Impact of Open Source on Open Innovation

McKinsey Quarterly talks about the impact of IP (particularly Open Source development) in a somewhat confusingly titled article (Managing the business risks of open innovation):

“… after all, who would give away patents to make more money from innovation? But as open-source innovation, “crowd sourcing,” and engaging with open communities become increasingly prevalent, could IP-free zones appear in the competitive landscape of other industries? “

Open Innovation is not the same thing as Open Source. As we have discussed in the past, Open Innovation implementation is quite challenging. A key risk involves sharing product development plans in details to identify and incorporate innovation into a delivered product. This is hard to do while maintaining IP ownership rights. One approach to overcome these constraints is to work in Open Source or Shared IP environment. The McKinsey article calls this Open Competition (do we really need another buzzword?). They have evaluated various industries for the potential of Open Source development by asking three questions:

1.Do specialized firms offer proprietary solutions within certain layers of my industry’s value chain?
2.Do integrated firms seek to cut development costs in my industry by drawing on open technologies to substitute for these proprietary solutions?
3.Are the underlying technologies complex—consisting of so many bits and pieces that a significant number could inadvertently infringe on proprietary IP held by specialized firms?

Their results are summarized in the following graphic:

The overall message is pretty intuitive. However, my key message for R&D managers remains that open innovation is hard to implement. In a few industries (such as software), it may be possible to ease implementation by using open source.

Why Open Innovation is hard to implement

We have often discussed how innovation has become a buzzword with many myths surrounding what drives innovation. I was recently discussing Open Innovation with an R&D executive. He made a pretty significant remark: There are lots of positive articles around open innovation, but there do not seem to be many balanced evaluations of the approach. Fortuitously, Knowledge@Wharton has an interesting note about The ‘Flip Side’ of Open Innovation that addresses some of the concerns.

A lot of people have been writing about open innovation,” says Wharton management professor Felipe Monteiro. A typical example, he adds, is Procter & Gamble’s Connect + Develop strategy, which encourages collaboration with outside organizations as a way to bring new products to market faster and more efficiently.

While the P&G approach “has gained a lot of traction,” Monteiro notes, it also raises questions about whether, and when, companies should be concerned about protecting their own knowledge. Monteiro’s research into this issue has led to a paper titled, “Does Strategic Protection of Knowledge Undermine the Effectiveness of External Knowledge Sourcing?” co-authored with professor Michael Mol from the Warwick Business School, and professor Julian Birkinshaw from the London Business School.

I am going to use the article as backdrop to summarize four key concerns about Open Innovation and why it appears that many companies are not really recouping their open innovation investments (much less earn a return on them). We should all think carefully about these before investing in open innovation:

Valley of Death: A key concern in innovation is getting it transitioned into delivered products. Many companies I have worked with fail pretty frequently at this stage. We have discussed the valley of death extensively. The more disruptive (and hence the most valuable) the innovation, the more difficult it is to get it to market because it disrupts company culture and bureaucracy. When accessing innovation from the outside, this becomes even more difficult because of “Not Invented Here” mentality. Unless one can find an internal technologist or champion, open innovation just withers on the vine. This is very hard to overcome and needs active management involvement.
Trade Secrets Protection: We have often discussed how innovation is not about an aha moment or one brilliant idea. Innovation happens at the interface of multiple disciplines and technologies. (For example, iPhone could be seen as combining a capacitive touch screen with low power processing and an intuitive user interface. Each was available in the market, but the integration generated value). To access innovation from the outside, companies will need to share their problems in enough detail that potential suppliers can describe solutions. However, this description will also be available to all competitors – which defeats the whole purpose.
Evaluation / Management costs: As discussed earlier, managers need to consider many potential issues before deciding on accessing any innovation from the outside. A key issue that is forgotten is the time involved in evaluating innovation ideas. Because of trade secrets related problems described above, most companies use open innovation to access ALL innovation. Broad ideas need to be filtered before they can be sent to the technical teams – a task that requires management involvement. Companies quickly realize that this is VERY expensive. Even when ideas sound interesting, the value is difficult to estimate. Innovation needs to be accessed when needed – we can not just let innovative ideas sit on a shelf and get to them when the need arises. Innovative ideas require maturation and many cospecialized assets to get them to market. This is not cheap to evaluate.
Liability: When suppliers submit their ideas to companies, how should they be protected? Any implied protection exposes the company to potential litigation liability. Disregarding inadvertent public release, consider the possibility of independent discovery. The company may have independently developed ideas similar to those accessed through open innovation. If they decide to use internal ideas, they might still be exposed to IP litigation. Hence, most companies ask suppliers to submit ideas with all rights released! Most people are not willing to do so…

I welcome comments…

Role of Government in Nurturing Innovation (Part II): China’s Awkward Quest for Bullet Train Technology

We recently talked about the role of government in nurturing innovation. The clear evidence was that China would not be in the wind power industry had it not been for government regulation:

