So Long, Silo
Thanks to the democratization of innovation, the smartest people in your business don’t work for you any longer. That, in a nutshell, explains the big move toward open and networked models of innovation at companies, nonprofits, and even governments today.
This trend promises many benefits, but caution is in order. Firms that embrace user-driven models of development risk being led down the garden trail of gold-plating offerings for the best customers, a classic trap that leaves an incumbent exposed to disruption by cheaper innovators. Crowdsourcing has produced such marvels as Wikipedia and Linux, but there is evidence that it can tap the mediocrity and stupidity of crowds, not just their wisdom. And incentive prizes, while generally an efficient way to encourage open innovation, work well only for certain types of problems.
Smart innovators should embrace open methods with gusto but keep a sharp lookout for potential pitfalls.
Berkeley seems like a fitting place to find the godfather of the open innovation movement basking in glory. The California city was, after all, at the very heart of the antiestablishment movement of the 1960s and has spawned plenty of radical thinkers. One recent sunny day not too long ago, Henry Chesbrough, a professor at the Haas Business School at the University of California at Berkeley, observed with a smile that “this is the fortieth anniversary of the Summer of Love.”
Chesbrough’s three books—Open Innovation, Open Business Models, and Open Services Innovation—have popularized the notion of looking for bright ideas outside of an organization. Firms are increasingly accomplishing this using several approaches. One way that firms, and even governments, can do this is by offering incentive prizes to those that solve specific challenges. Another approach is by using crowdsourcing, which leads firms to cast a wide net among a group—say, regular customers, or the public at large—to fish for bright ideas. Although these approaches are showing great promise, as the latter half of this chapter demonstrates, they deal only with the idea-generation part of the innovation process. Some firms are going much further by leaving behind their inward-looking, top-down innovation processes altogether.
As the concept of open innovation has become ever more fashionable, the corporate R&D lab has become ever less relevant. Studies show that many of the ideas that turn into successful products and services no longer come from there. To see why, travel to Cincinnati, Ohio—which is about as far removed culturally from Berkeley as one can get in the United States. This conservative midwestern city is home to Procter & Gamble, historically one of the most traditional firms in the country. For decades, the company that brought the world Ivory soap, Crest toothpaste, and Tide laundry detergent had a closed innovation process centered around its own secretive R&D operations.
No longer. P&G has radically altered the way it comes up with new ideas and products. It now welcomes and works with universities, suppliers, and outside inventors. It also offers them a share in the rewards. In less than a decade, P&G has increased the proportion of new-product ideas originating from outside of the firm from less than a fifth to around half. That has boosted innovation and, says its respected former boss, A. G. Lafley, is the main reason why P&G has been able to lift its long-term growth rate and boost its profits and flagging share price.
Why did the firm make the switch to an open approach, a risky move given the firm’s centralized and successful past? Simply put, Lafley saw the writing on the wall. The firm’s tight network of global innovation laboratories were simply not nimble enough to keep pace with the times. For one thing, multinationals such as P&G have grown so big that they need to keep generating enormous amounts of organic growth just to keep pace, which puts additional pressure on internal innovation labs that simply cannot keep up. By 2000, it became clear to Lafley that internal research productivity was stagnating even as the costs of innovation were soaring, thanks to the explosion of new technologies. Worse yet, globalization meant that markets were much more competitive than before.
The only way forward, the firm decided, was to embrace an outside-in strategy it calls Connect + Develop. Larry Huston and Nabil Sakkab, then senior innovation figures at P&G, put it this way in a seminal article published back in 2006: for every researcher inside the company, they calculated, the democratization of innovation meant there were two hundred just as good outside the firm. They also saw that the most important innovations were increasingly emerging from small and medium-size firms and even individual entrepreneurs, not from big research labs.
So the firm took the plunge. It opened its arms to outside innovators and frowned on the “not invented here” attitude common at research labs. It invited researchers from Los Alamos National Laboratory, German chemical company BASF, and other firms to sit in on the meetings of its once-secretive research advisory groups. The company invested in a number of novel efforts at open innovation, such as Yet2.com (an exchange for intellectual property) and YourEncore (a network for retired experts). It placed dozens of challenges on InnoCentive, the pioneering online platform that runs prize competitions matching firms struggling with technical problems with a wide array of clever “solvers” from around the world.
The progress has not always been even, but the results have been impressive. In the years following the launch of the scheme, research productivity shot up dramatically. The firm’s innovation success rate—as measured by successful market entry of new products—doubled, even as its costs of innovation declined. Scouring the globe for “adjacent products” and tapping the distributed genius of the firm’s network of suppliers (just the top fifteen suppliers employ some fifty thousand researchers, for example) has produced some dramatic winners. Mr. Clean Magic Eraser, a blockbuster product, was licensed from BASF, while the Swiffer Duster, another hugely successful cleaning product, was adapted from a product invented by Japan’s Unicharm Corporation.
