Should companies outsource innovation?

Outsourcing has had a negative connotation in the US. However, the trend seems to be here to stay. As product complexity increases, and it is not easy for companies to do everything in-house. Furthermore, competitive pressures are compressing product development cycles and companies have to use approaches such as co-development to grow. If companies are using suppliers for components and subsystems, should they not use them for innovation as well? Collaboration with strategic suppliers has been shown to enhance innovation.

More and more organizations are sourcing innovation from the outside through open innovation or borderless innovation. Leading companies such as Intel work with universities to source innovation. Companies from J&J to Ortho have setup innovation hotbeds to access innovation from the outside. There are interesting approaches to crowd-source innovation and reach-out to the masses for innovation.
Even so, there is a significant amount of confusion and controversy around the benefits of innovation outsources.

A great article in R&D Management journal provides a synthesis or current research in innovation outsourcing (Controversy in innovation outsourcing research: review, synthesis and future directions):

There is a growing stream of research into the outsourcing of innovation activities within the innovation, management, marketing and economics disciplines. Understandably, this coincides with the practice becoming more commonplace in industry. Here, we attempt to synthesize research surrounding the question of whether to outsource or internalize innovation activities and the performance implications of this decision.

As expected, there are many open issues and conclusive consensus has not emerged about aspects of innovation outsourcing. Some research shows that innovation outsourcing reduces costs while other shows that it increases them!

As innovation outsourcing research has progressed, several controversies have emerged in the literature and remain unresolved. For instance, case-based research provides evidence that outsourcing innovation activities can lead to faster product development and cost savings; yet, empirical research shows that outsourcing may lead to higher costs and slower new product development

However, there are some clear trends that R&D managers should pay attention to:

Outsourcing is most likely when specific assets are required, behavioral uncertainty is low, intellectual property is well protected, the activity is not seen as a path to developing competitive advantage and when low cost is not the primary goal of the development effort. Also, large firms have a greater tendency to outsource.

So, it makes sense to outsource when:

Supplier has specific equipment, laboratory or assets that are expensive to acquire.
It is easy to understand and evaluate innovation results from the supplier (low uncertainty about supplier behavior)
Sourced innovation is not critical to the company nor is it a significant competitive advantage (critical innovations are normally controlled by the company)
Costs are not a key driver (companies still tend to feel that sourcing innovation is more expensive than doing it in-house)
Large firms are more likely to outsource innovation than small firms

There is a lot more info in the article, but it is a bit difficult to read…

Does modularity reduce innovation?

The Journal for Product Innovation Management had an interesting article on The Impact of Product Modularity on New Product Performance. We recently discussed the benefits of modularity to combat component shortages (Impact of component shortages on R&D). The article points out that modular design may have an impact on innovation. Availability of a large number of alternate modules allows designers to try multiple alternate solutions and select the best alternate:

In light of problem solving, system complexity, and dominant design theories, some researchers suggest that modular product design promotes product innovation through experimenting with many alternative approaches simultaneously. This leads to rapid trial-and-error learning and accelerates new product introduction.

The problem with modularity is that it requires compatibility and limits the solution space because modules need to fit together. Also, if a module is fulfilling 80% of the requirements is available, designers may not push for the rest and hence not be as innovative.

However, others argue that modular product design inhibits innovation because common modules can be overly reused, the degree of freedom for innovation is limited due to module compatibility, and knowledge sharing among module teams is weakened.

The paper has results based on a survey of 115 electronics companies that suggest that the relationship between modularity and innovation is indirect. The main recommendation is for R&D managers to be vigilant and monitor the negative impacts of modularity. One red flag may be too many alternate configurations. Another key concern is communication across different module R&D teams.

If there are any signs of diminishing product innovativeness, problems with poor communication across module teams, or excessive design alternatives, the manufacturers should stop further modularizing their products. Alternatively, manufacturers can take steps to reduce the negative effects of modularity. For instance, manufacturers can develop ways to strengthen communication among module teams. They can also use a set of design rules to reduce the number of design alternatives systematically or a design method to balance product commonality and differentiation during the development processes.

It is clear that as R&D becomes more modular, R&D teams for each module will become less engaged with other teams and more virtual. We have discussed several approaches to boost productivity or drive satisfaction in virtual teams. We could also try project networks to enhance communication.

Article first published as Does modularity reduce innovation? on Technorati.

