In the 21st century, the most innovative organizations do not only rely on their internal workforce to innovate, but also on their supplier, partner, and even customer network to co-innovate successfully. Toyota successfully co-innovates together with its suppliers to improve its supply chain. Huawei Technologies co-innovates with large customers, suppliers, government, and regulators. In the process, the Chinese Telco company emerged as a leader in European telecommunications. In the new market-leading position, the previously forged partnerships with Governments and regulators work well for Huawei. In practice, there are two kinds of open innovation: Open product innovation and open process innovation.

Open product innovation

Open product innovation is already a well-known and established strategy as to include selected customers early in product development. Whenever a consumer gets an invitation to test a beta software or product preview, the company uses a variation of open product innovation. For businesses, open product innovation usually starts in the ideation phase to reach out to partners to seek their input during product ideation and design.

Open process innovation

On the other hand, open process innovation touches the very core of how a business creates value through its unique business processes. The strategy explains best how a company creates value creation through business processes. Competitive strategy is about being different and deliberately choosing different methods to create value. As such, a company can do activities differently or do different activities than its competitors.

Doing activities differently

For example, Pixar Studies started to create digitally animated movies, so Pixar is doing its activities differently than traditional movie studios.

Doing different activities

Weta, the company best known for the visual effects in Lord of the Rings and Avatar, offers services no other FX company can provide, such as design consulting, stage props design and manufacturing, complete movie postproduction, and franchise production and distribution. As a result, Hollywood studies partners with Weta from the beginning to the end of blockbuster production. As the Weta example shows, business value creation gravitates around unique process integration to deliver end-to-end service.

Traditionally, companies use close processes to integrate tightly within a company’s boundaries. Open process innovation extends beyond the limits of a company to integrate business processes across several companies.

Open innovation centers around including suppliers, partners, and even customers in an open innovation process. Businesses that win in the future will master both the process and product sides of open innovation.

For established companies, three challenges emerge:

1. New and existing innovation capabilities
2. Process and product focus
3. External and internal innovation

A company that wants to solve these challenges has to reconsider its resources, processes, and profit formula to determine what it can and cannot do regarding innovation. For the most part, resources can be purchased or sold, talent can be hired or fired, and processes can be re-engineered. Ultimately the company’s profit formula determines the fate of innovation. In accounting, the profit formula is:

Total Revenue — Cost of Goods Sold = Gross Profit.

In other words, a company’s primary source of revenue and the implied cost structure dictate all major business decisions. That means if an innovation neither adds to revenue nor reduces the Costs of Goods Sold (COGS), it will not be undertaken. A prime example of how the profit formula drives decisions was Blockbuster Movie rental, which at some time was negotiating to buy a new movie streaming company called Netflix. However, Blockbusters profit formula was optimized for late fees on movie rentals, and because Netflix did not add much to the late fee profit, the deal was passed. Meanwhile, Blockbuster is history, and Netflix is the market leader in digital movie streaming.

The fundamental dilemma is that the profit formula incents efficiency optimization of the existing business while the market rewards radical change and disruptive innovation. As a result, for an existing company, the central challenge is to manage both, preserving the current business model while simultaneously innovating by building a new business model with a new profit formula.

(1) Balance new and existing innovation capabilities

A company can use three approaches to build innovation capabilities while preserving existing ones. The first is launching a new brand to compete in a new and emerging market. The second one is integrating R&D silos through shared platforms; an approach is commonly used in manufacturing. The third one is to launch a separate business unit. A typical scenario is a response to market disruption. For example, when EasyJet challenged British Airways in the low end of the market, it launched GoFly as a separate business unit to compete in the low end of the market under a different brand. Likewise, when The Body Shop challenged Estee Lauda, Estee responded by launching an “ Origins “ brand to compete in the natural cosmetic market.

(2) Balance process and product focus

During the development of a new product or brand, the most striking insights center around the integration into existing production processes. Sometimes new product requires new procedures, and more often, new business processes enable new products and services. To do so, the key is converting products into platforms and processes into services. For example, the iPod is just a product, but with the addition of iTunes, an integrated platform to distribute digital content, drives the actual value. As it turned out, the Job to Be Done for iTunes is: “Help me to enjoy digital media.” The Ipad, iPod, and iTunes ecosystem solves the job very well. Converting processes into services refers to streamlining internal business processes to the point that allows starting a new business. Amazon AWS emerged from the need that programmers frequently asked IT for quick access to a virtual machine to do some testing. At some point, the Amazon IT department established a self-service so that programmers could launch virtual machines themselves. Eventually, the process was converted into a service and sold to customers under the EC2 brand, which became the cash cow of AWS Cloud service. To grow the business, AWS was launched as a separate business unit and since then doubled its annual revenue year after year.

(3) Balance External and internal innovation

When partners enter a development process, the central challenge centers around co-creating value through these partnerships despite different cultures and approaches. In practice, the crucial benefit is precisely the ability to empower partners to co-create value through platforms and services. Specifically, instead of executing cumbersome and complex projects to integrate partner contributions in the innovation process, a company can use its resources to build a platform through which its partners can sell its existing services in exchange for a fee. Swedish Car Manufacturer Volvo developed its Car Cloud to give partners access to the in-car digital system while preserving its internal innovation process. Digital companies like Spotify Music use the Car Cloud to bring new services to Volvo car owners.

Marvin F. L. Hansen

History:

• First published: March 4, 2018
• Republished: Jan 6, 2023 on Medium.com
• Moved to personal blog on March 16, 2024