Not satisfied, the firm has now redoubled its efforts. It has set up a disruptive-innovation college, and expanded its program of sharing people with noncompeting firms. In 2008, for example, P&G and Google swapped two dozen employees for a few weeks; the marketer wanted more online experience, while the search firm wanted to learn about building brands. It expanded its Connect + Develop efforts, and now aims to triple the plan’s contribution to innovation development (which means getting $3 billion of its annual sales growth from outsiders). As a result of all this, half of its innovation efforts meet profit and revenue targets, whereas back in 2000 only 15 percent did. The company projects that the typical new initiative in 2014 and 2015 will have nearly twice the revenue as those of 2011. Most impressively, it has managed to triple its innovation success rate. If it is able to sustain such improvements, it may justify the claim made by Huston and Sakkab that open innovation will become the dominant innovation model for this century—and that “for most companies, the alternative invent-it-ourselves model is a sure path to diminishing returns.”
IBM is another iconic firm that has jumped on the open innovation bandwagon. The once-secretive company has done a sharp U-turn and embraced Linux, an open-source software language. IBM now gushes about being part of the open innovation community, yielding hundreds of software patents to the creative commons rather than registering them for itself. However, it also continues to take out patents at a record pace in other areas, such as advanced materials, and in the process racks up some $1 billion a year in licensing fees.
Since an army of programmers around the world work on developing Linux, essentially at no cost, IBM now has an extremely cheap and robust operating system. It makes money by providing its clients with services that support the use of Linux—and charging them for it. Using open-source software saves IBM a whopping $400 million a year, according to Paul Horn, the firm’s former head of research. The company is so committed to openness that it now carries out occasional online jam sessions during which many thousands of its employees exchange ideas in a mass form of brainstorming. The largest one was its Innovation Jam in 2006, which involved 150,000 people from more than a hundred countries and sixty-seven companies, and it led directly to the launch of ten new businesses seeded with an initial total investment of $100 million. As a result of all this, IBM now makes more money from innovative, outward-facing services (which are used even by its rivals) than from traditional business lines.
Chesbrough, of course, heartily approves. He reckons that “IBM and P&G have timed their shift to a high-volume open-business model very well” and that if their competitors do not do the same, they will be in trouble. And dozens of firms ranging from Clorox, a household products firm, to Air Products, an industrial gases company, are, in fact, now moving toward open innovation. Kimberly-Clark, which sells paper products, cut its time to market with new products by almost a third using open innovation. Thanks to help from an outside collaborator, it was able to bring SunSignals, a wearable product that alerts the user when she is getting sunburned and needs to reapply sunscreen, to market in just six months.
Xerox’s PARC laboratory in Palo Alto was long the archetype of the vertically integrated model of research, but the firm has recently gone the other way with a new open innovation center in Chennai, India. Usually when firms open research labs overseas, they spend lots of money on fancy equipment and hire hundreds of researchers that end up as part of its secretive global web reporting back to corporate headquarters. In contrast, what Xerox is doing is hiring a handful of “connectors” in India who are there to scan the local horizon for potential partners. Sophie Vandebroek, the firm’s chief technology officer, explains that “every person we hire will partner with at least fifty or more people.”
From Ivory Tower to People Power
Open innovation was not always the rage. A few decades ago, notes Chesbrough, corporate strategy gurus such as Michael Porter of Harvard Business School were advising companies to invest heavily in in-house corporate research and development as a competitive edge against their rivals. Either offer a cheaper product or invest and innovate to come up with differentiated offerings, went the mantra. In that era, a key metric of a firm’s health and innovativeness was the percentage of its sales that it plowed back into research and development. This was the heyday of such legendary corporate research labs as Xerox PARC and AT&T’s Bell Labs, which produced many brilliant academic papers and Nobel Prize winners. When Bill Joy, a cofounder of Sun Microsystems, declared back in 1990 that “no matter who you are, most of the smartest people work for someone else,” he was viewed as a radical.
Today, firms are rushing to pare back their in-house research and beef up their open and networked innovation efforts. A big reason for this is the fact that pouring ever more money into yesterday’s research model simply does not produce better results. Analysis done by Booz & Company shows that “more money is not connected to any better outcome.” Every year the firm scrutinizes the amount of money spent on R&D by hundreds of leading firms, adjusting for the sector in which they compete, and gauges whether there is any correlation with metrics such as financial performance and market success. Spending nothing on research is unwise, to be sure, as the firms in the bottom 10 percent of a sector do underperform. However, even allowing for the fact that there are some minimum thresholds and benefits of scale in R&D, Booz found year after year that the lavish spenders do not get better performance.