But the fact is that none of this would have been remotely possible if China did not regulate the market to allow its own industry to become strong. May be there is a place for regulation – as long as the protection is for a short time, targeted and with significant competition. We know that rivalry and scarcity are drivers of innovation – so as long as money is not given out freely, it might encourage innovation and give national companies a chance to become strong. Countries could consider outsourcing innovation when necessary, not just buy the whole system from a foreign provider. May be the reason why Indian regulation did not work was because they did not have a large number of companies competing for contracts. In fact, they probably regulated the number of companies…

The article China’s Awkward Quest for Bullet Train Technology in Knowledge@Wharton highlights a few more considerations. Here is the overall background:

It took just seven years for China to build the world’s biggest — and purportedly most advanced — bullet train system. That lightning speed and the political capital invested in the showcase program come with more liabilities than acclaim. The collision on July 23 on a high-speed line near Wenzhou may not have derailed Beijing’s ambitions to dominate cutting-edge passenger rail technology, but it has shed light on the program’s shortcomings.

Some problems should have been expected because development of large systems such as wind mills or high speed rail (HSR) is complex and requires time. There is only so much a country can do to accelerate implementation to catch-up with others.

Transportation experts assert that the accident was a consequence of China’s haste. New lines have opened in quick succession, and corners inevitably cut to meet deadlines — the most visible evidence of which being the low-tech, crumbling rail stations dotted across the country that have yet to be upgraded. “China’s high-speed rail program proceeded at breakneck speed, with a far faster roll-out than any other country has attempted, and this was seen as a matter of pride,” says Richard Di Bona, technical director of LLA Consultancy, a transport consulting company based in Hong Kong.
According to Tsung-Chung (T.C.) Kao, a professor at University of Illinois’s Rail Transportation and Engineering Center at Urbana-Champaign, China is facing up to the fact that it failed to spend enough time testing the high-tech system. “They built the HSR system and networks too quickly and there are many bugs … that have to be fixed now,” adds Kao, a former vice president of Taiwan High Speed Rail Corporation, who was part of an 11-year HSR project on that island.

The rush to speed-up innovation caused problems in Chinese wind power industry as well. I still believe that there is a role for government in nurturing innovation. However, the overall scale/type of problems in the high speed rails is a bit different. Here are some lessons from the article:

Unlike wind mills, there were only a couple of companies developing HSR in China. Unlike wind mills, there was only one major customer (Railway Ministry). The lack of customer and supplier diversity actually prevented true competition / rivarlry and and reduced the drive for innovation. The lack of diversity also drove corruption.
HSR became primarily driven by politics and national pride instead of innovation. This is much harder to do when there is a diversity of customers and suppliers.

So in the contract decisions was based on politics, rather than technology, says Ryoji Nakagawa, a professor of international relations at Ritsumeikan University in Kyoto.
National pride reached its apex this spring when a Railway Ministry spokesperson boasted during the unveiling of the Beijing-Shanghai bullet train that the Chinese rail system had surpassed Japan’s renowned Shinkansen
HSR is much more complex compared to wind power and requires significantly larger investment. It is difficult to maintain government nurturing environment for very long-term. Even at break-neck speed, roll out of HSR probably takes a order of magnitude higher resources and time.

“It took 18 years for Japan to develop a bullet train that could run at 300 km/h after the Tokaido Shinkansen opened in 1964,” says Kamiura. “We spent so much time just improving rail track technology to be able to take the speed from 200 km/h to 300 km/h.” Even today, the maximum speeds for most of Japan’s bullet trains are 240 km/h and 270 km/h. The Sanyo line, connecting Osaka to Hakata in Kyushu, raised its maximum speed to 285 km/h in 1997 and to 300 km/h in 2006.
Chinese HSR companies were very closely tied to foreign partners and the project became technology transfer instead of innovation.

The reality, experts say, is that at best China has integrated the technology of its overseas partners, rather than leapfrogging it. The main so-called CRH2 trains rolled out as China’s own were produced under a joint venture between state-owned CSR Qingdao Sifangand Kawasaki Heavy Industries. According to experts, the CRH380A is based on the same technology as the CRH2 and Japanese bullet trains, and on July 23,it was a CRH2 train that slammed into a train developed in a joint venture between Bombardier of Canada and CSR Sifang Locomotive and Rolling Stock Company, known as a CRH1.

Finally, the national pride also led to pressure to file for patent protection (to demonstrate that China was innovating). It is important for R&D managers to remember that Trade Secrets are probably as important as – in not more than – patents in a true IP-based innovation protection strategy.

Seeking such patents is a double-edged sword. Commercial considerations are only part of the reason why China wants such patents. “Again, this is a political statement,” says Kao. “They want to show off their success to the top leaders and bosses,” who want evidence that the government’s huge investment in the bullet train program is paying off.
But the process would force China to reveal details of its technology — even possibly that it made limited changes to the technology transferred by its foreign partners, Nakagawa contends.

Microsoft vs. Apple – a lesson in IP protection

The Computer World blog had an interesting post “Microsoft dominates Apple in patents, so why does it lag in innovation?”

Just-released information shows that Microsoft was granted the third most U.S. patents of all companies in 2010, with Apple way down the list at number 46. Why, then, does Microsoft lag so far behind Apple when it comes to developing innovative products?