Sparking creativity in teams

McKinsey Quarterly has a useful guide in Sparking creativity in teams:

In fact, our experience with hundreds of corporate teams, ranging from experienced C-level executives to entry-level customer service reps, suggests that companies can use relatively simple techniques to boost the creative output of employees at any level.

The article has four simple suggestions to increase creativity. Lets dig in:
1. Immerse yourself: As we discussed in Steve Jobs Methodology, an engaged R&D manager is crucial to motivating R&D teams. Many senior R&D managers I have met seem to have a hands-off approach to their teams. As the McKinsey article points out, there is no alternative to clear engagement from the leadership:

The antidote is personal experience:p in ways that abstract discussions around conference room tables can’t. It’s therefore extremely valuable to start creativity-building exercises or idea generation efforts outside the office, by engineering personal experiences that directly confront the participants’ implicit or explicit assumptions.

2. Overcome Orthodoxies: Personal engagement from leaders in required for the success of any organizational change. However, the leaders also need to question conventional thinking and challenge teams to do better:

All organizations have conventional wisdom about “the way we do things,” unchallenged assumptions about what customers want, or supposedly essential elements of strategy that are rarely if ever questioned.
By identifying and then systematically challenging such core beliefs, companies can not only improve their ability to embrace new ideas but also get a jump on the competition.

3. Use Analogies: This is a new and interesting point. As the article points out, leaders need to frame the problem with analogies to actually help the teams do better. The examples include: “How would Google manage this Data?” or “How would Southwest Airline cut these costs?”

Our own experience confirms the power of associations. We’ve found a straightforward, accessible way to begin harnessing it: using analogies. As we’ve seen, by forcing comparisons between one company and a second, seemingly unrelated one, teams make considerable creative progress, particularly in situations requiring greenfield ideas. We’re not suggesting that you emulate other organizations—a recipe for disappointment. Rather, this approach is about using other companies to stir your imagination.

4. Create Constraints: As we have discussed many times, managers are key to driving innovation. Only managers have the cross-enterprise visibility to help frame the challenge for the R&D teams.

Imposing constraints to spark innovation may seem counterintuitive—isn’t the idea to explore “white spaces” and “blue oceans”? Yet without some old-fashioned forcing mechanisms, many would-be creative thinkers spin their wheels aimlessly or never leave their intellectual comfort zones.

Does Wall Street hate innovation?

I found an interesting article in the Star Tribune Does Wall Street hate innovation?

Recent studies by Mary Benner, an associate professor at the University of Minnesota’s Carlson School of Management, concludes that’s often the case for major players in their industries. She examined how analysts reacted when companies like Kodak and Polaroid shifted to digital photography or when telecommunications companies began pursuing Voice over Internet Protocol technology. Analysts showed a preference for incremental change rather than breakthrough innovation.

This is an interesting look at innovation – from the outside and from the financial analyst perspective. The research has some significant lessons for R&D managers. First, for publicly traded companies, innovation is expected/rewarded from growth companies and not from value companies.

The thing that separates the ones that are affected from those that aren’t is whether they’re publicly traded where expectations have been created that earnings, cash flow will be predictable. It’s very hard for them to change and do something entirely new. There are firms that are categorized as growth stocks where analysts and stakeholders are more willing to see them innovate. Even Amazon spent many years being a growth stock without a lot of expectations for predictable earnings. Private companies also have more leeway with their shareholders.

So how do companies get pressured? They get rewarded when they focus on process improvements and efficiency enhancements such as Six Sigma that provide predictable results. These processes actually squeeze out disruptive innovation and only allow companies to focus on incremental innovation.

They focus on mapping processes and predictable, measurable improvement. My research shows that tends to spur more incremental innovation and crowd out radical innovation. The direct effect is that Wall Street tends to react very positively when companies adopt these management practices. They can be wonderful in some parts of companies that need efficiency, stability. But they’re not always wonderful, particularly with technologies that are so new we don’t really know them yet.

Amazing! There is a cause and effect paradox here. Large companies are often blamed for not innovating. Everyone actually expects innovations to come from small nimble firms. But the behavior of large firms is governed by the rewards they get from their boards of directors. These rewards assure that the firms will actually not innovate! This is another reason why financial incentives do not work.
However, only large firms really have the resources and manufacturing capabilities to bring products to market. Knowing this, large corporations should be better served by setting up Xerox PARC-like innovation organizations that do not get hindered by processes. The problem then would be to have effective means of integrating the innovations into the product line. We have discussed that several times in the past.