Big-company bosses have figured out the bottom line: merely pouring more money into in-house corporate labs does not equal more innovation. In 1981, spending by firms with more than twenty-five thousand employees made up some 70 percent of all industrial R&D spending; by 2007, that had fallen to just 35 percent. Meanwhile, spending by firms with fewer than one thousand employees shot up over that same period from a 4 percent share to 24 percent. Big firms and in-house R&D still matter, as the overall spending by the big outfits did increase fourfold to $95 billion in 2007. But if you want to see which way the wind is blowing, consider the fact that R&D spending by small firms shot up fiftyfold to $65 billion during that same period. Barry Jaruzelski of Booz puts a sharp point on his firm’s number crunching: “AT&T actually didn’t benefit much from that Nobel-winning research back then, and today nobody has the resources or capacity to do everything on their own. Collaboration is a must.”
That explains the big move in recent years toward crowdsourcing, a term popularized by Jeff Howe of Wired magazine. Back in 2006, he wrote an influential cover story on the topic with this provocative passage: “Remember outsourcing? Sending jobs to India and China is so 2003. The new pool of cheap labor: everyday people using their spare cycles to create content, solve problems, even do corporate R&D.” In the years since, everyone from marketers to aid workers to government bureaucracies has jumped on this bandwagon.
How well has this especially sexy tool of open innovation fared? The idea is not as new as its boosters would have you believe, given that it builds on decades-old efforts at getting close to customers. And it’s hardly easy to do or risk-free. For those organizations that have figured out how to use crowdsourcing properly, though, it can produce spectacular results.
Get Ready for a Wiki World
On a day in east London one recent summer, a warehouse was taken over by a company eager to make a splash. It was decked out to look like a cool New York loft. The Ministry of Sound, a London nightclub, was hired for a party afterward. The event was packed with journalists. At last the stars took to the stage. Alas, it was not the latest British rock sensation—it was a group of besuited Nokia executives there to announce a dramatic change in corporate strategy.
Nokia, a Finnish company, makes mobile phone handsets that are used by nearly a billion people around the world. However, it now wants to be a services firm. Why? Niklas Savander, of Nokia, argued that the mobile phone business “is moving so rapidly, thanks to the democratization of the Internet, that we must innovate or die.” Providing people with devices alone is not enough, the company has concluded.
With half of the value and most of the innovation in a mobile phone handset now made up of software, “the leap to services is not so great as it seems,” he added. After extensive consultations with its best customers, Nokia rolled out novel products offering users networked gaming, music downloads, and other services from their handsets. As customers became enthralled by the ecosystem of services on offer, went the theory, they would in turn co-create the next generation of innovations with the firm.
Visionary companies need to do even more than that, argued C. K. Prahalad, the late business professor at the University of Michigan who shot to fame with his theories about doing business with the world’s poorest people. He argued that firms should cultivate a network that includes consumers in which “personalized, evolvable experiences are the goal, and products and services evolve as a means to that end.” That sounds like a notion straight from the Summer of Love.
Yet despite the dangers, some companies have successfully brought consumers and others from outside the firm’s R&D labs into the innovation process. Lego, the Danish maker of children’s building blocks, did it successfully. Inspired by research done at MIT on how children learn, Lego launched Mindstorms, a robotics kit that allows people to design their own robots and other devices. Users—including many adults—have come up with all sorts of ways of putting together the kit to make things ranging from intruder alarms to sorting machines and even the controls for small unmanned aircraft.
Eric von Hippel of MIT, author of the influential Democratizing Innovation, has long advocated user-driven innovation. He says you can see it all around you. Users who feel passionate about certain products—a mountain bike, a kayak, or even a car—often fiddle around with them because the products fail to provide exactly what they want. He reckons open innovation misses the point if it’s not inspired by users, because companies are then “just talking about a market for intellectual property rights, it’s still the old model.”
Von Hippel thinks that firms close to their lead users can come up with much better designs for new products and get them to market faster. This advice appears to contradict what Clay Christensen says (that listening to one’s best customers leads firms to gold-plate assets and grow vulnerable to disruptive rivals), but in fact the two theses are compatible. Christensen’s point about disruptive innovation is that firms should not uncritically cater to the demands of their most profitable current customers. They must question those demands or they could end up doing little more than gold-plating their current offerings; like von Hippel, he thinks firms should keep a closer watch on new and dissatisfied users, who are much more likely to be the source of disruptive ideas.
Invented on Facebook
Von Hippel adds that networks of hypercritical users can even help firms quickly filter out bad ideas and thus encourage the process of fast failing. The craze for social networking sites such as Facebook could be useful. Studies have shown that how people relate to the products they use, something often discussed on such sites, reveals social structure and preferences. That can help firms understand more about their customers and how to market products more effectively.
User networks operate in many businesses. OnStar, a mobile information system widely launched by GM in 2000, was initially meant only to provide safety and emergency services for drivers. But motorists wanted it to do more, and they pushed GM to innovate. Now OnStar can check if a car is working properly, open the doors for a driver who accidentally locks the keys inside, shut off the engine if the auto is carjacked, and even locate the nearest pizza place. GM believes OnStar helps to improve the firm’s brand loyalty because it keeps the company in constant touch with its customers.
