valuable knowledge
acquisition. With user generated media increasing by a 100% every year [17], companies should take
advantage of the rise of online social networking sites and utilize them as channels for open
innovation, whereby companies can locate, identify and execute solutions generated from members
of online communities [3].

Open innovation should not only be confined to R&D departments of an organization but should be
practised across its value chain. This approach would produce a sense of uniformity across the
operational processes of an organization which would yield commercially valuable returns; it would
also make it far more complex for competitors to try and imitate innovations created.

A traditional company that embeds open innovation into their business model should also change
the culture of the company throughout all strategic departments in order to ensure staff members
embrace the new mentality of sharing and collaborative engagement both internally and externally;
the “Not Invented Here” [1] approach to innovation should be scrapped in its entirety [22].

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References

1. Chesbrough. H. (2003) Open Innovation: The New Imperative for creating and profiting from
technology. 1st ed. Harvard Business School Press.
2. Chesbrough. H. (2006) Open Business Models: How to thrive in the new innovation
landscape. 1st ed. Harvard Business School Press
3. Nestle (2009) Creating Successful Innovation Partnerships [Online]. Available from:
http://www.nestle.com/Resource.axd?Id=2327313D-79FD-4F7E-9479-528D3E7E5543
(Accessed 2nd August 2010).
4. Kari-Pekka Estola: Nokia Research Centre. Open Innovation [Online]. Available from:
http://www.scribd.com/doc/430077/Open-Innovation (Accessed 3rd August 2010).
5. Harvard Business Review (2010) Inside Best Buy’s Customer - Centric Strategy [Online].
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August 2010).
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penInnovation.htm (Accessed 3rd August 2010)
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11. BT (2007). Embracing Open Innovation: A new approach to creating sustainable
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missions_and_Consultation/BT_White_Paper_on_Innovation.pdf (Accessed 5th August
2010)
12. Kameran Ahari (2007). Advantages of open innovation [Online] Available from:
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August 2010)
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(Accessed 16h August 2010)
15. Bloomberg (2010) Qualcomm Revenue Forecast Tops Some Estimates, Shares Advance
[Online] Available from: http://www.bloomberg.com/news/2010-07-21/qualcomm-revenue-
forecast-tops-some-estimates-shares-advance.html (Accessed 16th August 2010)

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 16. OSS News Review (2006) Subex Systems Limited and Azure Solutions Merge – New Company
Named SubexAzure Systems Limited [Online] Available from:
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merge-new-company-named-subex-azure-systems-limited/.(Accessed 14th August 2010)
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August)
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2010)
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(Accessed 15th August 2010)
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(Accessed 6 August 2010)
22. Harvard Business Review (2006) Connect & Develop: Inside Procter & Gamble’s New Model
For Innovation [Online] Available from: http://www.digital-
ecosystems.org/doc/papers/2006-march-hbr-LarryHuston.pdf (Accessed 5th August)
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from:http://www.zephram.de/blog/wpcontent/uploads/2008/08/istock_000005005668xsm
all.jpg (Accessed 19th August 2010)

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