Nurturing disruptive innovation

First of all, I really loved the ars technical article Is gravity not actually a force? Forcing theory to meet experiments. It has a great explanation of the new (perhaps revolutionary) theory of gravitation by Dutch theoretical physicist Erik Verlinde. I recommend reading the whole article. It has a great explanation of the
theory that made quite a stir last year.

More importantly, it points out how science has been able to take disruptive ideas and get them accepted for hundreds of years:

“How are controversial ideas handled by modern science? A common charge leveled against science (generally by those who are unhappy with its conclusions) is that the only way to get funding or continue your research is by going along with the current theories and not rocking the boat. For those who spend their careers in science, this is laughable—it is those who successfully rock the boat who are the most successful. In this article, we are going to look at a manuscript that purports to overturn hundreds of years of accepted ideas about gravity, and use it as an illustration of how controversial ideas are dealt with in modern physics.”

May be we can learn from science on how to integrate disruptive innovation into new products and over come the not-invented-here rejection plaguing most R&D organizations engaged in open innovation? I think we can. Here are the steps:

Publish the innovative idea (accessed through open innovation) to internal experts. Clearly, internal experts will be circumspect and disinclined to accept the new idea. So, it is critical to provide a compelling argument or test results that back up the actual work.
Invite internal experts to replicate the idea. This is quite common in science as the article points out. This will start getting some buy-in. IP issues will be critical and you will need to ensure that the external idea does not get integrated into your internal R&D without a proper license.
Review results to verify and validate the idea. This again is quite common in science and many people check the new theories on different scientific domains. Similarly, R&D managers need to ensure experts examine the value of the innovation from different perspectives (user experience, manufacturability, etc.). A big advantage of this step would be to reduce risks around integrating the disruptive innovation. This step will also further drive acceptance of the new innovation.
Solicit future involvement from experts and develop a plan to mature the innovation. It is critical that this step is executed very quickly after step 3. A plan and associated metrics will get over the valley of death in product innovation.

Sounds quite intuitive. I hope to try this in the near future. Any thoughts?

Why Hasn’t Innovation Provided a Reliable Alternative to Oil?

The article Out of Fuel: Why Hasn’t Innovation Provided a Reliable Alternative to Oil? in Knowledge@Wharton has some good pointers about innovation management in general:

“Innovation consists of matching a solution to a need,” says Wharton professor of operations and information management Christian Terwiesch. “As it stands right now, the sad reality in the U.S. is there is simply little need for alternative energy from the mass markets. Energy is too cheap. You might look at US$4 a gallon and disagree, but in countries that are moving faster on the alternative energy side, gas is taxed at much higher rates. Cheap traditional energy makes innovation in alternative energy simply less profitable.”

Also, a very interesting graphic showing US government R&D investments over last 50 years.

So, what is the single most important driver of innovation: Funding! Clearly, funding itself is driven by perceived need. In case of energy R&D, all of the funding disappeared once the 70s oil crisis was over.

According to a study done by the Pacific Northwest National Laboratory for the U.S. Department of Energy, the U.S. government spent nearly US$4 trillion on research and development (R&D) from 1961 to 2008. Of that amount, energy technology development received nearly US$172 billion. But the bulk of that spending was done during the oil crises; since the mid-1990s, the study found, energy R&D has accounted for only 1% of all federal investment.

So what are the lessons an R&D manager should be learning from this? First, carefully study the target market before committing to a large investment beyond technology exploration:

One of the challenges facing energy innovators in creating an alternative to oil is that Mother Nature’s version is hard to beat. “Oil is attractive as an energy source,” Gately says. “It is abundant, easy and cheap to produce, store, transport and convert to many usable forms of energy.”
“No single solution is able to replace oil,” agrees A.T. Kearney’s Besland. “One liter of oil gives more energy than any other resource. Oil is denser. It is also easier to transport and to stock … so nothing will be found which can be comparable to oil. It should be a combination, a mix of alternative energy solutions.”

Second, innovation projects that have a very long timeline to maturation are much harder to fund. Be careful about taking on innovation projects that will take ten years or more to get to market – unless of course there is a clear government funding thrust in the area (as you can see in the figure above).