There is another compelling argument for firms to think hard about recruiting users to speed up and improve their innovation efforts. In rich countries much of the economic activity now involves services, but profit margins are eroding. Commoditization often occurs even faster in services than in physical products: because innovations are easier to copy, patents can provide less protection, up-front costs are lower, and product cycles are shorter.
User-driven innovation is exciting, but the full-octane blend of crowdsourcing involves all kinds of people, not just your best customers. Its poster child is Wikipedia, the online encyclopedia that has surpassed the Encyclopedia Britannica entirely through crowdsourced efforts.
These approaches fall into several principal categories. Firms can seek wisdom from the crowd: Quora does this by allowing people to post questions that can be answered by anyone online, with the best answers earning points or visibility. Firms can create using the imagination of the crowd: an early example of this was Threadless, a T-shirt manufacturer that gets its designs by casting a wide net among nondesigners. Firms can also allow the crowd to vote on things: eBay does this by allowing users to rate the reliability of counterparties on the site, and Amazon does this by allowing users to vote on which comments and reviews were most useful. Firms can even use the crowd to do funding: Marillion, a British band, led the way in the 1990s by getting fans to underwrite an entire tour, while Kiva, a peer-to-peer lending site, channels money from small lenders in rich countries to small entrepreneurs in poor ones. Taken together, these approaches can be an incredibly powerful way to tap into the distributed brain cells of the global population.
Novartis, a Swiss pharmaceutical giant, has put its raw scientific findings in the area of diabetes up on the Web for all to see. This seems odd at first, given that pharmaceutical firms are notoriously secretive about intellectual property rights and given that the market for diabetes drugs is, unlike the ones for neglected diseases afflicting only developing countries, hugely lucrative. It did this not out of altruism, however, but because it grew convinced that this field is so complicated that only a concerted global push, aided by crowdsourcing, will speed solutions. Because the firm still retains in-house knowledge of what all that data means, Novartis believes it still has a valuable head start on any rivals when the time comes to go for a patent or rush a drug to market.
The incumbent firms in stodgy old-economy industries such as cars and energy are reluctant to follow this trend, but newcomers in those industries are jumping in. Local Motors is an American start-up automobile manufacturer that crowdsources the designs for its specialty vehicles. When Facebook came up with a radical new way to make its servers much more energy efficient in early 2011, it made the blueprints available to all for free. That came as a shock, for the energy efficiency of one’s server farms is a key competitive edge in this business. Google, for example, keeps its green techniques quiet. Being much smaller, and without the army of in-house engineers that the search giant has, Facebook decided it could benefit more from any improvements made on its designs by a global collective brain than it would by secrecy.
This is all pretty impressive, but a rather basic question seems in order. How is it possible that so many people—presumably some with day jobs and lives to lead—are now suddenly coming together to solve other people’s difficult problems? Clay Shirky, a prominent technology commentator, argues that the key is the “cognitive surplus” that he claims people have these days to work on such projects. The shift to a postindustrial order gave most people lots of free time and spare thinking capacity, he argues, but until recently ordinary folk were not able to do much with it. On this view, television sucked them into a passive stupor, and for decades society wasted much of that theoretical cognitive surplus. But now, thanks to the new tools of social media and the latest iteration of Web and wireless technologies, people can connect and develop other people’s products, analyze public health data in other people’s cities, and send micropayments to microfinance charities in other places such as Micronesia. Donald Tapscott, coauthor with Anthony D. Williams of the provocative book Wikinomics and its recent follow-up Macrowikinomics, even makes the grand claim that mass collaboration with social networking adds up to an entirely new mode of social production.
Beyond the Wisdom of Crowds
Through much of history, crowds were seen not as a fount of wisdom but rather as a source of folly, radicalism, and even bloodthirsty excess. Investing in the Dutch horticultural industry or the Peruvian fertilizer trade are, taken at face value, reasonable propositions. But as the madness of crowds took over, though, wild-eyed speculation led to the infamous tulip and guano financial bubbles.
In other cases, reasonable men and women have been shouted down by zealots howling for blood, be they Puritans in witch-hunting Salem, crusaders in the Holy Land, or democrats in the French Reign of Terror. That explains why, for centuries, crowds were regarded with suspicion. Charles MacKay captured the excesses of the nineteenth century beautifully in his book Extraordinary Popular Delusions and the Madness of Crowds: “Men, it has been well said, think in herds. It will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”
Ah, but that was before the age of wikinomics. With the triumph in the last decade of Internet commerce, ubiquitous connectivity, and much more democratic access to information about everything, a new theory began to take hold. Rather than herd behavior, argued such heretics as the New Yorker’s James Surowiecki, what the new collective consciousness emerging on the Web displayed was the wisdom of crowds. Thanks to the Internet, this contrarian camp argues, a disparate bunch of strangers can make more accurate decisions and predictions than any single person or technical specialist. Just look, argue such folk, at how successful this approach works online in everything from eBay vendor ratings to Amazon book reviews even to content sites such as Wikipedia and Digg.
