1.1 Open innovation business models

V 0.2 / 03-07-09

We have heard a lot about the potential of open innovation communities, but when it comes to actual execution there is a significant gap. Nambisan, 2007

Innovation can be defined as the outcome of a set of activities that use knowledge to create new value to those benefiting from its use (de Sousa, 2006). The importance of innovation for companies needs no explanation. Innovation has been identified on many occasions, as the main driver for companies to prosper, grow and sustain profitable (e.g. Drucker, 1988; Christensen, 1997; Thomke, 2001). One could even argue that innovation is a prerequisite for doing business.

Innovation is the specific instrument of entrepreneurship. The act that endows resources with a new capacity to create wealth. Drucker, 1985.

Open innovation

It is not why to innovate, but how to innovate that remains the subject of much research and discussions. Shorter innovation cycles, research and development’s increasing costs as well as the scarcity of resources are some of the reasons for companies to look for new ways to innovate. A fairly recent view on the subject is the one of open innovation. It is based on the need for companies to open up their innovation processes and combine internally and externally developed technologies to create business value.

Open innovation funnel

The notion of open innovation was first proposed by Chesbrough in 2003. He defines open innovation as: “the use of purposive inflows and outflows of knowledge to accelerate internal innovation, and expand the markets for external use of innovation, respectively. 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” (Chesbrough, 2003). Since the introduction of the concept, open innovation quickly gained the interest of both researchers and practitioners, illustrated by the number of publications, dedicated conferences and a rapidly growing body of literature (Fredberg, Elmquist & Ollila, 2008). The reason for open innovation to attract so much attention is that it is not ‘just another management fad’; Chesbrough merely distinguished a trend in innovation practices – and gave it a name.

Chesbrough (2003, 2006) explains the rise of open innovation practices by the changing economics of innovation. He argues that useful knowledge and technology has become increasingly widespread, distributed across companies both large and small, in many parts of the world. He distinguishes two main forces in the economics of innovation that are forcing companies to open up their innovation process (see figure #: step 1, Chesbrough, 2006):

• Rising costs of technology development;
• Shorter product life cycles.

According to Chesbrough, open innovation business models address both issues (see figure #: step 2, Chesbrough, 2006):

• Open innovation business models attack the cost side of the problem by leveraging external R&D resources to save time and money in the innovation process;
• Open innovation business models attack the revenue side by broadening the number of markets addressable by the innovation.

Chesbrough: economics of open innovation

In the past decade, many organizations applied new, more ‘open’ innovation practices. Whole industries have been transformed by new open innovation practices and approaches to doing business (e.g. operating systems/software (Linux), FMCG (P&G), toys (LEGO), pharmaceutical industry (Eli Lilly) encyclopedias/knowledge-storage (Wikipedia) and many more. Still, the rise of open innovation does not seem to lose momentum – open innovation and related practices are increasingly being applied every day.

For these reasons, many organizations are asking themselves whether and how open innovation could improve their businesses: organizations are looking for ways to improve their innovation strategies/processes towards more open forms of innovation. This means that organizations need to redesign their innovation practices – and with it their whole view on how to create value and do business. In other words: companies need to design new and open ways to innovate and create value – organizations need to innovate their innovation strategies/practices towards more open forms of innovation.

Business models

A problem these organizations face is that they know the direction where to look (open innovation practices), but do not know exactly what it is they are looking for: “how can we design such open practices to be valuable for our organization”.  They need the right set of glasses – a framework to guide them in the search for new and successful open innovation practices, to innovate their innovation practices to create value. Business model theory is one such set to stimulate successful innovation.

A business model is a framework for creating economic, social, and/or other forms of value. The term business model is used for a broad range of informal and formal descriptions to represent core aspects of a business, including purpose, offerings, strategies, infrastructure, organizational structures, trading practices, and operational processes and policies. As stated before, Innovation can be defined as the outcome of a set of activities that use knowledge to create new value to those benefiting from its use (de Sousa, 2006). Hence, one can argue that every successful innovation has an underlying successful business model (framework).

In most cases, business models are used to describe or visualize how businesses intend to create value for customers in a marketplace. Following definition from KMLab Inc., a consulting firm reflects that operational view:

…a Business model is a description of how your company intends to create value in the marketplace. It includes that unique combination of products, services, image, and distribution that your company carries forward. It also includes the underlying organization of people, and the operational infrastructure that they use to accomplish their work (Chesbrough & Rosenbloom, 2002).

However, many different conceptualizations exist. In the most basic sense, a business model is the method of doing business by which a company can sustain itself – that is, generate revenue. The ultimate role of the business model for an innovation is to ensure that the technological core of the innovation is embodied in an economically viable enterprise (Chesbrough & Rosenbloom, 2002).

In recent work on open innovation, Chesbrough (2006) describes open business models in relation to ‘usual’ (more operational) business models, driven by a new division of innovation labor:

… [A recent] development is the growing division of innovation labor. By a ‘division of innovation labor’ I mean a system where one party develops a novel idea but does not carry this idea to market itself. Instead, that party partners with or sells the idea to another party… This new division of labor is driving a new organizational model of innovation…

A business model performs two important functions: it creates value and it captures a portion of that value. It creates value by defining a series of activities from raw materials through to the final consumer that will yield a new product or service with value being added throughout the various activities. The business model captures value by establishing a unique resource, asset or position within that series of activities, where the firm enjoys a competitive advantage.

An open business model uses this new division of innovation labor – both in creation of value and in capture of a portion of that value. Open models create value by leveraging many more ideas, due to their inclusion of a variety of external concepts. Open models can also enable greater value capture, by using a key asset, resource, or position not only in the company’s own business but also in other companies’ business.

During this research, I will regard the (open) innovation process of an organization as a separate business that creates value (innovations) for its actor(s). Seen like this, the open business model is the framework (architecture/organizational structure) of how different participants (both internal as well as external to the company) work together to (co)create and capture value. This means that the actors (/organization(s)) of an open innovation incentive are its customers (I will explain this in more detail in chapter 2.#). In other words; open innovation practices are all innovations in their own rights, and thus should have underlying successful business models (frameworks).

Next paragraph: Objective & research questions