Another issue alternative energy innovators say they face is the intense pressure to quickly prove their work can become commercially viable. Entrepreneurs in ‘clean tech’ say convincing investors to make long-term commitments to fund their work is an uphill battle, though this problem is not unique to their field.

There have been major innovations in the digital technology but there are a couple of key points that make oil different. 1) There has been a very significant investment in maturing digital technologies from the US Government (part of the defense slice); 2) There is no serious alternative to digital technologies that can provide the user experience – clearly not the case in oil; 3) The technology cycle is much shorter (at least now) and self sustaining in digital than in energy.
Final point to remember is the business model that supports the innovation. Many energy innovations have gotten bogged down because the business model just does not make it profitable to invest in R&D:

Besland believes solar and natural gas are alternatives with the best potential for future development. “Gas pockets are discovered continuously,” he says. “Amazingly, it is not developed in the Gulf region because gas resources have been sold on long term export contracts. Biomass energy faces a concurrency issue with food. However research on seaweed and used oil are in development. It would take 10 or 15 years for these to reach maturity.”

Why Failure Breeds Winners

Business Week article Intelligent Growth: Why Failure Breeds Winners has two important lessons for R&D managers consider growth or innovation investments (and R&D planning in general):

(1) Define what failure looks like for growth investments—specify when and why disinvestment should occur. Then stick to the plan.

This is quite intuitive, but I have been consistently surprised at the lack of clearly defined goals/objectives for R&D projects. This lack of discipline always results in goal creep, waste of resources and reduction in R&D team morale.
So, the take home message is to develop a clear plan on how the growth bet (or innovation bet) is going to get delivered in products and tie investments to that plan. Also decides what signals a clear departure from the plan and have the discipline to cancel projects if they do. This plan would help combat the valley of death that frequently leads to innovation project failure. Furthermore, this plan would also help to

(2) Upgrade your growth investment process by shifting analytical resources away from up-front screening toward life-cycle analysis. Create a ‘learning loop’ for management by dedicating staff to mid-cycle and post-completion project evaluations.

There is significant evidence that consistent evaluation of innovation projects can have tremendous benefits to the organization in terms of management learning and market understanding. However, this is difficult to do:

Cycle discipline is intuitive but difficult to recreate in a large, complex corporation. Less than 10% of the companies we examined exhibited this kind of financial savvy for more than a few consecutive years at a time.

But well worth trying because the results are impressive:

Companies that are able to consistently grow sales and improve margin across multiple business cycles realize a 4.4% compound total shareholder return (TSR) advantage relative to industry returns over pure growth leaders, and a 5.4% compound TSR advantage over pure margin leaders.

Why Project Networks Beat Project Teams

MIT Sloan Management Review has a great article on a new concept for R&D execution organization in Why Project Networks Beat Project Teams. The focus is on R&D of complex systems and driving collaboration and knowledge sharing. As frequent readers may recall, this is an area of great interest for me. We have often discussed how increase in complexity of systems under development has been the driving challenge in R&D management. We have also talked about knowledge workers in virtual teams and what drives collaboration and knowledge sharing in large multi-disciplinary teams.

The overall message of the article is straight forward: R&D managers should encourage at least some of the team members to bring information/knowledge from experts in their personal networks into the R&D activity. Involvement of these non-core members (experts) was shown to increase R&D success. Detailed learnings from the article are below:

To research the factors that affect the success of teams working on knowledge-intensive projects, we studied an established companywide recognition program for project teams at a large multinational food company. As part of that study, we surveyed 1,304 members of project teams in the company to identify key characteristics that promote success in knowledge-intensive work. We then compared responses from the project teams regarding how they went about their work with the company’s assessment — through the judging of the team recognition program — on the significance of the projects’ outcome.”

The idea they have come up with is that of Project Networks:

Typically, project networks consist of a core set of team members who bring in noncore contributors (such as other company employees, suppliers, consultants or customers) from their personal networks who can provide knowledge, information and feedback regarding the team’s task. The project network thus takes advantage of both the project team as a whole and the personal networks of the members.