The counterrevolution certainly won over big business, as many firms have invested heavily in technologies to harvest the wisdom-of-crowds. Greater openness and inclusiveness in decision making, whether about what vendors are crooks or which books to read, is probably a good thing, but could it be possible that the wisdom-of-crowds crowd goes too far in its claims? Scrutinize some of the celebrated examples, and it turns out there is not much of a crowd involved—and there may not be much wisdom either.
It turns out there are limits to the magic that crowdsourcing can do. The spin on cognitive surplus put by Shirky’s argument is an appealing theory, but it implies that people with free time only want to do productive, socially valuable things such as saving the rain forest or marginally valuable things such as helping consumer products companies come up with better slogans for toilet paper. Human nature being what it is, surely some people will use any cognitive surplus toward unproductive or even illicit or immoral ends. Jaron Lanier, author of You Are Not a Gadget, argues that another fundamental flaw of this approach is that it could lead to a dystopian world of “just everybody doing everything.”
What’s more, at times barely 1 percent of any given crowd—say, on Amazon or on Digg—actively participates in voting or vetting. Studies done by the Wharton Business School suggest that “power users,” who may be motivated by some self-interested agenda, may be skewing the results. Attempts to average out results could lead to something worse: a reversion to a bland mediocrity of answers, ignoring the truly brilliant outliers. Experts argue that some of these problems can be overcome by ensuring that a genuinely open and large crowd, as opposed to a close circle of heavy users, both participates in the crowdsourcing and shares in the profits that arise from it. But that approach produces headaches of its own, for it often takes just as much time and effort, if not more, for a firm to do crowdsourcing properly as it does just to do the job in-house.
An Open and Shut Case?
It is not just crowdsourcing that has attracted skeptics: some are unimpressed by the broader claims made for all of open innovation. Kenneth Morse, formerly head of MIT’s Entrepreneurship Center, scoffs at IBM’s claim to be an open company: “They’re open only in markets, like software, where they have fallen behind. In hardware markets, where they have the lead, they are extremely closed.”
David Gann and Linus Dahlander, of London’s Imperial College, are also skeptical. They argue that firms have always been open to some degree and that the benefits differ depending on their line of business. Those using older technologies, for instance, may benefit less. They also point out that the costs of open innovation, in management distraction or lost intellectual property rights, are not nearly as well studied as its putative benefits.
Yet another critique comes from capital-intensive industries, where products take a long time to develop and remain on sale for years. Toyota’s Bill Reinert laughs when asked about open innovation. With the billions of dollars his firm spends on research and on equipping its factories—not to mention a five-year product development cycle—he suggests it would be foolish to open up and allow rivals to steal its edge. “Eventually even Google will have to make something tangible, and when they do they will protect it—just like Tesla Motors [a much-ballyhooed Silicon Valley start-up that makes electric cars], which does not have an open model,” he adds.
GE’s boss, Jeff Immelt, observes that his firm is a leader in a number of fields, such as making jet engines and locomotives, which requires “doing things that almost nobody else in the world can do” and where intellectual property rights and a degree of secrecy still matter. Mark Little, his head of research, is even more skeptical and says outside ideas “don’t really stick well here.” He professes great satisfaction with the output of GE’s own research laboratories. “We’re pretty happy with the hand we’ve got,” he adds.
Though it is a formidable force sweeping through business today, even boosters of open innovation agree that there are perils. One of them is that it is not easy to work with outsiders. When two firms try to tango, priorities can differ, trust may be lacking, they may have wildly differing expectations on returns on investment and risk, and they may be working on very different time horizons. Corporate cultures can sometimes clash, and some outsiders are not used to working in a business environment.
Other difficulties arise when traditional R&D centers try to work with many outside innovators, as typically happens in incentive prizes or with crowdsourcing. Alph Bingham, cofounder of InnoCentive, observes that “it takes a leap of faith for big-company R&D to believe that freelance scientists are reliable.” The biggest problem is that researchers at a firm ordered to work with outsiders can fear losing control. They are also sometimes worried that successful ideas from the outside might make them look less valuable to a firm. Many also dread the workload of having to sift through thousands of suggestions of variable quality in hopes of finding that precious needle in the haystack.
Open Up and Say Aha!
Despite all of these legitimate concerns and obstacles, a growing number of firms are concluding that the benefits of working with people from such diverse organizations are worth the effort. For one thing, patents are becoming much less important than brands and trade secrets, given the speed at which products can be brought to market. It is true that some of the rising stars in developing economies are beginning to take out more patents, but many of their innovations are still kept quiet. So fluid are their markets, and so weak the historical patent protection in them, that bosses often prefer to keep things in the dark and come up with the next innovation as necessary to stay ahead of the competition.
