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The Continuing Payoff from Open Innovation

The use of external partnerships grows increasingly productive over time.

Title: Learning from Open Innovation (PDF)

Authors: James H. Love (University of Birmingham), Stephen Roper (University of Warwick), and Priit Vahter (University of Birmingham)

Publisher: Warwick Business School Working Paper No. 112

Date Published: July 2011

At the heart of the innovation process is the search for new ideas and market opportunities with commercial value. With so much on the line, companies are increasingly turning to an open innovation model built on external partnerships. Despite the model’s challenges and drawbacks, companies are betting that they will get more from such partnerships than they would from going it alone and keeping all their research and development efforts in-house.

Their bet is a sound one, this paper finds. Openness not only pays off now, the authors say, but paves the way for even bigger dividends down the line. Firms that stay with the model become more adept at picking partners and managing joint projects, which improves the odds of coming up with new products and services. But the model goes only so far, the researchers warn — trying to maintain too many external links can be counterproductive and costly after a certain point.

Previous research has noted the difficulties surrounding open innovation. Companies looking for partners — research labs, universities, suppliers, and customer focus groups, among others — inevitably experience some failures as they learn to match their needs with those of the partners. They must cast a fairly wide net because no linkage is guaranteed to provide a solid outcome. And then there is the difficulty in agreeing on intellectual property rights to the fruit of some forms of partnership.

But the plus side is formidable: External links have been shown to stimulate creativity, provide a useful way to search for new technologies, reduce risk, and improve the quality of the innovation.

Given the high stakes involved in deciding whether to pursue open innovation, the authors looked at how a history of openness affected a firm’s innovation performance over time. They also assessed the relative value of different types of partnerships.

The researchers analyzed data from Irish Innovation Panel surveys conducted by an academic consultant group, InnovationLab (based in Ireland), on the R&D activities of manufacturing plants in Ireland and Northern Ireland from 1994 to 2008. The surveys came at three-year intervals. Firms that disclosed outside links as part of their product or process development were asked to identify the types of partners they had: customers, suppliers, competitors, joint ventures, consultants, universities, industry-operated laboratories, or government-run laboratories.

The most common partners were customers and suppliers, followed by consultants and universities. Partnerships with competitors, through joint ventures and industry laboratories, were far less common. The share of plants with any external linkages was 39 percent in the first three-year period, 1994–96, and 46 percent in the most recent period, 2006–08, showing a gradual increase in open innovation efforts.

The researchers measured innovation output by examining the proportion of the firms’ total sales that came from products introduced or improved during the previous three years. This approach measures not only the ability to bring new or improved products to the market but also whether they were a hit with consumers. The researchers found that an average of almost 22 percent of sales were derived from either newly introduced or improved products, and over the sample period, about 63 percent of the plants reported such launches or improvements.

The data also allowed the researchers to gauge the firms’ breadth of openness — how many external links they had and with which types of partners, and how long the partnerships had lasted. Over the course of the five surveys, plants with previous external relationships had an average of 1.8 linkages at the time they were surveyed, whereas plants with no prior linkages averaged less than one, reflecting a sort of snowball effect for acquiring partnerships.

The researchers found that a firm’s breadth of openness was related to performance — the more open it was, the higher the level of new and improved products as a percentage of sales. But there’s a tipping point after five linkages: Beyond this number, firms experience decreasing returns. The researchers say that this decline could come from a number of factors, including the cost of “over-searching,” when companies no longer have the ability to absorb large amounts of new information, and managers lack the time and attention to process important ideas. But the researchers note that only a tiny fraction of plants in the study used more than five linkages.

For the rest, the authors write that there are two possible reasons that firms get better at learning how to innovate when they have a history of looking beyond their own R&D departments. The first is that companies improve their ability to juggle multiple external relationships. For example, certain in-house teams might work on a regular basis with certain types of innovation partners, such as university labs, thereby lowering the cost and increasing the return from a given set of relationships. The second reason is that the management team might become more open to new ideas as it learns to process the information coming from different forms of external links.

Overall, the researchers conclude that the lessons learned by a management team from handling multiple relationships carry over to future efforts, making the process more efficient down the line. The researchers note that prior linkages involving customers — whether through focus groups or focused product trials — were the most important in boosting the effect of current ties. In other words, knowing what your customers have historically valued is vital when introducing new products or services.

The study’s results imply that investing time in learning how to manage outside partnerships — and in deciding which ones bring the highest returns — will pay off dramatically.

“Time spent even in relationships that do not pay off in the short run need not be time wasted,” the authors write. “Learning which relationships not to pursue is an important part of the learning process, and may help to make future linkages more productive.”

Bottom Line:
Firms can carry forward the lessons they have learned from innovation projects involving outside partners. The larger the breadth of a firm’s external links, the higher the level of new product sales. But only to a point: After five outside links, companies become saturated with new information and face diminishing returns.




The Continuing Payoff from Open Innovation