The researchers studied 177 teams with 1,304 members in ONE food company (I have never worked with food companies, but I am sure their development can be quite complex). They found that team success – as measured by the same recognition measures across all teams – improved with the involvement of non-core members. Here is why they think the addition of non-core members is beneficial:

Project networks take advantage of the benefits noted by team-focused researchers — such as the commitment and dedication of members — but can overcome the risks associated with a small group’s limited perspective by crossing team boundaries for project feedback.
Project networks can also take advantage of the benefits associated with members who cross organizational boundaries for new ideas and broadened access to knowledge, yet the team structure provides accountability that can be lacking in informal personal networks.
…
Managers are often not given the luxury of hand-picking exactly the members they would like on a project team; they may have to go with who is available at the time. Encouraging project networks allows managers to look beyond the core project team and to take advantage of what noncore contributors outside of the project team have to offer.
emphasis added

According to the authors, project networks are beneficial in all kinds of situations (innovation, customer service or operational improvement). They only had two innovation teams – one with non-core members and one without. The team with non-core members was able to come up with a fundamentally new product, while the one without just had incremental improvements. The team involved non-core members by:

The Innovation Project A team involved a number of functions — sales, marketing, R&D and process development — and was located across six U.S. states in nine different facilities. Through its project network, the Innovation Project A team acquired relevant food formulation knowledge that customers had about their specific applications for this type of ingredient. In addition, the core members of the project team augmented their own knowledge by accessing food production expertise both from other colleagues in the company and outside vendors. While not core members of the team, these contacts were all part of the project network.

So, how and when should one involve non-core members? The figure from the article (replicated below) provides details. My suggestion is to do it carefully. Only involve non-core members when the project is complex. Even then, clearly define boundaries and ground rules. There is clearly a possibility of proprietary information leakage if the process is not managed carefully.

Hotbeds of Innovation

The Strategy + Business article Hotbeds of Innovation has some useful benchmarking information about how large corporations are accessing innovation from outside. We have talked about Intel and others in the past. Here are some more:

Called “ecosystem investing” by some innovation executives, it refers to the increasingly complex network of suppliers and innovators supporting large companies.
In this model, well-established U.S. companies are creating strategic partnerships with startups and small companies whose technologies and skills can help the large companies expand their own capabilities.

The idea is to gain access to the technology through strategic partnerships and alliances:

The goal of the incumbents is to systematically target emerging technologies and “harvest” ideas without having to take on the risk of acquiring the smaller companies. Sometimes the large company takes an equity stake, and its top executives may sit on the small company’s board or mentor its top management. Alternatively, it may seek to license the small company’s technology or buy its products and distribute them to global markets.

Here are a couple of results. First from J&J:

Ortho-McNeil Inc., a J&J division, invested the modest sum of US$40 million in Metabolex Inc., a privately held biopharmaceutical company based in Hayward, Calif., so the two companies could collaborate on the development of compounds used to treat type 2 diabetes. …
In June 2010, Ortho-McNeil received an exclusive worldwide license to commercialize several Metabolex drugs, including the diabetes compound, for about $330 million. That’s far less than the $1 billion a pharmaceutical company typically spends to develop drugs internally, and far more than Metabolex could have expected to bring in on its own.

Second from Intel:

Intel was able to dramatically increase the clout of its ecosystem investment strategy recently when it teamed up with 24 other venture capital (VC) firms as part of the company’s “Invest in America” alliance, Intel’s commitment to promote U.S. competitiveness by supporting technology development and creating jobs for college graduates. Intel put up a mere $200 million of its own money, but the VC firms pledged to match that investment, for a total of $3.5 billion over several years.

Some best practice info about R&D and innovation

The post Six Myths of Corporate R&D at Corporate Executive Boards has a convenient list of best practices for encouraging innovation as opposed to incremental improvements. I have arranged them in three categories and my comments are in parenthesis:

Encourage learning

Organize R&D functions to encourage learning instead of alignment with corporate strategy (I am not sure both are mutually exclusive.)
Encourage R&D staff to form informal networks inside and outside the corporation. (Good point, but difficult to do.IP Control will need to be a constant focus).

Take more risks with investments

Increase investment on breakthrough ideas as opposed to product improvements (The real answer is a balanced portfolio of investment. The right balance depends on the the type of business and competitive environment).

Be more flexible with early stage opportunities

Be flexible with metrics, such as return on investment, for early stage opportunities (Clearly, it is difficult to estimate the value of breakthrough ideas. However, it is also very difficult to identify which ideas are breakthrough…)
Be flexible with project reviews of early stage opportunities. Focus instead on customer value and related scenarios. Review early stage opportunities as a portfolio and mitigate risks at a portfolio level.
Be flexible with project management and related processes.