Even in developed markets, the acceleration of innovation is making patents less relevant. What is more, say brand experts at P&G (which claims not even to count patents any longer), the dizzying pace of change today confuses consumers with a baffling array of choices. Such firms are increasingly turning to trusted brands to simplify things for their customers. Andrew Herbert, head of Microsoft’s research center in Cambridge, England, puts it this way: “Our brand hides a tremendous amount of innovation.”
Open innovation also appears to keep corporate bureaucrats on their toes, making companies better at competing. The combination of exciting new technologies and juiced-up management processes has, according to Lafley, helped P&G to reduce its rate of failed product launches from eight out of ten to just half.
Unilever’s David Duncan insists that his firm—one of P&G’s biggest competitors—is much better connected to its customers than it was. “Years ago, when I joined, we were very closed, vertically integrated, and owned most of the value chain—even the chemicals and software we used,” he says. Now it is much more receptive to ideas and services from the outside, even posting challenges on the Internet for people to come up with new ideas. But he too confesses that there can be difficulties: “It’s like the first time you used Google; it’s scary and a bit tricky, but soon you see that it’s great.”
So how do you know if open innovation will work for a particular company? It may well depend not just on what a company does but also on how it is perceived in the market. Hal Sirkin, of the Boston Consulting Group, suggests that rather than see firms such as P&G and IBM as truly open innovators, it is better to view them as beacons. They have enough world-class experts working for them to attract outsiders who have brilliant ideas. Such firms are “open” in the sense that they are now casting a very wide net in their search for ideas. However, once they have captured the essence of those ideas, argues Sirkin, “they control them and the process of getting them to market.”
Despite all the caveats, though, it is clear that open innovation done properly is a good thing and that it is here to stay. For a business that uses open and networked innovation, it matters less where ideas are invented, especially if it uses the sorts of remarkable incentive prizes that are now in the making.
Eyes on the Prize
One recent weekend, a curious cabal gathered in a converted warehouse in a fashionably grungy part of San Francisco for a closed-door conference. The group included some of the world’s leading scientific experts in fields ranging from astrophysics and nanotechnology to health and energy. Also attending were leading entrepreneurs and captains of industry, including Ratan Tata, the chairman of India’s Tata Group. The group was brought together by the X Prize Foundation.
What were they up to? The foundation shot to prominence with the Ansari X Prize, which offered $10 million to the first private sector outfit to fly a reusable aircraft 100 kilometers into space safely twice within two weeks. Defying skeptics, a team financed by Paul Allen, a cofounder of Microsoft, won that prize in 2004. Peter Diamandis, the mastermind behind the foundation, grew convinced that “focused and talented teams in pursuit of a prize and acclaim can change the world.”
So he gathered those big shots and big brains in San Francisco to dream up more audacious prizes to tackle grand global challenges ranging from climate change to malnutrition. In the wake of the disastrous BP oil spill in the Gulf of Mexico, for example, the foundation announced a $1.4 million challenge to come up with clever ways to clean up oil spills. This came just days after the final round of competition for the foundation’s Progressive Automotive X Prize, a $10 million contest designed to spur the development of the best car that can achieve a fuel economy of 100 miles per gallon of gasoline-equivalent energy.
The X Prize plotters are hardly alone. Many charities, including the Gates Foundation, are now increasing their use of incentive prizes. Industry is also growing keen on this approach and is often turning to online prize platforms. The biggest shift may be yet to come, though, as there are signs that governments are now jumping on the prize bandwagon.
The result is a dramatic surge in prize money on offer. This trend raises two questions. First, do prizes really induce innovation? And second, is it really a good use of taxpayer money for governments to be offering prizes?
Prizes in themselves are nothing new, of course. The Longitude Prize—a purse of up to £20,000—was offered by the British Parliament in 1714 for the discovery of a practical means for ships to determine their longitude. This was an enormous problem on the high seas, as the inability to work out longitude on the sailboats of the age often led to costly and deadly errors in navigation. The greatest minds of the British scientific academy wrestled with this problem but could not crack it. Sir Isaac Newton, for example, was convinced the answer lay in astronomy.
Happily, the Board of Longitude set up to administer the prize did not favor those with fancy credentials or, for that matter, those with British passports. This was a true global exercise in open innovation. And in the end, it was a self-educated English watchmaker, John Harrison, who found a down-to-earth solution. His invention, a marine chronometer, ultimately transformed ocean transport.
Nearly a century later, Napoleon offered a prize of 12,000 francs for an invention that would preserve food well so that his army could march on a happy stomach. He had found on his earlier campaigns abroad that locals often refused to sell his army food, or that there was simply not enough to feed his troops even if it was seized at the point of a gun. Nicolas Appert, the son of a vintner and a purveyor of bonbons, took the prize in 1809 with a disarmingly simple solution. He put food in champagne bottles, which he then sealed and threw into vats of boiling water. Though he could not explain why, it turned out that food trapped in airtight containers did not spoil if it had been heated. This insight led to related advances, such as using tin cans instead of bottles, which directly led to a surge in the amount of vegetables, meat, and fruits eaten by the growing urban masses of Europe—a huge boost to public health. It remains the basis of canned food today.