Let us get rid of one point of contention – patents DO NOT signify innovation. Patents are one approach to protect inventions. There are many others with different advantages (trade secrets, copyrights, trademarks etc.). Hence, the rest of this post is about what is the best approach to protect inventions or results or R&D in general. I lean towards keeping inventions secret as long as possible and choosing patent ONLY if:

The invention is fundamental and disruptive
The invention is easily visible and can not be kept a secret
The invention has a long life. Hence if and when the patent issues (six years), the patent will be still valuable
If some one were to infringe a patent on the invention, it would be easy to detect said infringement. For example, an algorithm to detect movement in video is not easily detectable as there are many possible alternates.
There are no simple workarounds. Even if the patented approach has value, people might just find an alternate way to achieve the same result (and hence the patent would be worthless).
There is a clear business case for patenting (it can cost tens or hundreds of thousands of dollars depending on coverage)

Here some BAD reasons to file for patents:

Patents to reward inventors: It might be better to give a cash award instead
Patents to protect near-term markets: By the time the patent issues, it might be completely irrelevant
Patents for incremental inventions: May not justify the investments

Here are my my suggestions for IP protection:

Innovate quickly: This what Apple does. If you are moving through technology quickly, there is no need to bother about other people copying some of your ideas (especially with some of the concepts below)
Use trade secrets: If you can keep your invention secret, you have to spend no money on protecting it. It also lasts indefinitely (as long as you can keep it a secret) as opposed to patent that expire.
Build a software-hardware ecosystem: The iPhone-iOS-iTunes market ecosystem protects each invention much better than any patents or individual invention protection could.
Use innovative barriers to entry: Even though Goolge gives away Android source code for free, the Android Market is a great way for Google to control IP. Only “authorized” devices are able to access Android market place. This helps Goolge control the IP AND make money from app sales!

In summary, Patents are not a measure of innovation, they are not a measure of how well a company is performing on R&D and they are not always the best way to protect IP.

Disruptive Innovation and IP

A quick article that elaborates on something that I have observed in many firms:

Though it may be difficult to convince a business to invest millions in pursuit of a speculative disruptive innovation, it is much easier for a small team to gain support in pursuing low-cost intellectual assets in the name of mitigating potential threats.

I have actually seen empirical data that the aggregate investment in these speculative patents far exceeds the net investment in innovation! The author repeats what many managers believe – patents are cheap so use them to protect markets:

A two-pronged approach is proposed that builds on the authors’ experience at Kimberly-Clark Corporation in dealing with disruptive threats and opportunities. The approach calls for generation of intellectual assets, often using small proactive teams

Specifically, the author suggests:

Protect yourself form other’s disruptive innovation by patenting first;
Use patents to create new business.

This approach though popular, is not easy to execute. It takes more than five years for a patent to issue. If one waits for patent issuance to decide which R&D projects to invest in, they will be far behind competitors and never be able to catch up. Millions of patents are issued each year.

It is pretty much impossible to keep up with issued patents, much less figure out who is infringing your patent and prevent them. So patents are a pretty weak approach to speculatively reducing competitive pressures. We sometimes see Motorola suing Apple. But Motorola has 10,000+ patents in cell phones. The cost of obtaining those patents $300M!

Even if one finds infringement, patent assertions are expensive and a pretty inefficient way to drive R&D strategy. In most cases, assertions take years to conclude. So from the time the inventor had an idea to asserting and changing market landscape will take 10-15 years at the minimum. How can one drive R&D strategy with that kind of a lag?

Finally, if the organization really knows which innovations are valuable, they could develop them in the first place. This approach of trying to do work around poor management decision making can lead to nothing but wasted effort.

Take home message from me is exactly the opposite of what the author suggests. Patent ONLY when you believe it is going to help you develop a significant product. Speculative patents should be limited to foundational technologies not individual products.

Strategy for maintaining proprietary information in R&D outsourcing

R&D management journal has laid out an interesting strategy for managing Information leakage in innovation outsourcing:

This paper studies an R&D outsourcing contract between a firm and a contractor, considering the possibility that in the interim stage, the contractor might sell the innovation to a rival firm. Our result points out that due to the competition in the interim stage, the reward needed to prevent leakage will be pushed up to the extent that a profitable leakage-free contract does not exist. This result will also apply to cases considering revenue-sharing schemes and a disclosure punishment for commercial theft.

Take away in this case is that the before the R&D matures and revenue sharing begins, the contractor has an incentive to maximize revenues by “leaking” the information. Rewards and or punishment for leaks need to be higher during the R&D phase and can be moderated at manufacturing stage.

Then, we demonstrate that in a competitive mechanism where the R&D firm hires two contractors together with a relative performance scheme, the disclosure punishment might help and there exists a perfect Bayesian Nash equilibrium where the probability of information leakage is lower and the equilibrium reward is also cheaper than hiring one contractor.

This is very interesting. If we have two contractors than probability of leakage is lower! Sounds counter intuitive on the surface, but clearly there is some logic to it – if rivalry can work in internal R&D teams, it could help with external collaborators as well. May be R&D managers can consider Coloplast’s approach?