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Best Business Books 2003: Innovation

Chesbrough offers a framework for how businesses can move toward open innovation. He uses the example of IBM, once a pinnacle of closed innovation, which adopted an open approach after, as he puts it, “a near-death experience.” From 1945 to 1980, IBM dominated the computer business. It had the largest sales, largest research budget, and most patents of any company in the industry. In 1992, its business was facing powerful competition on every front from the likes of Microsoft, Compaq, Sun Microsystems, Hewlett-Packard, and DEC. At the end of that year, IBM recorded the largest quarterly and annual loss in U.S. corporate history. Something had to change.

Louis V. Gerstner Jr., an outsider, was brought in to lead the charge. His IBM shifted its focus from products to customers and soon realized that its research dollars were being squandered on lower tiers in the value chain. IBM needed to redirect its efforts toward the applications and solutions that its customers valued. So Gerstner hired research managers to broker technology between IBM’s labs and its business units, with special emphasis on those innovations that could directly influence sales. And IBM stopped using its intellectual property largely as a defensive measure to ensure itself the freedom to innovate products safe from litigation. Rather, it attached its intellectual property to processes and components that its fabrication and manufacturing supplied to other companies — including would-be competitors. In this way, IBM’s component customers pay for the otherwise contestable right to use a particular technology that IBM has developed, and IBM earns a return on its intellectual property apart from issuing naked licenses or selling finished goods.

What really caught my attention in Chesbrough’s book, however, was his discussion of the role of business models in innovation. The value of technology is not inherent; instead, it is derived from how the technology is ultimately deployed. A major challenge for large companies that innovate is not that they can’t invent technology, but rather that they are impaired in creating new business models to best exploit it. Startups have nothing invested in their business models; they are agnostic in their pursuit of the best way in which to capitalize on an innovation. Large companies, on the other hand, are constrained by the dominant logic that pervades their organization and culture. The result is the exodus of talent and ideas to startups.

Take Xerox, for example. In the 1980s, the corporation’s business model sprang from its legacy copier business. The company made a modest profit on equipment and relied heavily on the sale of supplies. The key to capturing value was that Xerox required customers to purchase things like paper, toner, and maintenance only from Xerox. When researchers at its famed Xerox PARC labs in Silicon Valley developed PostScript (page “layout” software that enabled Xerox workstations to communicate with Xerox printers), there did not seem to be a compelling business model for PostScript as a stand-alone product. Rather than remain captive to Xerox’s closed systems, PostScript’s inventors, John Warnock and Chuck Geschke, spun off and began selling libraries of fonts for desktop publishing based on PostScript. The company they formed was Adobe, and the rest is history. Xerox’s dominant, closed-technology business model could not accommodate the open-standard approach that underlies Adobe’s success.

This type of phenomenon leads Chesbrough to go beyond encouraging businesses to open up to outside ideas: He also recommends that they make their internal innovations available for others to exploit. Where structural impediments hinder the realization of an invention’s potential, an innovator can still reap its value by licensing it to others who are not so impeded; startups, spin-offs, and existing companies with compatible businesses. The innovator can still share in the rewards through equity investments or royalties. More important, the returns from investment in research will be greatly improved over those that result from simply shelving innovations that don’t fit the dominant model.

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