Perhaps the most dramatic such incentive prize in history was the Orteig Prize, which ushered in the age of long-distance air travel. Raymond Orteig, a flamboyant hotel magnate, sent a letter in 1919 to the head of the Aero Club of America, offering a $25,000 prize to “the first aviator who shall cross the Atlantic in a land or water aircraft (heavier than air) from Paris or the shores of France to New York, or from New York to Paris without a stop.” Nobody even dared attempt such a flight in the five years Orteig stipulated, so he extended the deadline by another five years. As technology had advanced by then, numerous teams poured vast amounts of money into the effort.
All in all, nine aviators joined the fray and spent a combined total of $400,000. The winner was, of course, Charles Lindbergh, an airmail pilot and mechanic, who pulled off the feat of daring in May 1927. That prize demonstrates how incentive prizes can spur innovation in cost-effective ways. For one thing, the total investment far exceeded the actual value of the purse, offering a huge bang for the buck. Also, such prizes often turbocharge the tinkering process that leads to breakthrough innovations. Lindbergh, for example, started with a conventional plane but modified its fuselage, wings, cockpit, and various other features to withstand the journey. Another element of such prizes is that they attract enormous amounts of publicity to a given grand challenge. When Lindbergh’s plane went on a national tour after his victory, it is claimed that one-quarter of the country came out to gaze in wonder at the Spirit of St. Louis. The Orteig prize and the resultant Atlantic crossing kick-started the aviation industry, argues Diamandis, and led directly to the development of today’s $250 billion aviation business.
Alas, incentive prizes then fell out of favor in subsequent decades, especially among governments. There were still plenty of prizes around, but these—such as the Nobel—mostly rewarded accomplishments after the fact. The problem is that there is little evidence that such recognition prizes actually spark innovation. T. S. Eliot famously remarked after receiving his Nobel that it was like getting “a ticket to one’s own funeral . . . no one has ever done anything after he has got it.”
Prizes for All?
The big news is that incentive prizes are back in fashion. McKinsey did a thorough global review of prizes and awards and found that a big shift is under way from recognition prizes to incentive prizes in recent years. Its experts also catalogue a surge in prizes offered for science and engineering, climate change and space—a departure from the dominance of arts and literary prizes of the past.
There is now also evidence that such incentive prizes actually spur innovation. A study led by Liam Brunt of the Norwegian School of Economics scrutinized agricultural inventions in nineteenth-century Britain, and found a link between prizes and subsequent patents. The Royal Agricultural Society of England (RASE) awarded nearly two thousand prizes from 1839 to 1939, ranging from prestigious medals to purses worth £1 million in today’s money. They found that not only were prize winners more likely to receive and renew patents (a useful if imperfect proxy for innovation) but even losing contestants went on to seek patents for more than thirteen thousand inventions.
Incentive prizes spark innovation in several important ways that go beyond mere money. The academics studying the agricultural prizes in Britain, for example, thought that the prestige involved with winning such a prize was a more powerful force than money. Many inventors, including one who founded a company that later became International Harvester, a well-known manufacturer of agricultural machinery, proudly advertised the fact that their inventions won RASE medals.
Another feature of well-designed incentive prizes is that they can attract enough investment and invention to create entirely new industries. The key lies in the power of a provocative prize to inspire by transforming what people believe is possible.
The Ansari X Prize, for example, attracted over $100 million in investment into the (previously nonexistent) private-sector space industry—and all that for a prize worth only $10 million. The technology developed for the winning spaceship is now being used by Virgin Galactic, part of Richard Branson’s business group, in its new commercial space travel service. For a mere $200,000 or so, Virgin Galactic will soon whisk you into suborbital space from its spaceport in New Mexico. Many of the losing contestants have formed companies and are now profiting from the burgeoning sector.
The most striking benefit is the opening up of the innovation process. Firms increasingly turn to InnoCentive and its online rivals. After all, everyone has had an aha moment—but usually nothing comes of it. The democratic nature of online prize platforms may be making the world a smarter place by connecting grand challenges with hitherto untapped human potential.
A study co-authored by Karim Lakhani of Harvard Business School, which reviewed many thousands of problems solved on InnoCentive, confirms this. It found that outsiders not from the scientific or industry discipline in question were more likely than subject-matter experts to solve a challenge on that Web platform. Intriguingly, women were more likely than men to be successful solvers—which Lakhani thinks may indicate that brilliant women are often sidelined at their corporate or academic jobs, leaving them with the time and incentive to pursue outside prizes.
Companies are waking up to this notion that incentive prizes are a powerful way to attract clever outsiders to a thorny problem. Netflix, an American company that rents DVD or digital copies of movies to customers online, decided in 2006 that it wanted to improve the algorithms that help it match available movies with customer tastes. It offered a $1 million prize to anyone that could beat the model developed by its in-house experts by 10 percent. The firm was stunned to receive entries from more than 55,000 people in 186 countries. Not only did the contest tap open innovation, but it also benefited from online networking and collaboration. Astonishing as it may seem, the winning team’s seven members all met together for the first time during the prize ceremony in 2009.
