Background: In the just-published Open Innovation: The New Imperative For Creating And Profiting From Technology, Henry Chesbrough of HBS discusses how, when, and why the shift from Closed Innovation to Open Innovation happened, using case studies from such companies as Xerox, IBM, Lucent, Intel, Milennium Pharmaceuticals, and others.

One of the basic principles of Open Innovation is “not all the smart people work for you.” In this landscape of “enhanced knowledge,” the innovation challenge has become how best to identify and use the knowledge that’s available both within and outside the company. Some industries are doing a better job at this, as Dr. Chesbrough discusses in Part 2 below.

Interview, Part 2

IdeaFlow: I notice you spent some time in the book talking about reasons other than direct financial return for companies to innovate. What are the most important reasons for companies to practice open innovation, besides direct financial gain from the innovation?

Henry Chesbrough: One discussion in the book relates to situations where a research team busts their butts to get something out the door, only to find that some business type has decided to hold it off the market, for fear that it might cannibalize an existing product. Note the implicit assumption: if we don't obsolete our products, no one else will either.

These days, that is usually naive. Innovation in companies IS about the money, but there is more to it than that. In addition to adding new sources of revenue, a more innovative climate can increase the satisfaction of one's job, can increase the satisfaction of one's customers with the company, and can stimulate a higher rate of absorbing, transferring and utilizing knowledge. And how do you motivate your team to take on the next challenge, if they never get to see their last project tested in the market?

IdeaFlow: Yes...can you say a little more about this: "Note the implicit assumption: if we don't obsolete our products, no one else will either. These days, that is usually naive."

Henry Chesbrough: Sure. In the days of Closed Innovation, many leading companies held monopoly or oligopoly market positions in their industries. They had to think hard about when to introduce the next new product. If you introduce too quickly, you lose chances to milk additional profit from your current products. Better to wait. But this is only sensible if your competitors wait too, or if your customers are locked into you and cannot switch.

That’s the hidden assumption. If competitors jump and customers switch, then your waiting has just squandered your market. And the poor researchers who worked so hard and then watched you sit on the stuff, never get to see the fruits of their labors in the market. And more philosophically, the researchers never get the feedback from the market, which would complete the cycle they started, and enhance their learning.

IdeaFlow: And in an atmosphere of enhanced knowledge, it's unlikely that you'd be able to keep ahead this way in any case, yes?

Henry Chesbrough: Thank you for making my point. If you don’t use it with alacrity, these days you’re likely to lose it.

IdeaFlow: Let’s talk about Open Innovation as it relates to industries. Do you think biotech as an industry is more oriented toward Open Innovation now than the "regular" technology industry is?

Henry Chesbrough: Oh no. I think IBM and the PC industry got there way ahead of biotech. What IS happening today, though, is that the science base for biotech is exploding in new discoveries (and, not incidentally, public research funding is also exploding), while the infotech sector is living off the research discoveries of the 1960s and 1970s.

This is not a criticism. Biotech companies have perhaps the best value proposition of all: living longer, healthier lives. Curing previously incurable diseases. Talk about "finding the customer’s pain!" At the same time, the FDA regulatory apparatus has preserved the big pharma companies in a way that DEC, Data General, Apollo and others were not. So we have far more survivors in big pharma than we had in the computer industry twenty years ago.

IdeaFlow: Big pharma is being preserved in the sense that only big pharma can afford to negotiate the FDA regulatory processes?

Henry Chesbrough: Yes. As a society, we demand greater and greater safety, which translates to more regulatory oversight, longer trials, and higher costs. These advantage the large companies over the small ones.

IdeaFlow:  What are some other industries that are, in your opinion, out front at practicing Open Innovation? Which ones need Open Innovation the most, but have not yet gotten there?!

Henry Chesbrough: A fascinating industry that has been "there" with Open Innovation for decades is Hollywood. Think of it. The old studio system was vertically integrated, and everything from scripts to actors, directors, sound stages, and producers was under one roof. These days, studios buy and sell scripts, develop them to some extent and then swap or abandon, while actors, directors, producers, agents and specialized subcontractors like special effects providers "mix and match" movie by movie. Each movie is a project, and every project is organized differently from the last one.

IdeaFlow: And yet they are not at all open in terms of distribution, right? Not embracing digital rights, etc.?

Henry Chesbrough: Right. Of course, there are hopeful signs. Movie trailers are widely accessible with little or no hassle. Soundtracks are sold through stores and over the web. Merchandise rights are now part of the package, along with international distribution.

So who hasn't gotten there and needs to? I think the personal finance industry is a long way from where it needs to be. I hear that in England your house can support a mortgage, a line of credit for all your personal financial needs, from checking to credit cards to savings, and so forth. None of the overdraw charges, less of the late payment problems and fees, and lower costs of borrowing money, owing to the better security of against the line of credit.

IdeaFlow: What about consumer packaged goods? You mention Procter & Gamble in the book, but by and large the industry is not that open, is it?

Henry Chesbrough: P&G is definitely in the forefront there. But I think others are watching them closely. And P&G itself is becoming more public about its unique innovation strategies, and that should promote that Open Innovation movement we started this thread with.

IdeaFlow: In a little different direction--you talk about patents rather than copyright in your book. Have you read the Michele Boldrin/David K. Levine argument that all copyrights and patents are bad--they only reinforce monopoly control, inefficient high prices and low quantities, and lead to stifled innovation? Thoughts?

Henry Chesbrough: Yes. It is simplistic to argue that patents and copyrights are ALL bad. Moreover, patents are a part of our Constitution, so they’re not going away. It is, however, very helpful to have the debate that such positions engender. My own sense is that patents can have beneficial effects as well as anti-competitive effects.

For example, patents help to create markets to trade ideas, as we see in biotech, for example, where small biotechs develop new compounds and then license them to big pharma for clinical testing and development. Patents, however, are expensive to get, are not clear in their claims, and are costly to enforce. This hurts small businesses and individuals the most. It would be better to improve the clarity of claims and reduce enforcement costs. But I am of the "mend it, don't end it" school.

IdeaFlow: I know you don't really discuss copyright in the book, but do you have a position there vis a vis Open Innovation?

Henry Chesbrough: The area where Open Innovation connects to copyright probably falls in the area of Digital Rights Management. Like many of your readers, I was a user of Napster once upon a time. I still feel that the music industry is trying to hang onto an obsolete business model in the face of enormous evidence of consumer dissatisfaction with that format (the “album,” where you buy 12 songs to get the one or two you really wanted).

If we can provide technologies to deliver digital rights management, we will then need to initiate the business models that deliver value and satisfaction to people. I just noticed, for example, that Apple will now sell individual songs for 99 cents. That's a help, a step away from the old model that is broken. We need more innovations and experiments, and technology will enable them, if the content owners will WAKE UP.

IdeaFlow: Does Creative Commons (an alternative to copyright whereby there are various "levels" of protection the content owner keeps and levels he or she gives away) fit the Open Innovation model?

Henry Chesbrough: I would categorize it as a new and possibly valuable way to share knowledge. And I like the fact that it isn’t just all or nothing, black or white, but instead enables nuanced levels of sharing and protection.

Which prompts me to mention something we haven't yet discussed--the idea of the business model and its role in innovation. The business model is a cognitive device to convert technical aspects of a product or service into economic value. Any successful innovation (vs. invention) needs a business model, and that model must do two things: first, it must create value in its ecosystem, and second, it must capture a portion of that value for the innovator, so that additional advancements will be forthcoming.

In Part 3, tomorrow: More about the importance of the business model to Open Innovation.