Inspired by such successes, governments are now growing keen on prizes. Britain and several other countries, in cooperation with the Gates Foundation, are funding the Advanced Market Commitment (AMC), a massive prize for development and diffusion of vaccines for neglected diseases of the developing world. The first such prize, at a cost of $1.5 billion, was offered to pharmaceutical firms to deliver vaccines for pneumococcal disease (a big killer of children in the poor world) at low prices. Merck and Pfizer are now shipping this vaccine.
Government agencies ranging from NASA to the city of Chicago are now using online prize platforms to offer prizes, and international governments are making inquiries too. Thanks to a big push by the Obama administration, Congress passed legislation at the end of 2010 that grants every federal agency the authority to run incentive prizes. This matters, because before the law passed, only NASA and the Department of Defense had clear legal authority to run such prizes.
Grand or Booby?
This all is very exciting, but there are some trade-offs and limitations. Nobody should care if a plutocrat tries to spend his fortune on fanciful prizes—as one Robert Bigelow, heir to an American budget-hotel fortune, did on an overly ambitious $50 million space prize that failed miserably. But government resources are scarce, and taxpayer money spent on prizes may come at the expense of other policies, such as grants to universities or tax credits for corporate investment in research. What is more, prizes used as public policy can be vulnerable to political manipulation. In one case, an American government prize for environmental performance saw the winning firm suppress its breakthrough when the losers lobbied Congress to relax the relevant regulations in their favor.
Thomas Kalil, a science advisor to Barack Obama and a longtime advocate for the use of incentive prizes by government, acknowledges the potential pitfalls. Still, he argues that the very process of dreaming up challenges will sharpen up the bureaucracy’s approach to big problems: “I like prizes because they force agencies to think clearly about outcomes.”
One success was NASA’s Lunar Lander Prize, which delivered a much greater bang for the buck than the traditional procurement process. Robert Braun, the agency’s chief technologist, points to the example of its recent prize for the design of a new astronaut’s glove. The winning entry came not from an aerospace firm but from Peter Homer, an unemployed engineer and onetime sailmaker in Maine. He used the $200,000 in winnings and his well-deserved fame to launch a new firm in aerospace. Kalil insists that prizes make for good policy because they can generate a “diversity of ideas from experts in many different disciplines.”
Fine, but not every problem can be solved with a prize. Where the objective is a technological breakthrough, clearly defined prizes work well. Other perils can also trip up prizes. Netflix tried to run a second prize after its wildly successful first but encountered a fierce public backlash over privacy rights: it turned out that the “anonymized” customer data given to contestants was not so anonymous after all. The firm was forced to scrap the effort. Reed Hastings, Netflix’s chief executive, reports that his firm has not used this mechanism again: it’s just one tool in the toolbox, he now says, albeit a highly effective one. Even in areas where other open innovation approaches seem promising, prizes may be inappropriate. And as governments drift toward using prizes for policy ideas rather than technical challenges, as Chicago recently did to increase use of its mass transit system, the results may get woolier and less useful.
Some politicians have even talked of setting up funds worth billions to spur drug development. Ah, but prizes may not be as useful for that purpose, warns Tachi Yamada of the Gates Foundation. He has credibility in this area. Not only was he formerly the head of research and development at GlaxoSmithKline, one of the world’s biggest pharmaceutical firms, but his current foundation is also a big believer in incentive prizes in other areas of development. It offers millions of dollars in small and big prizes to people coming up with radical new ideas to tackle various global grand challenges.
But developing a new drug and bringing it to market takes fifteen years or more, and Yamada thinks even the AMC’s carrot of $1.5 billion may not be enough incentive. Observing that no purse can match the $20 billion or so a blockbuster pharmaceutical drug can earn in its lifetime, he cautions that oftentimes “market success is the real prize.”
Never Invented Here
The upshot of this exciting move toward openness is that researchers can no longer ignore ideas that are “not invented here.” Managers need to focus on extracting value from ideas, wherever they come from. After all, history shows that companies and countries that come up with new technologies are often not the ones that commercialize or popularize those inventions. Thomas Edison did not invent the lightbulb and Henry Ford did not invent the automobile, but the business models developed by those innovators helped them make fortunes commercializing those inventions.
That is a lesson that government officials and global technocrats at such organs as the United Nations would do well to learn too. That is because the world is getting to be a much riskier place, as the next chapter describes, and the new risks of the hyperconnected global economy demand bold new strategies for innovation that go beyond the traditional turf-bound, insular approaches. Richard Halkett, formerly executive director of policy and research at the National Endowment for Science, Technology, and the Arts (NESTA), a British research body devoted to innovation policy, jokes that the right policy for companies and governments obsessed with creating national innovation champions should really be “never invented here.” He may be right.